Capital gains: Delaware Statutory Trusts
Delaware Statutory Trusts as 1031 replacement property
A Delaware Statutory Trust lets several investors own fractional interests in professionally managed real estate, and the IRS treats those interests as real property for a 1031 exchange. It removes the landlord work. It also removes your control, and it is very hard to sell early.
The structure
Owning a share of a building without owning the deed
A Delaware Statutory Trust is a trust formed under Delaware law that holds title to one or more properties. A sponsor organises it, arranges the financing, and sells beneficial interests to investors. A trustee then runs it within narrow limits for as long as the trust holds the property.
Each investor owns a beneficial interest, not a deed. That matters because a 1031 exchange has to end in real property, and a beneficial interest in a trust would not normally qualify.
Revenue Ruling 2004-86 is what bridges that gap. It treats a properly structured DST as an investment trust, and a beneficial interest in it as a direct interest in the real estate for Section 1031 purposes. The price of that treatment is a trustee whose hands are largely tied, which is where the seven limits below come from.
Revenue Ruling 2004-86
The seven limits on what the trustee can do
Step outside any of these and the trust risks being treated as a business entity, which would mean investors no longer hold real property for exchange purposes. Every DST offering is built around them.
| Limit | What it means in practice |
|---|---|
| No new money | Once the offering closes, neither current nor new investors can contribute more capital to the trust. |
| No new borrowing | The trustee cannot take on new debt or renegotiate the terms of existing loans. |
| No reinvesting | Proceeds from selling the trust's real estate cannot be reinvested in other property. |
| Repairs, not projects | Capital spending is limited to normal repair and maintenance, minor non-structural improvements, and work required by law. |
| Short-term cash only | Cash held between distributions can only sit in short-term debt obligations. |
| Distribute the cash | All cash other than necessary reserves has to be distributed to investors on a current basis. |
| No new leases | The trustee cannot enter new leases or renegotiate existing ones, except where a tenant is in bankruptcy or insolvent. |
The trade-off
What you gain, and what you give up
Why owners look at them
- No landlord work: no tenants, repairs or refinancing decisions on your desk.
- An interest can be sized to an exact dollar amount, which helps match the value and debt you need to replace.
- A ready-made candidate for the 45 day identification, often used as a backup to a direct purchase.
- Access to classes of property that would be out of reach for a single owner.
What they accept in return
- Illiquid. There is generally no secondary market, and you should expect to hold until the trust sells the property.
- No control. The seven limits above apply to the trustee, and investors have no vote on management.
- Distributions are not guaranteed, and fees and expenses at several levels reduce what investors receive.
- Interests are securities, generally sold by private placement to accredited investors, and you can lose some or all of what you put in.
Where we fit
A DST is one answer, not the default
A DST suits some owners very well, usually the ones who are tired of managing property and value predictability over control. It suits others badly. We hear you out first, and if a DST fits your goals, we connect you with a partner firm that works with them.
- Your goals and timeline come first, before any introduction.
- The partner firm is chosen for your situation, not the other way round.
- Bring the questions your CPA and attorney should ask of any offering.
Questions
Delaware Statutory Trust questions
What is a Delaware Statutory Trust?
A trust formed under Delaware's Statutory Trust Act, 12 Del. C. Section 3801 and following, that holds title to real estate. Investors own beneficial interests in the trust rather than a deed to the property, and a trustee or sponsor manages it.
Why does a DST interest count as real estate for a 1031 exchange?
Revenue Ruling 2004-86 holds that a properly structured DST is an investment trust and that a beneficial interest in it is treated as a direct interest in the underlying real property for Section 1031. That treatment holds only while the trustee stays inside the seven limits the ruling describes.
Who can invest in a DST?
DST interests are generally offered by private placement and limited to accredited investors as defined in Regulation D. The sponsor's offering documents set the actual requirements for each trust.
What happens when the trust sells the property?
Investors receive their share of the proceeds. At that point each investor decides separately whether to exchange again into new replacement property or take the proceeds in a taxable sale.
Is a DST the same as a Deferred Sales Trust?
No. They share an abbreviation and nothing else. A Delaware Statutory Trust is real estate ownership used inside a 1031 exchange. A Deferred Sales Trust is an installment sale arrangement under a different section of the Code.