Real estate investing is a powerful way to build wealth… when done correctly! But all too often, investors aren’t aware of all the options at their disposal. Worse yet, they underestimate the costs in time and money when buying their own rental properties.
This is especially true if you’re looking to buy a rental in 2022.
But that’s a shame. Because there’s a variety of ways to approach real estate investing. And if you’re too busy to stay active in the buying and selling, a Delaware Statutory Trust (DST) may be the perfect place to park your money. The problem is… hardly anyone’s heard of it.
In this article we’re going to review Delaware Statutory Trust pros and cons. And we’ll cover how you can hit the ground running on maximizing the performance of your real estate investing. Let’s get started.
What Is A Delaware Statutory Trust?
A Delaware Statutory Trust (DST) is simply a model of ownership for real estate properties. Through a DST, investors are given ownership in the form of fractional interest.1 This fractional interest can be thought of as shares of the property.1
And yes… you can invest in DSTs if you/they aren’t in Delaware!
When you own shares of a company, you’re entitled to a portion of its profits. But that doesn’t mean you’re making the company’s decisions. Well, the same goes for DSTs. Having fractional interest entitles you to your share of income. However, you won’t have any decision-making authority over the property itself.2
It’s also worth touching on how DSTs are different from other ownership structures like real estate investment trusts, or REITs. Unlike some REITs, DSTs are not publicly traded. Also unlike the majority of REITs, income is not treated as capital gains. Instead, income from DST distributions is treated as ordinary income come tax time.3
What Is A 1031 Exchange?
Before touching on the key benefits of DSTs, it’s important to have a working understanding of the power of a 1031 exchange. That’s because it plays an integral role in not only what you can do with DSTs, but also with real estate investing in general.
The 1031 exchange refers to a section of the tax code. In it, there’s an allowance for the postponement of paying capital gains taxes. This 1031 exchange tax perk works by rolling the profits from the sale of one investment property directly into another.
You can see the specifics here, but there’s a few key details you should know:
- The 1031 tactic only applies to “like-kind” exchanges. This means you have to be reinvesting your profits into a property that’s seen as similar in the eyes of the IRS.4
- You may not receive the profits of the initial sale (even temporarily). They must be held in escrow by a third party before reinvesting through a 1031 exchange.5
- There are time restrictions in which you have to make the exchange. You’ll only have 45 days after a property sale to designate (in writing) the replacement property to the appropriate parties. And you’ll only have 180 days after a property sale to close on its replacement.5
- 1031 exchanges generally do not apply to personal residences. Its primary function is for investment properties, which are purchased for additional income (ex: rental property).5
What Are The Benefits Of Delaware Statutory Trusts?
There’s some really solid reasons to get involved with DSTs. Especially if you’re looking for truly passive income, and don’t have tons of capital. Benefits of DSTs include, but are not limited to:
- 1031 Friendly: DSTs generally qualify for “like-kind” exchanges. This means you can roll the profits from a sold investment property into a DST and leverage the 1031 exchange tax advantage!2
- Passive Nature: Remember, through the structure of DST, you won’t have to make any decisions on the property itself. You’ll be receiving passive income without having to take on the headache of any property management (ex: repairs).2
- Lower Entry Costs: Minimum investments can be as low as $100,000, which allows you to take fractional ownership of properties you may not be able to afford on your own (ex: industrial properties, office buildings, and multifamily apartment communities).1
- Diversification: There can be a multitude of properties under a DST. This can allow for fractional ownership in a diversified set of real estate assets.1
What Are The Problems With Delaware Statutory Trusts?
Unfortunately, every super investment has its kryptonite. So before you get all dreamy-eyed looking at DSTs, make sure you’re also aware of their drawbacks. These include, but are not limited to:
- Illiquidity: DSTs have longer holding periods. Typically, they range between 5 – 10 years before you can exit.6
- No Authority: You’ll save yourself the headaches of having to deal with many property issues with a DST, but this comes at the cost of personal control. You won’t have a say in decisions regarding tenancy or even the sale of the property.2
- No New Capital: Once a DST offering is closed, no new capital can be raised by current or new investors. This can be become problematic in the event of major repair jobs where substantial profits become tied up.2
How Can Crafted Finance Help You Further?
At Crafted Finance, we specialize in real estate planning. We love helping our clients take advantage of the various opportunities afforded by the industry to help bolster their financial freedom.
Undoubtedly, Delaware Statutory Trusts offer a unique, but complex opportunity. Their structure allows for investors to enter into a diversified set of assets at a lower price. And the passive income these trusts generate is actually passive. But still, there are some drawbacks.
There’s stringent regulations applied to DSTs, which can be cause for concern to investors. You won’t have control of the properties that you partially own, no new capital can be raised, and the time before sale can be on the longer side. And finally, you pay the management of the DST for their work. Always find out what the inherent costs are for this before diving in.
DSTs are just one of the many options you have as a real estate investor. And at Crafted Finance we personally find the one(s) that works best for our clients. Please feel free schedule a complimentary consultation, or reach out to us at 650-336-0598.
