1031 Exchange Rules

this is the primary logo used by www.1031exchangerules.com and represents the 45 day and 180 day timeline of a 1031 exchange.
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DST (Delaware Statutory Trust)

A Delaware Statutory Trust (DST) is a legal trust used for real estate investment, allowing individuals to own fractional interests in properties without active management responsibilities. DSTs qualify for 1031 exchanges, enabling tax deferral and access to larger or diversified assets.

What Are The 5 Ways To Invest In Real Estate?

Real estate offers various investment approaches, including options for single or multiple owners. When multiple parties are involved, they may each hold direct ownership of a fractional share of the property, or they may own shares in an entity that holds the title. Each ownership structure presents unique advantages and disadvantages, depending on the specific investment goals and circumstances. Here, we’ll explore five popular structures for real estate ownership:

– Sole Ownership
– REITs (Real Estate Investment Trusts)
– Tenant-in-Common Arrangements
– Delaware Statutory Trusts
– Equity Funds

These structures simply outline ownership methods and do not affect the type of property. Each allows for investment in similar property assets, just through different frameworks.  You can discuss the potential benefits and drawbacks of each structure with an Investment Advisor or 1031 Exchange Specialist, but we are going to focus only on the DST’s for now.

Why, DST's?

DST shares are regarded by the IRS as “like kind” with real property, making DST investments 1031-compatible. Unlike ordinary exchanges, however, investors are not burdened with any management obligations for their replacement properties, which instead are assumed by the DST’s trustee.

The pros of DST-structured investments: they are 1031-compatible investments that provide passive cash flow (at least quarterly, but typically monthly) without any management obligations for the investor.

    The cons of DST-structured investments: they are long-term, illiquid investments in which the investor has little control over asset management.

this is a representation of a Delaware Statutory Trust of DST that is used for 1031 exchanges

Understanding DST's - Highlighting 8 Main Talking Points (REV. RUL. 2004-86)

No Loan Renegotiations or New Financing
Potential Drawback: DSTs cannot refinance or adjust loan terms, which means investors might miss opportunities to benefit from lower interest rates. They may also face forced property sales when loans mature, even if market conditions are poor, which could lead to losses. Potential Benefit: This rule promotes stability by keeping debt terms fixed, shielding investors from unexpected changes that might disrupt cash flow. The predictable financing structure minimizes risk, providing passive investors with a stable investment environment free from volatile financing shifts.
New Leases or Lease Renegotiations are Prohibited
Restrictions on entering or renegotiating leases can be challenging, especially for properties like multifamily units and self-storage that have high tenant turnover. Without flexibility, these assets may struggle to adjust to market demands. Sponsors often work around this with a “Master Tenant Lease,” which lets them negotiate subleases. However, this workaround can create a tangled web of legal structures and cash flow uncertainties. Potential Benefit: Static lease terms promote steady income and encourage sponsors to secure high-quality, long-term tenants from the start, reducing risks associated with turnover. This results in predictable cash flow, which is highly appealing to passive investors seeking income stability without hands-on management.
Only Minor Capital Expenditures
Potential Difficulty: DSTs can’t make significant improvements beyond routine maintenance, limiting the potential for value-add renovations. The DST only spends money on repairs, maintenance, minor improvements, and legal obligations. Investors looking for growth through property upgrades may find this restrictive. Why People Like That: This conservative approach minimizes costly renovations and aligns the DST’s focus on stable, manageable expenses. By sticking to routine maintenance, DSTs keep overhead low and protect cash flow, making it ideal for passive investors who want consistent returns without the risk of high capital outlays.
Cannot Automatically Reinvest Sale Proceeds
Potential Drawback: Proceeds from property sales can only be distributed or invested into short-term debt instruments on behalf of investors, limiting the potential to reinvest into new opportunities within the same DST. This can also complicate taxes for investors if only a portion of the portfolio is sold. Potential Benefit: Promptly distributing proceeds provides investors with liquidity, enabling them to pursue other 1031 exchange opportunities or different investments. This rule simplifies exit strategies, ensuring investors are not tied up indefinitely, adding flexibility for those who value control over their capital.
Capital Reserves Limitations
Restriction: DSTs are only allowed limited reserves, usually up to 3% of the property value, which could limit flexibility during economic downturns or unexpected property expenses. Benefit: Requiring excess reserves to be distributed increases transparency and accountability, as sponsors must manage finances within a conservative budget. This translates to regular income for investors and limits the risk of funds being misused, providing a more secure, reliable investment experience.
Income Solely From Real Estate
Limitation: DSTs must avoid engaging in active business activities, meaning potential revenue sources beyond rent collection are off-limits. This can limit the potential for additional income streams. Strategic Design: By keeping DST operations passive, this rule preserves eligibility for 1031 exchanges, which is central to the tax benefits DSTs offer. This focus on rent collection keeps the investment straightforward and predictable, ideal for those who prefer stable real estate income without additional business risks.
Closed Off From Future Capital Contributions
Con: DSTs prohibit additional capital contributions after the initial investment. This restricts flexibility for growth or managing emergencies without dipping into reserves. Pro: Prohibiting further contributions shields investors from surprise capital calls, ensuring that all financial commitments are clear from the start. This simplicity helps investors plan accurately without the worry of unexpected financial demands, maintaining an equal investment structure where each participant’s contribution is known and fixed
Legacy Benefit
With a 1031 exchange, you can continue deferring capital gains taxes on real estate investments throughout your lifetime, ultimately passing these assets to your heirs. DST shares can be divided equally among heirs, streamlining estate planning for investors. When real estate is inherited—whether held directly or through a DST—the capital gains basis is adjusted to reflect the property’s market value at the time of inheritance. This means heirs can choose to sell the property at its current market value without realizing any capital gains on prior appreciation.

ADVANTAGES OF INVESTING IN DST's

Tax Deferral:
DSTs let investors defer taxes on property sales, including capital gains and depreciation, with the original property basis rolled over.
Passive Ownership:
DSTs handle property management, giving investors ownership benefits without the stress of tenants or maintenance
Exchange “Upgrade”:
Invest in fractional ownership of higher-value assets, not just similar properties, through DSTs.
Professional Management:
DSTs manage properties, freeing investors from direct responsibilities.
Passive Income & Estate Planning:
Earn monthly passive income and simplify inheritance by minimizing tax impacts.
Portfolio Diversification
Investing in a share of one or more DSTs with diverse asset portfolios helps safeguard your capital by reducing reliance on any single property, location, asset type, tenant, industry, lease, or debt term.
721 UPREIT
Some Delaware Statutory Trusts are designed with an exit strategy that allows a one time exchange into a REIT, called an UPREIT. This preserves the tax deferral benefits of a 1031 exchange, but gives more flexible liquidity options.
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