A DST, or Delaware Statutory Trust, is a financial investment that can provide individuals with undivided fractional ownership of commercial real estate properties, potential tax-advantaged income, and the ability to complete 1031 exchanges for entry and exit. That's a lot of potential in one investment option, and as a result, these instruments are complex. Like all investments, DSTs have risks.
Despite the Delaware reference in the name, there is no requirement for the property or the investors to be in that state, although Delaware laws form the basis of the trust structure. Every investor in a DST is a beneficiary, and there is theoretically an unlimited number allowed, although typically fewer than 500. The IRS considers the fractional beneficiary interest of each investor to be direct ownership, which means that the participation qualifies as replacement property for a 1031 exchange.
What Are the Requirements for Beneficiaries?
Beneficiaries of the DST are the investors, and each one must hold the status of an accredited investor to participate legally. An accredited investor is allowed to invest in securities that aren't registered with the SEC. This category includes hedge funds, private equities, some crowdfunding opportunities, and DSTs. To be considered accredited, you need at least one of the following:
- Personal income of $200,000 with reasonable assurance of a similar level in the current year. For married persons, the joint income level required is $300,000.
- Net worth (single or joint) of over $1 million, excluding a primary residence.
- Holding professional investment credentials such as Series 7, 65, or 82.
- Being a “knowledgeable” employee of a private investment fund.
However, these qualifications do not automatically confer accredited status on an investor—there is no test or certificate to show you have achieved it. The company (or trust) you want to invest with is responsible for making its own determination as to your eligibility. The DST sponsor may request that a prospective investor complete a qualifying form and supply supporting documents to demonstrate the income or other indicators of eligibility. The SEC demands that the DST sponsor objectively verify the status of each investor.
DSTs are structured by the sponsor, which creates the investment plan, acquires the target properties, and often identifies and contracts with a master tenant, depending on the asset type. In addition, the sponsor determines the number of investors, the capital needed, the holding period, and other management and governance decisions.
How Does a Beneficiary Dispose of the Investment?
As mentioned, DSTs are sophisticated financial instruments. They are potentially considered appropriate for investors who are comfortable with passive investments and do not expect to need or want to exit the investment before the anticipated disposition of the assets. While an early exit may be feasible in some circumstances, it may not be.
DST investors do not have control over decisions made by the sponsors, and indeed, the sponsors have limited ability to make significant changes once the trust is in place in order to preserve the tax advantages of the investment. For example, once the offering closes, the sponsor can't seek or accept additional capital. That means that if a property needs significant repairs, for example, current cash flow could be diverted to that purpose, impacting potential profits. Similarly, the trust management can't renegotiate leases or loans. If they sell assets, they can't reinvest the proceeds.