What's a DST?
DSTs EXPLAINED
A Delaware Statutory Trust (DST) is a tax-advantaged real estate investment vehicle that qualifies for 1031 exchanges, making it an attractive option for investors seeking to defer capital gains taxes. Unlike LLC or LP interests, DSTs allow for seamless 1031 exchanges both into and out of the trust. In a DST, the trust itself holds legal title to high-quality, institutional-grade properties, while you, as an investor, become a beneficiary. This entitles you to your share of the equity, along with the benefits of income distributions, tax shelter, and potential property appreciation. A major advantage of DSTs is their fully passive nature—professional managers handle all aspects of the property, so you can reap the rewards without the demands of active management.
HISTORY AND MARKET GROWTH OF DSTs
DSTs Popular Post-2004 IRS Ruling
DSTs have been around since 1988, when the Delaware Statutory Trust Act was enacted. They gained significant popularity in real estate investment following a 2004 IRS ruling that allowed DSTs to qualify as 1031-eligible property.
DST Market Raises $20 Billion+ in 5 Years
Over the past five years, the DST industry has seen significant growth in equity raised through 1031 exchanges. The DST market has raised over $20 billion in the last five years, highlighting its growing popularity among investors looking for passive 1031 replacement real estate.
STRUCTURE AND MANAGEMENT OF DSTs
Formation and Structure
A DST is formed as a trust under Delaware law, specifically under the Delaware Statutory Trust Act. It is similar to other types of trusts but offers more flexibility and benefits in terms of asset management and investment.
Ownership and Investment
Investors purchase beneficial interests in the DST, which represents a fractional ownership in the real estate held by the trust. The trust itself holds title to the property, and investors are considered beneficial owners.
Management
The trust is managed by a sponsor who makes all decisions regarding the management and operation of the property. Investors have limited control over the property but benefit from the professional management provided by the sponsor.
Investment Benefits and Characteristics
Tax Advantages
There are three key tax advantages for DST investors that span the entire investment lifecycle. Initially, most DST investors benefit from deferring capital gains taxes upfront by entering through a 1031 exchange, where their DST interest qualifies as ‘like-kind’ property. During the hold period, the income generated by the DST is often significantly sheltered, reducing or even eliminating the tax burden on distributions. Finally, at the end of the hold period, DSTs provide the flexibility to either enter another 1031 exchange or, in some cases, opt for a 721 exchange, further deferring the tax bill. Many investors strategically defer taxes until they receive a basis step-up, at which point the deferred tax liability may disappear altogether. In short, the strategy is simple: defer, defer, defer… and ultimately, eliminate.
Income Distribution
DSTs typically generate income from the operation of the property, which is distributed to investors as automatic ACH monthly distributions.
Investment Characteristics
DSTs offer a way to invest in large, high-quality commercial properties that might otherwise be inaccessible to individual investors. They provide passive income, tax shelters, and potential appreciation, but investors should be aware of the illiquid nature of these investments.
DST Mechanics
DSTs are reported pro-rata based on investment equity
If properly structured, a DST is classified as a grantor trust for federal income tax purposes. This means that when an investor purchases a beneficial interest in the trust, they acquire an undivided ownership interest in the underlying assets.
In practical terms, investors own their proportionate share of the assets by purchasing a corresponding equity interest in the DST. For example, an investor who contributes $1 million to a DST raising $100 million would hold a 1% beneficial interest in both the trust and the underlying real estate assets. This ownership includes a 1% share of all rental income, expenses, debt payments, and potential future appreciation.
Tax reporting for a DST is done on Schedule E, similar to other investment properties, using the property operating information provided by the Sponsor. The Sponsor typically provides this information along with Form 1099 and, if applicable, Form 1098 (for interest on loans) before April 15th each year.
WHO'S INVOLVED WITH DSTs
1031 Investors
- Collect distributions (typically auto-ACH ~15th each month)
- Forward tax statements (1098/1099s to CPA each year)
1031/DST Brokers
- 1031 Investment Strategies is an example
- Available inventory of 1031 offerings
- Get paid a commission similar to a real estate agent
- 1031 Investment Strategies is your middleman and coordinate with Sponsors on your behalf
1031/DST Sponsors
- Find and purchase institutional property
- Manage the asset (historically this is often for 4-7 years)
- Work with their investors (pay distributions, send tax statements & updates, etc)
- There are ~50 Sponsors currently raising equity. The top 10 have raised ~75% of the $25B in equity over the last 5 years
- Sell the asset (either thru a 3rd party or rolled into an UpREIT)
