Delaware Statutory Trusts (DST) and Investors

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Thank you for visiting this forum. If you are hear you have heard about the Delaware Statutory Trust (DST) and are looking for more information on what they are, what they are good for, how do they work in protecting me and my assets, and its scalability etc. Or you are a CA resident investor looking for asset protection and have come across the DST in bloggs / some forums on BP or other investors who have a DST System established already.

The point of this forum is to be a direct point of references for information, education, and professional resources on the DST, particularly for California investors looking for asset protection options. I have not found a specific forum yet addressing this topic, but some specific posts directed to individual needs. @Scott Smith @leslie  @leslie pappas and @bill exeter have been very useful professionals for those posts. So I hope you bring your knowledge to this forum for those investors who are looking for and or considering a DST.

This is not for legal advise but education. So do not take what me or anybody else says as legal or professional advise. But opinion and a starting point for you to use. Always go and hire an Attorney and CPA.

My next post on the DST will be about what it is, who can benefit from it etc. I plan to get that up later tonight. Look forward to hearing from you, your questions, comments, experiences, knowledge. The great thing about BP is it vast community to learn from and with.

So what is the DST? The DST is a statutory business trust. If you are a California investor, then this is something to listen up and research up on. The DST (Delaware Statutory Trust Act 12 Del.C. section 3801 (1988) allows for a series structure like a Series LLC. Think of a parent-child relationship. The DST is your parent, and it can have as many children as it wants. Each child is a ‘series'. The benefit of this for CA investors is the ability to avoid the Franchise Tax imposed upon LLC's. The DST is one company with one filing, and one tax return. Each child is treated as if it were its own company for liability purposes.

It is structurally analogous to other business entitles where management and control is separated from equitable ownership. The DST is similar to a corporation in that the beneficial owners of the trust have no greater liability than that of a stockholder in a corporation. A DST is similar to a LP and LLC in that it leaves it to the parties to the governing instrument to craft many of its governing provisions, and prevents creditors from only collecting what the beneficial owner is entitle to according to the germs of the governing instrument. This has to be done in its creating documents so you must have an experienced attorney do this for you.

Think of the DST like a trust. It will have a Grantor, a Trustee, and a beneficiary. The Trust will have the REI Asset Holding DST - Child Series as the Grantor, the client will serve as the Trustee, and the beneficiary will be the series. The property is held in the name of the holding trust and is controlled by the company while the client (you) receives disbursements from the title holding trust.

To keep the DST from being pierced you MUST maintain compliance or the structure will collapse and all series would then be treated as one. You must have a valid trust agreement, be filed with the state of Delaware, maintain a Delaware Registered Agent, and abide by certain rules of the IRS, and maintain accurate accounting of money to each series. Hence, have an attorney experience with DST set this up for you. This is not a DIY project. And talk to your CPA. 

DST's are commonly used for:

asset-backed securities transactions – also consult a SEC Attorney

collateralized mortgage obligations

real estate investments

leveraged leasing transactions

mutual funds and investment companies

liquidating trusts

1031 exchanges

trust preferred securities transactions

private investment funds

This is obviously just the tip of he iceberg. 

@CJ Lee thanks fro writing. A lot would depend on your over all assets, what you invest in beyond notes, and what you are protecting. The DST is a Business Trust. Some benefits of using a DST is you get Holdover on capital gains, 1031 exchange eligible, save on franchise taxes over an LLC and you can compartmentalize each note. Compartmentalization is big in the sense say you get sued for wrongful foreclosure or a dodd frank violation, etc, then only that note is exposed thanks to the series nature of the DST. How many notes do you plan to hold at a time etc.

Being in CA, CA does recognize business trusts like the DST. A business trust doing business in CA is treated as a corporation under CA Law so would get the benefit of the lower corporate tax rate. And since the DST is not a statutory entity in CA you are exempt from paying the annual $800 franchise tax (See CA Franchise Tax Board). Depending on how many shareholders will depend on if you are taxed like a individual or a partnership. But you can elect to be taxed like a corporation. Talk to your CPA and lawyer. Using a Business Trust in conjunction with your SDIRA allows for more control and saves you on taxes.

Lots of other options exist also.

Some prefer investing in notes via a Self Directed 401K and invest in notes passively. This can be set up through the DST or LLC or SCorp. Talk to @Scott Smith   who sets up DST Business Trusts and SDIRA’s, and/or @Brian Eastman who sets up SDIRA 401ks etc. 

