Delaware Statutory Trust in lieu of 1031 exchange

15 Replies

Hi everyone. I'm new to the BP community and am absolutely loving the exchange of information I've seen on the forums and blog posts. I've been consuming both podcasts and loving them as well.

Here's my question: I have a single family investment property that has appreciated significantly and I am looking to sell the property to obtain a better ROI. A sale will result in a significant capital gains tax bill, which I would prefer to defer. While a 1031 exchange in theory is a wonderful option to defer the taxes, I've come to realize that being a landlord is not for me. I would be open to purchase another residential investment property provided I find a property manager to handle the day to day operations. So a 1031 is not completely off the table. Another challenge is that the 1031 timing rules make it incredibly challenging to find a replacement property or properties to invest in with a desirable cap rate in my city, so I would be interested in an out of state investment, which would put even greater pressure on locating a replacement property considering I haven't even started to consider which states I could potentially invest in.

While doing a bit of Googling, I came across the Delaware Statutory Trust (DST) that is a completely passive investment in real estate that allows for the deferral of capital gains on the sale of the investment property.

I've read the pros and cons that the DST providers list on their websites, but I would love to hear from individuals with real life experience who have opted to use a DST in lieu of a 1031 exchange and from those who did the analysis and decided a DST was not right for them. Basically I'm looking for real life pros and cons I should be considering.

Thanks so much! 

@Evanthia V. , DST's and their older sibling the TICs and their 800lb gorilla cousin the NNN lease can all be great products to move into if you like real estate investing but don't want to be a land lord. Or if you have substantial gain and want to move into a more passive role without paying the tax on that gain.

However, these all work in conjunction with the 1031 exchange not in lieu of.  

To make the move into a DST or TIC you sell your old property and actually perform a 1031 exchange to purchase one of these fractional interests and complete the 1031. However, the 1031 is usually much easier to perform as these type of products are more readily available and sell out less quickly. But the good ones also move fast so you do still have to be focused. It's just not as hard as purchasing fixed stand alone assets.

We have clients that go all three ways. In most cases the corporate tenants are actually the same in all but only the ownership structure of the individual building is different. A Walgreens or Fresenius Dialysis for example could be set up as a DST, a TIC, or a NNN single owner.

In very general terms the DST is going to require that you be an accredited investor. It will have debt requirements, and it will have higher fees and lower net returns due to administrative load. These will in usually be sold by broker dealers of securities.

The TICs have a rep for requiring unanimity of consent on certain issues which is true.  But the number of investors is limited and some folks like the smaller ownership groups.  Returns generally higher as management is streamlined.  And a lot of them carry no debt load.  These can be sold by either securities dealers or realtors.

NNN properties are nothing more than the above two without any other investors. You own the whole thing. These are generally in the purview of the commercial realtor.

The keys are the quality of lease, the guarantee of the lease, and the strength of the tenant.

@Evanthia V. Dave Foster hit the nail on the head with those explanations. I work in the DST space. Like anything, pros and cons.

One negative to DSTs is the heavy load/cost going in. My firm is a Registered Investment Adviser and we are not legally allowed to charge commissions period. So those large loads going in are waived with our firm.

But I would be thinking about how truly hands off you want to be. Assuming you’re an Accredited Investor, DSTs done with good planning work great for someone that wants to be totally hands off and collect mailbox money.

I would also be thinking about future returns irregardless of whether you exchange to DST, TIC deals, or stand alone deals. The market is pretty frothy for sure.

I would be thinking about risk in were I place my money. Dave was spot on - lease terms, length, and tenant quality...plus I’d add on expenses and property type...are going to drive DSTs.

@Evanthia V. Forgot to mention - irregardless of what you exchange to, you can list a DST or two as backups on an exchange which I have a lot of clients do. Makes a lot of sense if you’re in a market where it’s tough to find replacement property or close on time etc. Food for thought.

Thanks David and Joshua for the clarification.

As I see it the DST PROS are:

- completely passive investment while remaining in real estate (mailbox checks)

- avoiding the capital gains tax

CONS

- illiquidity

- no control

- potential to have investment tied up for 5 to 10 years

- lower ROI than a traditional 1031 exchange into another investment property outside of a trust

I would be willing to purchase another property, more likely a multi-family, and hire a property manager to handle the day to day. But I will need to move quickly to identify the property within the 45 day window from the date of closing on the property I am selling. Just about all of the multi-families in my city are either rent stabilized or rent controlled and the buildings are selling at ridiculously low cap rates as people seem to be buying as an appreciation play instead of a cash flow play. I am more interested in cash flow with the potential appreciation being a bonus.

I appreciate the input.

Is there anyone out there that has actually opted into or out of a DST that can share their experience? Many thanks!

You've got it. You'll generally going to get more return doing deals directly on your own. Its like anything - more risk, more potential reward. You definitely want to be more conservative in a DST in my opinion due to the fact that you're hands off and the DST Sponsor is making the call on liquidating the property.

One more thing to add to the "pros" side of the ledger is that you can defer not only capital gains taxes, but also the depreciation recapture. That's not unique to DSTs, of course, as it's a feature of any 1031X, but if you're crunching numbers to figure out which direction to go, that little extra plus might help. I would also like to hear if anyone has any experience with actually investing in DSTs, and which ones are reputable?

There are some more potential cons with a DST. First, the rules prevent them from doing certain things like making capital calls if there is an unexpected problem. So the good ones will hold reserves in advance which can be a cash drag if they are not used. If they don't have reserves or the reserves are not enough, then the investment could be in trouble if there's a problem. To get around this, some (but not all) of the DSTs have a springing option where they have the option to convert into a normal LLC. This gives them the flexibility to do things that normally are prohibited by the rules, but if they are forced to exercise it then you lose the tax-deferred advantage when they sell.

Also, what was not mentioned by anyone above is what I call TIC 2.0.. Unlike the old TICs which required unanimous consent, and all the individual investors to share in the liability of the debt, these new structures have an LLC which the investors belong to, and then a TIC underneath it. This gets rid of all those other issues. The other advantage over a DST is that the fees are usually much, much cheaper, and they are not restricted on what they can do like raising more capital, etc.

Also, another option for you is to purchase a residential property through a marketplace such as ownAmerica or Roofstock which allows you to purchase in a more favorable market then you happen to live in for cash flow. Then you can 1031 exchange into that and it would be all managed by someone else.

The other option that just came into the scene is the Opportunity Zones under the new tax plan. I’m just learning about them because I invest in a neighborhood in Kansas City that is now in one. You can roll just your gains into an opportunity zone fund. If you search opportunity zones on this site you’ll find more info.

@Doris Ng

No, I just invested it in my own LLC to do my own deal. But after guidance came out I don't think my LLC qualifies because I didn't use cap gain money for it. I was doing the deal anyway, so doesn't really matter to me!

Some of the cons mentioned regarding DSTs are not 100% correct. Generally, DSTs are illiquid, but you can sell your ownership to other investors. Your DST sponser would have to facilitate the transaction though. If you got in a good project, there should be no issue selling your ownership for a positive return.

Lower performance vs. traditional RE investments is also not 100% accurate. Remember, it's all about the sponser and their track record. Most DST sponsers aim for an IRR in the mid-high teens. I would say the average RE investor is NOT getting this type of return on their own without having to put in a lot of sweat equity.

@Bob B. Bob I think what happens is when operator liqiudates the DST, the goal is to shoot for the mid teens as an overall payout of the life of the DST. Of course it is not guaranteed. I am new to dst's but a colleague of mine had one sell after only 3 years. His monthly checks were at about 5.5% the overall return after the sale was just over 18%. I wouldn't count on it though.