The full abbreviation of DST is Delaware Statutory Trust Exchange. A DST 1031 allows investors to swap their property with someone else’s property. At the same time, it creates space for deferring any due capital gains taxes.
What is DST 1031?
DSTs are a popular structure for tax-deferred exchanges. A DST is a Delaware statutory trust and offers investors the benefits of an LLC combined with those of a REIT.
DSTs were created in 2007 as part of IRS Section §351 legislation. This allows property owners to exchange their ownership in one property for ownership in a DST.
How Does DST 1031 Works?
The entire process of a DST exchange is very straightforward and simple.
- You sell your property to the trust
- The trust buys a new property with the proceeds from the sale
- You become an owner in the new property, rather than just a tenant
It is important that you work closely with an experienced intermediary who can help you through the process and ensure that everything goes as smoothly as possible.
DST Ownership
A 1031 structure ownership is based on 1031 exchange requirements. As a DST 1031 owner, your property interests remain undivided. So, you can claim a share of the whole corporate office building, shopping center, industrial warehouse, or apartment complex instead of tenant space, only.
This offers investors a great sense of security, especially during times when the economy is uncertain.
DST Tenants
Since you become an owner rather than a tenant in a DST structure, you have more say over who your tenants are. You get to choose businesses that reflect your personal values and fit well into the overall design scheme for your property holdings.
With a DST, you are not required to have any tenants. You can hold the property for speculative purposes and wait until you find an investor willing to pay more than what it was worth before the exchange occurred.
DST Property Types
Property types eligible for a DST include:
- Single-family homes
- Apartments and residential properties
- Commercial/retail property
- Office buildings or industrial warehouses
Any type of real estate can be replaced in a DST. It does not have to be the same as what was sold, but it has to be similar.
If you sell a single-family home and buy another one, it does not qualify as a DST replacement because they are two separate properties. However, if you sell an apartment complex and replace it with another one before the end of your deferment period starts; then that qualifies for DST replacement.
DST Rules
- The total amount of the acquisition cost of the replacement property has to be equal to or higher than that of sold property
- Maximum time limit is 180 days, however, it can get extended for certain reasons. For example; natural disasters may cause an extension of up to 45 days
DST Deferment Periods
There are two deferment periods in a DST:
- The Replacement Period: This is the time frame in which you must identify and complete the replacement of your property.
- The Deferment Period: This is the time that you are allowed to defer any capital gains taxes on the sale of your property.
The Replacement period starts when you sell your old property and ends 180 days later. The Deferment period starts on the day you close on the replacement property and can last up to 180 days.
The DST deferral is automatically granted, assuming all requirements are met. No application or approval from the IRS is needed.
DST Investment Requirements
You can find out whether you are eligible for a DST investment by finding the trust’s sponsoring entity on IRS form 8824. There is also an exclusion limit of $150,000 per property and up to three properties overall.
If your income is low enough, you may be exempt from taxes altogether. More details are available on the IRS website under DST section code Q&A 24-32.
How to get started on DST Investments?
The best way to get started on DST investments is by finding a qualified tax professional. They can help you understand the complex rules and regulations around these types of investments, as well as whether they would be a good fit for your specific needs.
Benefits of a DST Investment
- In terms of investment size, diversification, and timing, DST 1031 is more flexible than a regular 1031 exchange.
- During the 45-day long identification window, the door is open for additional investment.
- Besides capital appreciation potential, there is an opportunity, too, for a current income flow.
- A DST 1031 is structured in such a way so that a buyer can take advantage of the IRS Revenue Procedure.
- Since you are investing in a professionally-managed investment property, it is free of the hassles of direct property management.
- An investor can easily acquire a high-value investment-grade property.
- Subject to all appreciation and tax advantage related to real estate.
- Available for direct cash investors.
- Non-recourse, pre-arranged, fixed-rate, and assumable financing. 0% to 80% leverage with easy approval.
- Easily satisfiable conditions for the 45-day identification period and the 180-day closing and exchange span.
These are some of the major procedures of DST 1031. For more details on the legal, investment planning, and tax you should be consulting a specialist.
DST Expected Returns
DSTs give high returns to their owners. Since the property is not divided into smaller units, you receive more income from those who occupy your space as a tenant. This also makes it easier for individual investors with low capital to purchase large-scale commercial properties that would previously have been out of reach.
In addition, deferred taxes on sale are lower in DSTs, making them more financially viable.
Why Do DST 1031 Exchanges Dominate the Marketplace?
Investors can take advantage of a DST to defer capital gains taxes on the sale of commercial real estate. This reduces their risk and frees up cash that they can invest in other opportunities or businesses.
It’s also much easier for many people to buy into a large-scale property via a DST, as opposed to having several different investors own a piece of it.
DSTs also allow you to choose your tenants and select those that reflect the values important to you. You can also participate in management decisions for your property, so if there is anything about its development or maintenance you want changed, you can do it as an owner rather than just a tenant.