Since you are specifically asking about notes and your business entity, @dan van horn has a great set up for note investors. You should read his book if you have not already. He does not get into the overall business structure but how to invest in notes and how he started his note investing and service business. He has also answered this question of business systems for note investors in the past via a Delaware LLC since it is a strong corporate and banking law state, and the LLC structure as a note investor gives you the personal pass through you want. Other states beyond Delaware also offer strong laws like TX and NV.

Whatever business entity you decide to use, you want to own the notes in your business entity, then have the notes serviced by a licensed servicer. Just depends on what your current assets are, total assets, what you are investing in, future plans, and must talk with your CPA and Attorney to find the best marriage. Business Trusts definitely have their place. Especially for states like CA. 

Thanks @Brian Bradley ! Yes, many investors have questions about the DST. The biggest one I get is: Why is the DST particularly useful for investors based or doing business in California?

Short answer: The DST is viewed as an estate planning tool and therefore not subject to the California state franchise tax that an LLC would pay.

Great info here! Yes, always make use of your friendly qualified professionals when forming a DST or any other structure for the purpose of protecting real estate assets. I cannot stress how often I hear about investors forming entities then not using them appropriately or failing to maintain compliance. This is less likely to happen when you form your structures under the supervision of a qualified professional. Thanks for the shout out and educational effort.

@Scott Smith @Brian Bradley

Thank you for posting this information. I have some questions about the Series LLC's that live under the DST.

The way I'm interpreting how this work, and please correct me if I'm mistaken, is that at the top of the pyramid is the DST, with branches coming down connecting it to each LLC that is controlled by the DST. Parent-child, like you said.

When filing the LLC, let's say I live in CA and create the LLC in NV for tax purposes, and the LLC will be the child to the DST.

Who is the legal owner of that LLC? Is it the DST, which is a Delaware-based entity?

Ultimately my questions is how do I, as a CA-based investor, avoid the $800 annual FTB fee for each LLC within the DST?

If I wanted to get really complicated, can a single LLC be partially owned by two independent DST's? Like if I wanted to set up a DST for my children and one for myself, but each would have part ownership in an LLC that owns real property. Is that possible?

@Abi Wegman  The DST is your parent, and it can have as many children as it wants. The DST is not a Series LLC. The DST is like an estate plan, that allows you to series out assets. The way you avoid the CA $800 franchise taxis because the DST is an ESTATE PLANNING TOOL, hence not subject to CA State Franchise Tax. The DST itself is the parent company, the tip of the umbrella. And then underneath it, it can have as many child DST's as it wants. Each of those DST children are called Series. The DST is technically one company with one filing and one tax return. Each child series has its own letter for example REI Asset Holding DST - Series A

The key piece is the Trust. You have a grantor, a trustee, and a beneficiary. Th Trust will have REI Asset Holding DST - Series A as the Grantor, you the client will serve as the Trustee, and the beneficiary is the DST Child Series. The property is held in the name of the title holding trust, and is controlled by the company while you received the disbursements. 

Connect with me on BP and once we are connected I can then send you a detailed attachment of the DST how it works with visual aids.

@Abi Wegman It sounds like you might be a bit confused. The DST doesn't own any type of LLC. It does, however, allow for Series beneath it.

@Brian Bradley gave you a great breakdown above. Here is a visual depiction of the DST's structure. 


So yes, the DST has Series but it is not the same thing as (nor would it typically own) a Series LLC. Using the DST in the first place is how you avoid the franchise tax. Cali continues to treat DSTs as estate planing tools. However, investors like you can and do frequently use them for both managing real estate investments and defending them from lawsuits. You'd simply use the DST in place of an out-of-state LLC/Series LLC.

@Scott Smith

You're right, I think I have been misunderstanding how the structure works. So every entity within the asset hierarchy is a DST.

What benefit does an LLC offer that a DST does not? From an accounting & tax perspective, does the income earned by a DST or any of the Series pass through to the ultimate owner in the same way it does with an LLC, or does the Trust itself retain the earnings and pay out to the owners via distributions?

@Brian Bradley

I appreciate all of the helpful replies in here. This is immensely helpful and will help me, and I'm sure countless others, help guide the eventual conversations with estate planners/attorneys.

