DSTs are passive investment vehicles that allow investors to purchase fractional shares of institutional-grade commercial properties. These assets can include industrial buildings, self-storage facilities, freestanding multi-story medical office buildings, net-leased retail centers, multi-family apartment complexes, and similar types of commercial properties.
There are many aspects of the Delaware Statutory Trust ownership structure that makes it a unique investment vehicle, including:
Accredited Investor
Fractional ownership
1031 exchange eligibility
Real property ownership
Accredited Investor. DST 1031 Properties are only available to Accredited Investors. In order to qualify, the following must apply:
Single: If Single, you must have an annual income exceeding $200,000 per year for the past 2 years or have a minimum net worth of $1 million not including primary residence.
Joint: If Joint, you and your spouse must have a combined income exceeding $300,00 per year for the past 2 years or have a minimum combined net worth of $1 million not including primary residence.
Entity: Specific entities or organizations owned by accredited investors can qualify. Such entities need to have total assets in excess of $5 million.
Fractional Ownership. Accredited investors -- also called beneficiaries -- who purchase fractional interests in the DST until the Sponsor’s original investment is displaced. Investors own a percentage of the property according to their investment amount, but no single owner can claim sole ownership rights of the asset(s) regardless of their investment amount. Beneficiaries receive regular monthly or quarterly distributions, when applicable, but they don’t have any authority or voice regarding the asset’s operation or performance. DST investors basically assume completely passive roles within the trust.
1031 Exchange Eligibility and Real Property Ownership. Despite the co-ownership structure, the IRS views DST interests as real property ownership. Investors receive tax treatment as individual owners within the trust. It’s an important distinction since it provides 1031 exchange eligibility for DST interests. Investors who divest real assets can reinvest the exact amount of proceeds needed to satisfy 1031 exchange replacement property requirements and defer capital gains taxes on their relinquished assets. Lastly, despite being treated as real property owners, investors are shielded from asset liabilities through the DST ownership structure.
DSTs also are subject to additional rules and limitations established by the IRS. These include a Sponsor’s inability to:
Receive new funds once the original offering closes
Renegotiate leases or enter into new lease agreements
Reinvest proceeds from the assets or retain any cash generated from its performance
Make major repairs on assets
The prepackaged nature of DST investments often makes them an attractive option for investors seeking to quickly complete 1031 exchanges. They also can be used to diversify real estate holdings since investors can purchase multiple equity interests in DST offerings of different asset classes and geographical locations. The ownership structure, meanwhile, can be beneficial to investors since Sponsors assume all the heavy lifting. The ownership structure also provides investor protection against bankruptcy and liens from creditors since beneficiaries don’t assume any personal liabilities within the trust.
Rules for Identifying a DST
To complete a successful 1031 Exchange, exchangers must identify replacement property(ies) within 45 calendar days after their relinquished property transfer. Exchangers can do this by following one of three ID rules:
Three Property Rule – The exchanger can identify one, two or three properties without regard to value of the property(ies) identified;
200% Rule – The exchanger can identify as many properties as they would like, so long as the aggregate value does not exceed 200% of the value of the relinquished property they are selling. For example: If the exchanger sells a property for $1M, they can identify properties with an aggregate value of $2M or less;
95% Rule – The exchanger can identify as many properties as they would like for as much value, as long as they acquire 95% of the value of the identified property. For example: the exchanger identifies 10 properties, each valued at $100K. If the exchanger only closes on 9 of them, the entire exchange fails.
Each property held by the DST should be counted for the identification rules. Accordingly, if XYZ DST only holds one Walmart store in Chandler, Arizona, the exchanger can consider this as one property. However if a DST holds four apartment complexes in four different cities, each property should be counted and they will need to use the 200% or 95% rule.
EXAMPLE OF A PROPER DST IDENTIFICATION:
Commercial Lease II DST
Percentage Ownership: 2.4555%
Total Equity & Debt: $1,775,000
1. 508 Dunbar Dr., Los Angeles, CA 90038
Self-Storage III DST
Percentage Ownership: 8.562%
Total Equity & Debt: $855,000
2. 77885 Sky View Way, Houston, TX 77069
3. 2455 Harbor Circle, St. Louis, MS 45056
As you can see the exchanger has identified 3 replacement properties. Each address counts as its own identification therefore the exchanger has satisfied the 3 property rule. In addition, when identifying DST’s as replacement property it is highly encouraged to include the Name of the DST, Percentage Ownership, and Total Investment (equity & debt).