DST Example Scenario
If you have a building worth $700,000 and decide to sell it through DST investment rules of replacement, then your tax liability will depend on several factors.
First, the $700,000 building would be considered your cost basis for the new property. If you sell it for less than this amount, then you will have to pay taxes on the gain that occurred between purchase and sale.
However, if you sell it for more than $700,000, then part of the gain will be tax-deferred. This is because the $700,000 value is considered your cost base for the new property and any amount above this would be seen as a capital gain.
The second factor that comes into play is how long you hold the new property. If you sell it within nine years of acquiring it, then all of the capital gains is treated as taxable income. But if you hold it for longer than this, then part of the sale will be tax-free according to DST rules on replacement
These are just some important pieces of information that can help guide your investment decision process. The best way to get more clarity about DSTs and whether they would work well for your specific needs is to speak with a tax professional.
If you are not interested in handling daily management responsibilities, then, DST 1031 is for you. This process, allows you to diversify interests into multiple ownerships, rather than just relying on one property.
FAQ
What Is DST?
A Delaware Statutory Trust is a distinct legal body that is established as a foundation under Delaware law. The DST owns the property (or properties) in a 1031 exchange, and every participant has “beneficial interests” in the DST. The IRS treats each investor’s ownership in the DST as an equal interest in the DST’s property for tax purposes. In comparison to all other investors, the extent of each investor’s ownership stake in the DST is proportional to the amount they contribute.
What is a 1031 Exchange DST?
Non-recourse financing for DST 1031 exchange properties is often long-term (normally seven to twenty years) and pre-arranged with the lender. For real estate investors who must identify a property within their 45-day identification timeframe, this can considerably decrease the 1031 exchange DST closure risk.
What Are Some DST Properties in a 1031 Exchange?
Multifamily apartment complexes, retail centers, self-storage facilities, and medical offices are among the other types of DST 1031 exchange assets accessible to investors. The renters at these properties are usually on long-term leases.
Is a DST an acceptable 1031 replacement property?
Absolutely. The DST can be used as a qualifying replacement property interest by an individual investor. A properly designed DST will qualify as a direct property investment, according to IRC 1031, as revised by revenue rule 2004-86. A private placement memorandum (PPM), which contains a legal opinion, is used to promote and sell DSTs.
What methods are used to advertise and sell DST interests?
Under the Securities Act of 1933, DSTs are classified as private placements. Despite the fact that these private arrangements are issued as securities, they are excluded from registering with the Securities and Exchange Commission (SEC) if they meet the requirements of the Securities Act of 1933. A FINRA licensed Broker-Dealer and their registered agents are typically used to sell an ownership stake in a DST. Most DSTs involve compensation that is paid by the DST Sponsor and mentioned in the PPM to the Registered Representative.
What are the requirements for purchasing a DST?
According to the SEC, the term “accredited investor” is “designed to embrace those people whose financial expertise and capacity to withstand the risk of loss of investment or ability to fend for oneself render the Securities Act’s registration procedure unnecessary.” The term “accredited investor” as defined under Rule 501 to encompass a variety of people and organizations. An accredited investor is often characterized by their income or net worth.
DSTs Invest In What Kinds Of Replacement Properties?
While the properties in which a DST invests are at the discretion of the DST sponsor, DST sponsors are often national institutional sponsors with a diverse portfolio of available properties that are diverse in terms of kind, location, and value. This makes it an excellent choice for a 1031 exchange. Due to the modest minimum investment level, investing in a DST allows you to pick from a list of substitute properties.
How long are DSTs held?
DSTs are usually held anywhere from three to ten years. If investors wish to sell their DST property, they should hold it for a minimum of two years. Prepayment penalties on DST loans usually become bearable after year three. DSTs with outstanding debt are not permitted to refinance, hence a 10-year fixed-rate commercial debt has a maximum hold term of 10 years.
Is it possible for me to sell my DSTs at any time?
There is a system in place if you want to sell your DST stake. Yet, unless market circumstances allow it, it is not assured that you will be able to sell the DST investment or recover your full investment back.
Are DST returns guaranteed?
DST ownership is essentially direct investment real estate ownership. As a result, no refunds are guaranteed. Because of the length of the lease and the fact that the leases are corporate guaranteed, certain products, such as net lease offers, emphasis the consistency of prospective revenue. DST returns, on the other hand, are never totally assured.
What if an Investor Passes Away?
When an investor passes before the DST liquidates or is sold, their investments in the DST will be inherited on a stepped-up basis by an heir from the investor’s property. This implies that the level of the replacement property will be determined by the legitimate price at the time of the investors’ passing. Furthermore, the investor’s heirs or beneficiaries will keep receiving the income until the DST is liquidated, even if the investor dies.
The heirs have the option of utilizing their portion of the selling revenues for a 1031 exchange or cash out once the DST is sold. This is why, if you want to postpone paying capital gains taxes on valued assets, the Delaware Statutory Trust is a wonderful instrument for wealth management.