Living in CA a DST sounds almost too good to be true as a way to provide asset protection while avoiding LLC franchise tax – potentially saving $thousands per year! However, from what I understand there seem to be two major drawbacks;

Firstly, DSTs do not provide asset protection through Charging Orders as LLCs do. This seems like a major drawback, as a Charging Order prevents a successful plaintiff from forcing the sale of an asset to pay the debt, instead limiting the plaintiff to only being able to place a lien. In the absence of a Charging Order are assets held by DSTs protected in a similar way, or can a successful plaintiff potentially force their sale?

Secondly, IRS Ruling 2004-86 has placed many restrictions on how an asset held by a DST can be managed, making it almost impossible to manage a typical investment property and certainly preventing BRRRR. These include; capital expenditure limited to normal repair and maintenance only; no additional equity contributions after the DST is formed; cannot renegotiate terms of existing loans or borrow new funds; cannot enter into new lease agreements or renegotiate current leases. Having read the relevant tax code is not clear to me whether this only applies to DSTs that are taxed as a trust, as opposed to ones which have elected to be taxed as a business entity (we seems to be possible). However, other sources say this ruling applies to all DST structures, with there even being a way to convert a DST to a 'Springing LLC' if the trustees find these restrictions are not working for them.

I am neither an attorney nor CPA and would love to have clarification on these 2 points - and hopefully be proved wrong! The CA LLC franchise tax savings would be great to have!

@James Haig Streeter good questions, and even lawyers and CPA's can get confused so don't worry that you are not one. Generally. You have to look at estate/trust law since the DST is a trust (business trust) and is legally treated as a trust. You are thinking of the DST as a Business Entity like a LLC or Series LLC, LP etc. It is an estate plan that has a benefits of a Series LLC by allowing placing assets into series. Think of Spendthrift provisions in estate plan trusts that prevent creditors from getting the assets in living trusts. A DST may be sued and may sue, just like a trust, and property held in the DST like a trust is subject to attachment or execution. Beneficiaries of DST do not enter into an agency agreement with DST or its trustee, nor does the DST trustee act as an agent. The suite must be attached to a specific property in the trust. So thats your asset protection issue and charging order issue.

A Delaware statutory trust is similar to a limited partnership and a limited liability company in that the Act leaves it to the parties to the governing instrument to craft many of the provisions regarding the governance of the trust. Unless the governing instrument provides to the contrary, the trustee, when acting in such capacity, is not personally liable to third parties for any act, omission or obligation of the trust. This is estate law we are talking about. 

A statutory trust is further similar to a limited partnership and a limited liability company in that the Act prohibits creditors of the beneficial owners from obtaining possession of, or otherwise exercising legal or equitable remedies with respect to, the property of the trust. As a result, a beneficial owner’s creditor may receive only what the beneficial owner is entitled to according to the terms of the governing instrument. The trustee’s liability to the Delaware statutory trust and to the beneficial owners is triggered if the trustee does not meet the requisite standard of care set forth in the governing instrument (subject to good faith and fair dealing limitations.) The Delaware Act expressly provides that “[n]o creditor of the beneficial owner shall have any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the statutory trust.” 12 Del. C. §3805(b).

To your other question it goes to if you are recognizing gains or losses under 1031 exchange and pertains exclusively to 1031 exchanges. Beneficiary’s under Rev. Rule 92-105 retain the right to manage an control the trust property. What you can do will determine a lot on the TRUST AGREEMENT that you have drafted and what powers are listed in the agreement and if the trustee has power to vary and other additional powers under the trust agreement. So the details of power come down to what you are given in the trust agreement that you have drafted. A taxpayer may exchange real property for an interest in the Delaware statutory trust described above without recognition of gain or loss under § 1031, if the other requirements of § 1031 are satisfied.

Also, @James Haig Streeter To the extent that the DST would be vulnerable, we add the language that any person obtaining an interest by way of a lawsuit receives no control rights and is not entitled to distributions as a beneficiary.

For the BRRR strategy specifically that you mentioned, you either run the risk of the extent of any upgrades being impermissible as improvements, or rehab it while the property is held in your personal name first, and then transfer it in after done.

@Brian Bradley thanks for the detailed reply.  To summarize, just to confirm I am understanding correctly;

Firstly, a DST uses estate plan trust Spendthrift provisions to provide comparable asset protection as an LLC with Charging Order protection. Therefore it sounds like a DST provides just a good asset protection as an LLC - which is great news!

Question: Has the use of a DST for real estate asset protection been tested in the courts? Has the use of series (child) DSTs also been tested in the courts, in terms of whether they can hold up against being collapsed into a single DST (assuming the trust is being managed correctly), or is this type of entity structure still too new to know for sure?

