DST Benefits and Risks

Learn more about the potential benefits and potential risks of Delaware Statutory Trust Investments.

Purchasing 1031 exchange replacement properties in the form of Delaware Statutory Trust (DST) is a popular option for many investors.

There are a number of potential benefits of exchanging into a 1031 Exchange DST. As a 1031 investor, reviewing the potential benefits and potential risks prior detail prior to investing.

For more information and experienced guidance about 1031 Exchange DST investments, contact the professionals at Corcapa 1031 Advisors.

Learn more about Delaware Statutory Trust (DST)

Potential Advantages of Delaware Statutory Trusts

DST’s are attractive for the following reasons:

Diversification

Investors can select multiple DST properties as part of their 1031 exchange allowing diversification of asset classes, cities and level of needed non-recourse debt.

Lower Minimum Investments

DSTs have lower minimum investments often as low as $100,000 of equity. If you require a lower investment amount than the stated minimum, let your Corcapa 1031 Exchange representative know and we may be able to negotiate a reduction in certain circumstances.

No Individual Annual LLC Filings

Potentially lower fees in DST investments than TIC investments. The DST investment does not require a special purpose LLC entity that needed to be annually maintained and paid for.

Potentially Greater Cash Flow

The most common reasons that investors select DSTs are Potentially Greater Cash Flow than they are receiving currently. Most DSTs have a projected cash flow based on the anticipated rental income less expenses. This could be a higher net cash flow than you are currently receiving on your rental property. As with all real estate, the income cannot be guaranteed because the rental income and expenses can increase or decrease unexpectedly.

Non-Recourse Loans

Virtually all the loans within the DSTs that are approved by DAI Securities, LLC are non-recourse which means the investor does not personally guarantee them.

Financing Access

Easier access to financing for investors needing debt on their replacement property and potentially quicker closings.

Larger Property Access

Access to Institutional Grade properties which are typically larger commercial properties that previously required significant capital to purchase.

Potential Risks of Delaware Statutory Trusts

As with any investment, 1031 exchanges and DST’s have certain risks:

No Assurance

General real estate risks and market also apply to DSTs. There can be no assurance that a property will perform as projected and DSTs are subject to economic volatility, tenants not paying their rent timely, and other traditional risks of owning, selling, and operating real estate.

Investors Do Not Hold Title

DST investors do not hold title to the investor but rather own beneficial interests in the trust and the sponsor controls the selling and managing of the property. The DST owners have limited control over the investment and are reliant on the sponsor.

Illiquidity

A DST interest is an illiquid investment and there is no current active secondary market for selling your interest.

Additional Expenses

Fees and Expenses of each offering should be carefully evaluated. Multiple owner offerings typically have additional expenses to owning real estate on your own and these fees should be weighed against specific capital gains tax liability. All investors are encouraged to have their tax and legal counsel advise them on taxes including any federal and state capital gains taxes, depreciation recapture and the recent 3.8% Medicare tax, which could be applicable.

Tax Status

DSTs are structured according the Revenue Ruling 2004-86. Corcapa and DAI Securities, LLC typically work with sponsors and properties that have “should” level tax opinions regarding 1031 exchange tax compliance but its possible the IRS would rule unfavorably on a DST offering and this could result in back and immediate tax liability.

Potential for Property Value Loss

All real estate investments have the potential to lose value during the life the investment.

Potential for Foreclosure

All financed real estate investments have the potential for foreclosure.

Reduction or Elimination of Monthly Cash Flow Distributions

Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is a potential for suspension of cash flow distributions.

Seven Deadly Sins

The enabling IRS revenue ruling which forms the basis for a DST transaction in a Section 1031 exchange program has prohibitions on the powers of the trustee, which are built into the Trust Agreement and have become known as the “seven deadly sins”. They are:

  • Once the offering is closed, there can be no future contributions to the DST by either current or new beneficiaries.
  • The Trustee cannot renegotiate the terms of the existing loans nor can it borrow any new funds from any party unless a loan default exists as a result of a tenant bankruptcy or insolvency.
  • The Trustee cannot reinvest the proceeds from the sale of its real estate.
  • The Trustee is limited to making capital expenditures with respect to the property to those for (a) normal repair and maintenance, (b) minor non-structural capital improvements and (c) those required by law.
  • Any reserves or cash held between distribution dates can only be invested in short term debt obligations.
  • All cash, other than necessary reserves, must be distributed on a current basis, and
  • The Trustee cannot enter into new leases or renegotiate the current leases, unless there is a tenant bankruptcy or insolvency.
DST Restrictions

Because of the DST restrictions the best types of real estate for a DST are Master Lease transactions where the Master Tenant takes on all the operating responsibilities or a Triple Net/Net Long Term Lease with a financially stable tenant. Additionally, it is prudent with DSTs to have sufficient upfront and ongoing reserves, as well as a plan for a sale prior to the maturity of a loan.

Springing LLC

Additionally, there is a “Springing LLC” provision option which could convert the trust to a limited liability company to solve property issues. However, this could prevent future 1031 ability and adversely affect the value of their investment.

One additional approach to give the Lender comfort is to place an operative provision in the Trust Agreement that if the trustee determines that the DST is in danger of losing the Mortgaged Property due to tax related restrictions on the trustee’s ability to act, (the seven deadly sins), it can convert the DST into a limited liability company (the “Springing LLC”) with a Lender-approved operating agreement. Delaware law permits the conversion by what is basically a simple election and which does not constitute a transfer under Delaware law. The “Springing LLC” will contain the same SPE and bankruptcy remoteness provisions as the DST (for the Lender’s benefit), but it will not contain the prohibitions against the raising of additional funds, the raising of new financing or renegotiation or the terms of the existing financing or entering into new leases. In addition, it will provide that the trustee (or Sponsor) will become the manager of the LLC.

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DST Benefits and Risks

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