Over the years, we’ve worked through just about every variation of with our investors. Each one is different from the last. The use of trusts in 1031 exchanges is no different. They can present some unique issues, especially when you’re talking about the use of Delaware statutory trusts (DST).
DSTs can offer significant advantages to investors when compared with other alternatives, but they may not always be the best choice. The desirability of DSTs is very much a case-by-case matter. If you’re considering pursuing this kind of arrangement, it’s recommended that you work with an expert with plenty of experience dealing with the complexities of 1031 exchanges to ensure your transaction goes smoothly.
What Are Delaware Statutory Trusts?
Before we explore the potential advantages of DSTs, let’s first review what these entities are. DSTs are trusts established under the laws of the state of Delaware and may confer an undivided interest in a common piece of real property to more than 35 investors. DSTs are similar to tenancy-in-common (TIC) arrangements in certain respects, but there are some differences.
Like TICs, DSTs confer undivided fractional interests to multiple investors, and the investors share in the overall financial performance of the underlying investment property. However, unlike TICs, with DSTs:
- The trust is not subject to the 35 investor limit imposed by Revenue Procedure 2002-22.
- Investors do not receive a title deed.
- Investors do not form single-member LLCs.
- Investors do not have voting rights.
There are other differences as well, but these are some of the most prominent.
Advantages of Using Delaware Statutory Trusts in 1031 Exchanges
Because of their unique structure, DSTs have the potential to offer several significant benefits to investors in a 1031 exchange. When you decide to use a DST as a replacement property, you are essentially acquiring a beneficial interest in a very large piece of real estate. Most DSTs have many investors enabling them to financially support huge commercial investment properties.
DSTs are managed independently by property sponsors who act as the “trustees” of the DSTs. This gives investors the benefit of having property management and procedural simplicity.
With DSTs, you will also have no need to establish a single-member LLC given that the trust itself insulates you from liability.
Disadvantages of Using Delaware Statutory Trusts in 1031 Exchanges
Though it’s clear that DSTs can bring benefits to you and other investors in certain cases, it’s also true that DSTs can carry drawbacks as well. For one, given that DSTs come with a pre-arranged property manager?the trustee?they are not suited to investors who wish to play a big role in the property management process. Many investors spend considerable time and effort managing their investment properties and intend to play a role in how their replacement property is managed. The nature of DSTs makes this impractical.
DSTs are also not the best option for you if you’re only planning to park your replacement property for a couple years before moving on to something else. DSTs require a lengthy time commitment. They are designed for investors who want to commit between two to 10 years of their beneficial interest to the DST. If this timeframe seems unworkable for you, then it may be best to consider other arrangements. It’s also worth noting that if the property is not sold after 10 years, then it must revert to an LLC, which may make it difficult for DST investors to carry out their own 1031 exchanges in the future.
Delaware statutory trusts are complicated entities, so it’s generally very helpful to receive counsel from qualified professionals before considering this as a potential replacement property. At CWS Capital Partners, we have a long background with helping clients navigate the complexities of 1031 exchanges. Read our white paper to learn more about these transactions.
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