Secondly, from your second reply it sounds like the IRS Ruling 2004-86 does apply in that properties cannot be improved/rehabbed when within a DST but repairs and maintenance are ok. The workaround would be to complete a rehab in my our name - and therefore unprotected - then transfer to the trust once complete. This is not such good news for someone doing BRRRR like myself but guess its ok if you invest in turnkeys.

Question: If the first 'R' of 'BRRRR' cannot happen within a DST, what about the other 'R's' of Rent, Refinance, Repeat? Can you enter into new lease agreements or renegotiate current leases?; do a cash-out refinance of an existing loan?; and then purchase new property, all within the DST?

@James Haig Streeter no I said think about it like a spendthrift clause in relations to creditors. To relate it to something that you might already now about. The rest of your questions start crossing the line of legal advise which I don't provide on public forums and to non-clients with no attorney client privilege. So for specific detailed questions you need to talk to an attorney and also be protected with attorney client privilege. So feel free to call for an appointment, or talk to an attorney for specific detail like you are asking. 

This post has been removed.

Thanks everyone who has contributed to this informative educational forum on DSTs. And to those who follow but not post, or have chosen to talk privately. 

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@James Haig Streeter this question was also asked by a person in a private IM so is a good additional topic to add. Relating to the 'restrictions' you mentioned, we have gone through it mostly, but to reiterate, you need to realize the IRS is not trying to prohibit you from investing. With the BRRRR Strategy and Renovating, rents, restructuring leases and lease agreements, the restrictions are not in place to make it so u cannot manage your property and cash flow. The government and IRS do not want you to go bankrupt or insolvent. So you can manage your properties held in the DST to avoid those situations (avoid insolvency and bankruptcy.) 

Because most property problems are the product of tenant cash flow difficulties that signal insolvency or possible bankruptcy, most property problems can be dealt with within the DST structure to avoid this. So it really is a non-issue since to avoid insolvency you will be able to renegotiate or enter into new financing, lease agreements, raise rents, etc. The devil is in the details of the rulings and codes. Hence why you should contact a lawyer to talk about it and NOT just take what you find on blogs and google at face value. I read and see the same 7 restriction blogs that pop up, but non of them actually talk about the details of the rulings and exceptions and how you stay in compliance. SO it leads to misconceptions. That is what experienced lawyers and law firms and CPAs are for. To keep you in compliance and to conduct your annual compliance and transactions for you, so that you do not cause a problem. 

NOW, for those situations hypothetical situations where a DST cannot address those problems because it does not avoid insolvency etc, the DST would simply convert to an LLC. The LLC Agreement, which is typically attached to the DST's trust agreement. The conversion does not result in a change of control of the property; rather, it is merely a change in the form of ownership. Once lenders understand the conversion process, including the fact that the borrower essentially remains unchanged other than its entity form, they are typically able to get comfortable with the DST structure. (So you may need to educate the lender a little on the DST and conversion processes if ever needed.)

You are not unprotected during the 'renovation' stage since you will be doing all contracting with venders and GC, handymen etc through your separate operating company LLC that is set up to operate / run the business, and collect rents etc. Even how you write your lease agreements will be revised to name the operating LLC and the specific series asset as the landlord, not you or the DST. The DST is simply the holding company, that is it. The DST does not do business with anybody. So if that property is sued by a contractor or vendor ect, it is the operating company LLC that is conducting business with them and that will be named, not the DST. That is the protection during the renovation and an added layer.

@Brian Bradley , if there is an operating company LLC that is doing business in California (under the very broad definition of doing business per the FTB), then it seems to me that we're just back at step one with a California LLC owing the high California franchise taxes and fees. In your hypothetical structuring, is there a DST and an LLC or just the DST (with an LLC organized/formed if needed)? If the first, what is the advantage of this structure in terms of California franchise taxes and fees?

