The Disadvantages of Delaware Statutory Trust (DST) 1031 Exchange Properties

The Delaware Statutory Trust is a mighty vehicle, but just as with any other legal tool, neither the DST, 1031, or power combo of both is without flaw. You may already be familiar with the benefits of 1031 exchanges for real estate asset protection. You may have seen our article about Delaware Statutory Trust advantages for investors. But today, we’re going to talk about Delaware Statutory Trust pros and cons.

Relationship Between the Delaware Statutory Trust and 1031 Exchanges

For the uninitiated, let’s briefly touch on why these concepts overlap. It isn’t for no reason that investors have spent over $50 million since 2004 on these types of property acquisitions. That's the year IRS recognized the Delaware Statutory Trust as an entity that could participate in “like-kind” or 1031 exchanges.

While some investors see DSTs and 1031 Exchanges as a “one or the other” proposition, others find value in pairing the structures, particularly where long-term investing or capital gains deferment are primary goals. That said, this type of deal structure isn’t without limits, which we’ll spell out in greater detail now.

DST 1031 Limit #1: You Have to Hang on To the Property For Years

Generally, to meet the criteria of the 1031 exchange, investors must hang on to the property for a matter of years. For this reason these real estate assets aren’t as easily liquidated, say, in a financial emergency. They’re great for those playing the long-game, but shorter-term investors may want to consider alternative strategies.

The average 1031 property is held for upwards of five years as a capital gains tax deferment strategy. Learn more about how this method works from our prior educational piece, your go-to guide to controlling capital gains costs.

DST 1031 Limit #2: You Don’t Have Maximum Direct Control Over DST Investments

Investors who are accustomed to the total control of say, a self-directed retirement account or even more traditionally controlled/owned property, may be uncomfortable with the DST with 1031 model. Here’s why.

When Uncle Sam okayed DSTs for participation in 1031 Exchange transactions, they placed direct regulatory limits on beneficial owners of the DSTs. That means you, dear investor. The Taxman breaks it down in the Internal Revenue Code, but allow us to paraphrase and spare you that riveting read. Basically, you aren’t allowed to have “direct operational control”--their words, not ours--or even simple decision-making authority over the properties involved. The object of the law is to keep you from getting your own hands too close to the investment. Many investors are not tolerant to such restrictions and feel suffocated by this limitation even though there are ways to maintain control with the help of your attorney.

DST 1031 Limit #3: New Property Doesn’t Mean New Money

All those funds that similar new property will raise come with a huge catch: you can’t pour any capital back into the DST itself. Even new investors into the property or DST are barred from benefiting financially while the 1031 is in effect.

Sucks, right? Fortunately, this is a problem your competent legal and tax pros should be able to help you address. The right Delaware Statutory Trust Attorney can help you navigate these confusing waters.