Passive Real Estate Investing With A Delaware Statutory Trust
Real estate investors today have options that have not always been available. For example, in 2002, Delaware passed the Delaware Statutory Trust Act, which was groundbreaking.
Revenue Ruling 2004-86 soon followed and allowed for DSTs to qualify as “Replacement Property” for the tried and true 1031 Exchange (part of our tax code since the 1920s).
One of the primary strategies for creating wealth in real estate has always been to buy properties, build equity, and then sell and move on to larger properties, in many cases using leverage to expand the size and scope of one’s real estate holdings.
1031 Tax-Deferred Exchanges have been investors’ saving grace and have allowed all capital gains to be deferred as investors move on to bigger properties. Thus, real estate is one of the greatest wealth creation tools known to humanity. It is estimated that over 70% of all millionaires in the United States credit real estate as their number one wealth creation source.
As time goes on, we all age, sometimes we reach a place in life where we no longer want to be a landlord, and here’s where DSTs can get very interesting.
Tax Advantages
DSTs can mean simply that real estate investing now has new tax advantages that could be a massive win for someone ready to sell but still wants to save/defer capital gains.
Here’s where an investor no longer wanted to deal with the headaches and hassles that often come along with income-producing real estate but can’t stand the thought of writing that big check to the IRS for capital gains … the proverbial “rock and a hard spot.”
Today investors can now sell their property and defer all of their capital gains using a 1031 exchange AND use a passively owned DST for their replacement property. In doing so, all capital gains can be deferred, assuming the investor works with a Qualified Intermediary and follows all of the IRS rules and guidelines.
More on that later.
Example
Instead of going out and finding another apartment complex or hotel to manage, an investor can now select from fractionalized institutional-grade real estate offerings and effectively “outsource” all of the management, reporting, maintenance, midnight phone calls, hassles, and headaches that landlords often lament. DSTs are for when an investor is ready to pass the control along to someone else but still wants the tax-favored income that comes along with owning income-producing real estate.
DSTs are pass-through entities, and fractional owners can participate in depreciation and amortization. This often means that investors can shelter much of their monthly DST income from taxation, in the same way they would be were they an owner/manager.
Many DST properties are capitalized with $100,000,000 or more. The offerings are syndicated and institutional. Properties are often medical buildings, Class A multi-family apartment buildings, hotels, senior living facilities, student housing, storage portfolios, retail, and industrial warehouse buildings.
Nationally known tenants are typically companies like Walgreens, Hilton, and Amazon.
Often, many investors might feel better with a large and stable company like Amazon guaranteeing a lease rather than the tenants who last skipped out on rent, leaving them high and dry. But unfortunately, these higher-grade properties are typically out of reach for smaller real estate investors.
DSTs and all other real estate investing come with risk, and investors should do their homework, perform due diligence and read the Private Placement Memorandum (PPM) before investing any capital.
DST offerings are typically illiquid and would not be considered suitable for a large portion of someone’s wealth. In addition, because DSTs are regulated and are “securities,” you must purchase them from a Registered Investment Advisor and/or a Broker-Dealer Representative who holds a proper securities license, Series 7 or Series 65.
Who can invest in a DST?
An Accredited Investor is an Individual with a net worth in excess of $1,000,000, excluding his or her home, OR an individual with an income over $200,000 over the last two years. If married the combined income required is $300,000. The income is required to be “reasonably expected” going forward.
Other Accredited Investors Under Rule 501
I would stress again the importance of working with a qualified CPA and Qualified Intermediary BEFORE you sell your investment real estate. Working with the Qualified Intermediary (QI) is required, and working alongside the CPA is advised.
Unfortunately, many CPAs in the marketplace are not informed and/or educated on how these real estate transactions work. You can find referrals for QI’s and qualified CPAs on our website. You can also speak with an advisor and receive counsel on whether a DST is or isn’t a good idea for you.
What if I am not accredited but still want to sell and invest in passive real estate?
The DST accredited qualification requirements are hard and fast, but other options exist for real estate investors. For example, if you are not accredited, you can still sell your real estate.
You can still do a 1031 Exchange, defer your capital gains tax and invest in a property that you manage, or you could sell your real estate and pay any applicable capital gains and then invest in something passive like a Real Estate Investment Trust (REIT).