@Bryan Zuetel one it’s not a hypothetical structure. Two, are you even familiar with Delaware statutory trusts? IF not scroll Up where We have talked about them. But you use the DST only as a holding company for the properties and to Series out the assets into separate series. You Then have a side operating business that just operates the business of the company with no assets in it. The DST now allowed you to place your assets into individual child Series like a series LLC for protection but since it’s a trust you avoid the $800 franchise tax per Series that CA charges. You utaliz both!
@Bryan Zuetel I was at gas station typing so did not get to finish sorry. But the bits and bolts of distinguishing if you are going to be taxed and treated as an estate plan trust or a business is the IRS compliance guilines. If you fall out then you will be deemed a business and yes each series taxed. If maintain compliance then no, you are an estate plan and not. The compliance requires a trustee, not the client who is registered in Delaware, a grantor and a beneficiary. The trustee (form or attorney) cannot manage the trust but only act to keep assets safe and protected. The grantor still maintains power to invest etc and must direct the trustee what actions to take. So that is the line of compliance. If crosses your now a business structure and taxed. So it’s a little more detailed and evolved then just setting up a LLC. But if the goal in CA is to protect your assets, Series out individual assets into their ien series for liability, and avoid franchise tax of each series - then this is how and all the clients need to do is work with their attorney / trustee to always maintain compliance.

@Brian Bradley , first I suggest that you don't take snippy shots ("are you even familiar with ...") at people asking probing questions and challenging your theories and underlying assumptions on a platform that is built for mutual learning. To answer your question, yes, I am familiar with Delaware Statutory Trusts to answer your question. Second, the suggestion that this was a hypothetical structuring was more for your benefit in that I'm sure you're not offering specific, direct legal advice on this forum. Third, your comment above that "The way you avoid the CA $800 franchise taxis because the DST is an ESTATE PLANNING TOOL, hence not subject to CA State Franchise Tax" appears to be incomplete when your later comment suggests a "separate operating company LLC that is set up to operate / run the business, and collect rents etc."

Now, the "separate operating company LLC that is set up to operate / run the business, and collect rents etc." would still be required to pay the California FTB all of the standard franchise fees and taxes, right?

@Bryan Zuetel you seem very sensitive. You got your reply. Not snippy or anything. I had to know what you have read or not to be able to say anything. You seem very easily aggitstrd by probing questions. Anyways enjoy the reply. And when you crunch the numbers one time fees are cheeper then annual fees and if you Hebe to create a seperste LLC every time for a property and pay and pay annual maintenance fees you don’t cash flow. When you initially write to me with snippy remarks descised as probing questions “hypothetical” etc you will get short answers back. So next time initially write with respect or don’t bother. Your questions show you don’t know the DST since of you did as a lawyer your questions would not be based on compliance issues since you would know that already. Just saying. You are welcome for the info. If you want an education package and CLE recommendations on DSTs and Series LLCs feel free to IM me and I’ll gladly send them to you. However, don’t ever initiate snippy comments on me and then not expect a curt reply back. I don’t know you or your personality and from the way you initially write to me we don’t need to.
@Bryan Zuetel but I’m honest. Feel free to reach out. I have lots of packets and legsl opinions and briefs to share if your interested. Just leave the passive aggressive comments somewhere else. It’s no place for it and Is not probing. If your writing not for education but to argue then it’s not education based and not for this forum also. Just ask questions like all the other respectful participants.

Is a DST owning REIs in CA subject to the $800 per year Franchise Tax applicable to LLCs and other incorporated entities?

NO.

As discussed some above, a DST is treated as a trust, rather than an incorporated entity like an LLC, for tax purposes, and is therefore not subject to the Franchise TAX of CA. A common confusion is thinking of the DST as a corporation, but is really an estate plan, that just functions like an entity. With the added benefit of creating series Structures thus separating your assets for protection, that otherwise in CA yo would be paying an $800 franchise tax on each child series. The franchise tax bypass is allowed because of its treatment as a Trust for Federal Tax purposes. But only if you maintain the compliance to be classified as a trust. IRS Section 301.7701-4(a). This section of the IRS states that "trust" refers to an arrangement created either by will or declaration whereby trustees take title of real property for the "purpose of protecting and conserving it for the beneficiaries." This means that the DST will be recognized as a trust if created for the purposes of protecting and conserving the trust property (your assets.)

The devils are in the details of DST to maintain compliance. The DST as stated above is composed of a grantor, the trustee (us the attorney and firm), and the beneficiary (You the client). Whether an entity is taxed as a trust or as a business is determined by whether the trustee (attorney / firm) powers are limited to the conservation and protection of trust assets. If not, then you are no longer classified as a trust and will be a corporation subject to taxes. The trustee shall have no managerial powers whatsoever but only act on the beneficiareis direction.

@Brian Bradley This is all very interesting to me, thanks for getting this thread started! I have a question in regards to estate planning.... was planning on moving my properties into a trust. Can this same DST be used for this same purpose (so 2-for-1 deal?!)

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