Introduction
Delaware Statutory Trusts (DSTs) have become a popular investment vehicle, especially in the realm of real estate. They offer unique benefits such as pass-through taxation and limited liability while allowing investors to diversify their portfolios. DSTs are almost exclusively offered to real estate owners involved in a 1031 exchange.
DST Formation
A DST is created when a sponsor or promoter identifies real estate properties for investment. They establish a trust under Delaware law and contribute the property to it. This trust is divided into beneficial ownership units, which are subsequently offered to investors. The sponsor prepares an offering memorandum detailing the investment opportunity. This document includes essential information such as property details, financial projections, and the terms and conditions of the investment.
Depending on the nature of the offering and the number of investors, the sponsor may be required to file the offering with the U.S. Securities and Exchange Commission (SEC) under Regulation D or other applicable regulations. Investors interested in participating in the DST investment review the offering memorandum and subscribe to purchase units. They provide the necessary funds to the trust.
Once the offering documents are completed, an agreement is executed, outlining the rights and responsibilities of all the parties involved. A responsible party is appointed to oversee the operation of the DST and is responsible for managing the property, distributing income, and ensuring compliance with Delaware law.
Purchasing DST Units
DSTs are only available to accredited investors. An accredited investor is an individual or entity that meets specific financial thresholds, such as having a certain level of income or net worth. Therefore, DST sponsors and managers must work with broker-dealers who have established networks of licensed brokers and financial advisors. These professionals have the necessary expertise to facilitate the purchase of DST units for individual investors.
The broker-dealer may also receive a commission or fee for their services in connecting investors with DST opportunities. Licensed securities brokers play a crucial role in are responsible for conducting a thorough due diligence process to determine if the investment aligns with the investor’s financial goals, risk tolerance, and overall investment strategy. This helps ensure that investors are making informed decisions about whether DSTs are suitable for their portfolios and once this process is complete, the broker can prepare the sales documents.
Once all the required documents have been completed the DST can be purchased. The turnaround time to purchase DST units can be as quick as one day, but it is better to allow for five business days. Timing is critical because of the 180-day period to close a 1031 exchange.
Holding DST Units
Investors hold DST interests by purchasing fractional ownership units in a DST. These units represent a share of the trust’s assets and income. When investors buy DST units, they become fractional owners of the underlying real estate or assets held by the trust much as if they owned shares in a stock or units in a Real Estate Investment Trust (REIT). Investors have passive ownership, meaning they have limited control over the DST’s operations and decisions. The sponsor or manager handles day-to-day management,
Reporting for Taxes
DSTs are typically structured as pass-through entities for tax purposes. This means that income, gains, and losses generated by the trust flow through to individual investors’ tax returns. Investors do not receive Schedule K-1 forms from the DST, instead the DST provides an annual financial performance of the trust and your fractional share of income, deductions, and other tax-related information. This information is used for preparing Schedule E of your Form 1040. In addition to this information, you can add additional expenses such as depreciation deductions associated with the underlying real estate.
Selling DST Units
Investors can list their DST units for sale on specialized marketplaces or through brokers who specialize in DSTs. However, finding a buyer for a specific DST unit may take time. Some DSTs have restrictions on the resale of units, so investors should review the offering documents to understand any limitations. The sale typically involves transferring ownership rights to the buyer, and the DST sponsor or manager may need to approve the transaction.
If an DST owner wants to continue deferring taxes, they may use the proceeds from the sale to invest in another DST or like-kind property through a 1031 exchange. then an investor sells their DST units, they may realize capital gains or losses. These gains or losses are reported on Schedule D of their tax return.
Conclusion
It’s crucial for investors in DSTs to work closely with legal and tax professionals to navigate the complexities of ownership, taxation, and the sale of DST units. Additionally, understanding the specific terms and conditions outlined in the DST’s offering documents is essential for making informed investment decisions.