Since the year 2000, Delaware statutory trusts have increasingly been used as a form of tax deferral, asset protection, and balance sheet advantages in real estate, securitization, mezzanine financing, real estate investment trusts (REITs), and mutual funds.
What is Delaware Statutory Trust (DST)
Delaware statutory trusts are formed as private governing agreements under which either property is held, managed, administered, invested and/or operated; or business or professional activities for profit are carried on by one or more trustees for the benefit of the trustor entitled to a beneficial interest in the trust property. Delaware Statutory Trusts are an alternative for 1031 exchange investors seeking replacement properties, offering the potential for monthly income and diversification without any on-going landlord duties.
Though Delaware Statutory Trusts (DST) are not new, current tax laws have made them a preferred investment vehicle for passive 1031 exchange investors and direct (non-1031) investors alike. DSTs are derived from Delaware Statutory law as a separate legal entity, created as a trust, which qualifies under Section 1031 as a tax-deferred exchange.
Formation Requirements
The formation of a Delaware statutory trust is relatively simple and inexpensive, when compared to that of the more complex filings of other entity types. To form a statutory trust, a private trust agreement must be developed by all involved parties to ensure that individual interests are protected. The private trust agreement need not be shown to any official of the State. Once the agreement is completed, a Certificate of Trust can be obtained from the Delaware Division of Corporations and completed. The signatures of the trustees involved are then required, followed by submission of the forms to the Division of Corporations, along with a one-time $500 processing fee. If the statutory trust is, or will become, a registered investment company, it must maintain a registered agent and a registered office within the State of Delaware. If no desire for the statutory trust to be an investment company exists, the only remaining requirement is that it must have at least one trustee who resides in, or has a principal place of business within the State of Delaware.
How DST Works
The real estate sponsor firm, which also serves as the master tenant, simply acquires the property under the DST umbrella and opens the trust for potential investors to purchase a beneficial interest. The investors may either deposit their 1031 exchange proceeds into the DST or the investor may purchase an interest in the DST directly.
The DST property ownership structure allows the smaller investor to own a fractional interest in large, institutional quality and professionally managed commercial property along with other investors, not as limited partners, but as individual owners within a Trust. Each owner receives their percentage share of the cash flow income, tax benefits, and appreciation, if any, of the entire property. DSTs provide the investor the potential for annual appreciation and depreciation (tax shelter), and most have minimum investments as low as $100,000, allowing some investors the benefit of diversification into several properties.
Disadvantages of DST
· 1031 DST Properties Are Illiquid. DSTs are long-term investments, with expected investment periods typically between five (5) and ten (10) years. There is no public market where an investor can sell their ownership interests in a DST.
· 1031 DST Investors Have No Control. When the IRS approved the DST structure for exchanges, it stipulated that the 1031 investors could not have any operational control or decision-making authority of the underlying properties.
· A 1031 DST Cannot Raise New Capital. Again, per IRS requirements, once the DST offering is closed, there can be no future contributions to the DST by either current or new investors. Major capital items like a replacing a roof or a parking lot can easily consume several years of profits.