As we’ve seen, a Delaware Statutory Trust is an entity used to hold title to investment real estate. A Limited Liability Company (LLC) can also hold title to real estate; however, a DST 1031 Property will qualify as “like kind” exchange replacement property for a 1031 exchange. “Like-kind property” generally means both the original and replacement properties must be of “the same nature or character, even if they differ in grade or quality.” In terms of real estate investing, you can exchange almost any type of property, as long as it’s not personal property. What Is A Delaware Statutory Trust? A Delaware Statutory Trust (DST) is a vehicle for passive real estate ownership. “Passive” means that you (the investor) are removed from the day in, day out headaches of property management such as dealing with tenants, collecting rents, maintaining the property, etc. The DST an also diversify equity to reduce your risk exposure in the event of a lawsuit. This, a Delaware Statutory Trust in California gives you both anonymity and lawsuit protection. A Series structure makes it infinitely scalable at no additional costs, no matter how many assets you acquire. Incorporating new real estate investments into the structure is quick and easy. Each individual investor possesses his or her own share of the DST property. Any potential income, tax benefits and appreciation are part of this share. How Does A Delaware Statutory Trust Work? Delaware statutory trusts, derived from Delaware statutory law, are a separate legal entity qualifying under Section 1031 as a tax-deferred exchange. DSTs are considered a preferred investment vehicle for passive 1031 Exchange investors (more on these in a minute) and direct (non-1031) investors. The real estate sponsor acquires a property under the DST umbrella and opens up the trust for investors to purchase a beneficial interest. Most DST investments are assets that your average real estate investors could not otherwise afford. However, by pooling their assets, DST investors may benefit from a professionally managed, potentially institutional quality property. These investors can deposit their 1031 Exchange proceeds into the DST or purchase an interest in the DST directly. What Is A DST 1031? In 2004, the IRS (via Revenue Ruling 2004-86) specified how to structure a DST to qualify as replacement property for 1031 Exchanges. This allowed the DST to own 100 percent of the fee simple interest in the underlying real estate, with up to 100 investors to participate as beneficial owners of the property. If you sell a property to invest in a DST, you can defer the capital gains tax through a 1031 exchange. You have 45 days to identify replacement property or else you are going to be slapped with the capital gains tax and/or the Depreciation Recapture Tax, along with state taxes and sometimes a NIIT (Medicare surtax). If you’re an accredited investor, you can defer taxes by investing your money into another property within a specific timeframe. This property replacement is called a 1031 exchange. Note: The Security and Exchange Commission (SEC) defines an accredited investor as an individual with a net worth of at least $1 million (excluding the equity in your home) or net income the last two years of $200,000 ($300,000 if joint income with spouse) and with a reasonable expectation of equal or greater earnings in the current calendar year. Thanks to IRC section 1031, investors can postpone paying taxes by reinvesting proceeds in similar property as part of a qualifying like-kind exchange. What Is A DST Exchange? A “DST Exchange” is the same as the tax strategy outlined above. The term “1031 Exchange” is defined under section 1031 of the IRS Code. To put it simply, this strategy allows an investor to “defer” paying capital gains taxes on an investment property when it is sold, as long another “like-kind property” is purchased with the profit gained by the sale of the first property. DST Offerings/1031 Exchange Properties As mentioned, DST offerings might include high-value commercial real estate that the private investor isn’t typically able to afford. The property could be a 500-unit apartment building, a 200,000 square-foot office property, or a shopping center. Other types of DST 1031 exchange properties include self-storage buildings or medical facilities. These properties typically have long-term lease contracts with the tenants. Most DSTs are set up by real estate syndicators or private investment corporations. Even though the beneficiary of a Delaware Statutory Trust has no management responsibilities, some due diligence on the tenants and the particular property is required. The trustee and the management company selected are also important Financing a DST Property The financing used on DST 1031 properties is typically non-recourse to the investor, meaning the lender’s only remedy in the case of a default is the subject property itself. The lender is not able to pursue the investor’s other assets beyond the subject property. So, in the case of a major tenant bankruptcy, marketwide recession or depression, you (the investor) could lose your entire principal investment amount, but your other assets would be protected from the lender. Internal Revenue Code Section 1031 defines an investor’s exchange requirements of taking on “equal or greater debt.” However, in order to mitigate the risk of using financing when purchasing properties, some DST 1031 properties are offered all-cash, without financing. You can find 1031 exchange DST portfolios with minimum investment requirements in your price range. Can You 1031 Out Of A DST? Yes, you can 1031 exchange out of a DST. Two scenarios for this to occur would include: Scenario One: When the DST property itself goes “full cycle” (meaning the property is sold on behalf of investors), you can exchange out. Once the DST sponsor has sold the asset (per the DST business plan) you and any other individual investor will enjoy the same options you had when you first exchanged into the DST. This means you can exchange into any other type of like property, which you would then own and manage. At this point you could exchange into more DSTs or simply pay taxes. Scenario Two: When an individual investor wants to sell out of their DST position before the DST property itself goes full cycle. This scenario is a bit more tricky. DSTs are considered illiquid investments; There is no public market where an investor can sell their ownership interests in a DST. That’s why you should only purchase a DST via a 1031 exchange if you can hold the investment for 5-10 years or more. There may be secondary markets available if you want to sell early, but all the same rules apply as though you were selling a traditional investment property.