A Delaware Statutory Trust (DST) is a separate legal entity created as a trust under Delaware statutory law and recognized by the IRS for federal tax purposes. A DST allows a great deal of flexibility in designing and operating the entity that becomes the DST. Investors own a pro rata interest in the trust and have the right to receive distributions from its operation, either from rental income or eventual sale of the property. Investors do not have deeded title to the property. The trust has the deed to the property and makes the decisions regarding its disposition. The trust delivers institutional grade real estate to the retail investor. The investor then has the ability to diversify amongst asset classes, sectors and demographics. Enabling individuals to truly diversify and create a turnkey solutions without the headaches of actively managing their holdings.
For the purposes of a 1031 tax-deferred exchange, the purchase of a beneficial interest in a DST is treated as a direct interest in real estate. This satisfies that requirement of IRS Revenue Ruling 2004-86, it can be used by other taxpayers in defense of a 1031 exchange position.
DSTs can also be attractive for investors not looking at a 1031 exchange. All the benefits of securitized real estate, as well as the financial specifics of the particular DST, remain. In addition, because it is a direct interest in real estate for tax purposes, the investor can perform a 1031 tax deferred exchange if and when the property is sold, thus beginning the cycle of tax-deferred real estate ownership.
Legal limitations and the nature of DST financing generally limit the use of a DST to properties leased to an affiliate of the sponsor (a master tenant) who will operate the property on a triple-net basis (a master lease).
A Delaware Statutory Trust is in the nature of a unit investment trust or a fixed investment trust. In such a trust, assets, securities, real estate, etc. are purchased for the trust and held until the proceeds are distributed to the investors. The trust is not considered a taxable entity and, therefore, all the profits, losses, etc. are passed through directly to the investors.
The business-trust concept, especially those that involve the holding of property, dates back as early as 16th century English Common Law. But until the passage of the Delaware Statutory Trust Act in 1988, no legal recognition of statutory trusts existed (12 Del. C. 3801 et. Seq.,). Statutory trusts were recognized as their own legal entity, separate from their trustee(s), offering freedom from the corporate law template. Within the tradition of trust law, freedom of contract allows the trustee(s) to structure their entity in a way that is most beneficial to the relationship of all parties and their expertise, while offering liability protection similar to that of a limited liability company or partnership.
Since 2000, Delaware statutory trusts have been used increasingly for tax deferral, asset protection and balance sheet advantages in real estate, securitization and mezzanine financing. For the purposes of owning a “direct interest in real estate,” which is critical to qualify for a 1031 exchange, IRS Revenue Ruling 2004-86 opened the way for DSTs to become the most common ownership structure for smaller investors to own investment-grade real estate with other investors. This ruling states that a beneficial interest in a DST that owned real estate would be considered a “direct interest in real estate” and thus qualify for 1031 exchange, assuming that all the other requirements are satisfied.