Key Takeaways:
Through no fault of their own, most investors are unfamiliar with the concept of a Delaware Statutory Trust (DST). Nonetheless, those familiar with these impressive wealth-building vehicles are more than aware of the unique advantages they award savvy investors. In addition to acting as a tax shelter, DSTs may serve investors as a dependable source of passive income. It is worth noting, however, that Delaware Statutory Trusts are far too underutilized. The more investors know about these investment vehicles, the more they may be willing to partake in them.
What Is A Delaware Statutory Trust?
Not unlike traditional trusts, Delaware Statutory Trusts are essentially fiduciary relationships in which a trustee carries out business to benefit participating investors. In its simplest form, a Delaware Statutory Trust is a legal entity specifically designed for real estate investors to conduct business through the help of a trustee. More specifically, however, real estate investors have turned to these trusts to hold, manage, administer, operate and invest in real estate assets passively. When property titles are added to a Delaware Statutory Trust, investors may profit from the trustee deciding to put the property in operation.
How Do Delaware Statutory Trusts Work?
More often than not, DSTs are owned by multiple investors, all of whom agree to pool their capital and entrust it to the trust’s manager. Contributions entitle investors to receive a portion of the trust’s proceeds. Whether it’s a portion of the rent collected or cash flow generated from managing and operating individual properties, contributors to a Delaware Statutory Trust will receive their fair share of profits relative to their initial investment.
It is important to note that Delaware Statutory Trusts are a passive investment strategy for investors. In other words, Delaware Statutory Trusts do not allow their contributors to actively partake in how the real estate assets generate profits. Instead, trust operators are responsible for taking an active role in each asset’s performance. As a result, Delaware Statutory Trusts are essentially a way for investors to invest in real estate without actually owning any real estate themselves.
Pros Of Delaware Statutory Trusts
In their simplest form, DSTs are merely another tool in investors’ toolkits which may simultaneously diversify portfolios and increase earnings potential. At their pinnacle, however, Delaware Statutory Trusts can elevate investment portfolios to an entirely new level. Investors gain access to a number of significant benefits by contributing to a DST, not the least of which include:
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Passive Income
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Diversification
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Tax Sheltering
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Multiple Streams Of Income
Passive Investment Benefits
Not unlike investors who have relinquished their rental property operations to a third-party property manager, those who contribute to a Delaware Statutory Trust gain access to another form of passive income. If for nothing else, DST participants aren’t allowed to actively manage assets within the trust. Instead, investors trade their active roles for a sponsor (also known as the “operator”) qualified to manage the assets held in the trust. It is the sponsor who will make the decisions on how to place the assets in operation. On the other hand, investors need to contribute to the trust and collect any returns made from the sponsor’s decisions.
Diverse Property Options
Delaware Statutory Trusts award contributing investors several ways to diversify their overall portfolio. In addition to the trust itself serving as yet another investment option, sponsors may further diversify the trust’s capital into several different real estate assets. More specifically, DSTs can hold the title of just about any property type; that means contributors can diversify between everything from single-family homes and 100-unit apartment buildings to commercial warehouses and shopping malls. The variety in which a DST may distribute its capital is a unique benefit in and of itself.
1031 Exchange Eligible
As perhaps the greatest benefit of all, investors can transfer the profits from a home sale into a Delaware Statutory Trust using a 1031 Exchange. Typically, investors would be levied a capital gains tax if they sell a property for more than they bought it for. When investors receive the proceeds from the sale, the government takes its fair share of the profits. However, a 1031 Exchange actually prevents the investor from physically receiving the proceeds. Instead of profiting immediately, the 1031 Exchange allows the investor to place the proceeds in another qualifying investment. Many investors choose to invest in another similar property to avoid capital gains. Still, the Internal Revenue Service (IRS) ruled (in 2004) that investing in a DST is considered “like-kind” property. As a result, qualifying investors may invest the proceeds from a home sale into a DST without being hit by capital gains. In doing so, investors may defer their tax obligations until the profits are actually realized at a later date.
Multiple Income Streams
We have already talked about how a single Delaware Statutory Trust may invest in several property types, but it’s equally important to distinguish DSTs from other streams of income. As an investor, diversity helps mitigate downside and risk. Therefore, merely investing in a Delaware Statutory Trust, along with other assets (whether the stock market or actively managed real estate investments), is a way to diversify holdings even further. At the very least, investors are advised to create multiple income streams, and this is just one more way to do so.
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Cons Of Delaware Statutory Trusts
These trusts have proven they can produce in a diversified portfolio. However, much like every other type of investment, investors must weigh the pros vs the cons. That said, there are drawbacks to this particular investment strategy investors need to be aware of:
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Illiquidity
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No Active Management
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Strict Qualifications
DST Properties Are Illiquid
Delaware Statutory Trusts are founded on moderate to long-term holding periods; they are not intended to produce immediate returns. Subsequently, it’s common for most DST to coincide with holding periods of at least five to 10 years. As a result, investors can’t touch the capital they invested until the holding period has expired. Consequently, the inability to access the capital means these investment strategies are particularly illiquid and lock up money for an extended period of time.
No Control For Investors
Delaware Statutory Trusts are managed by operators, which inherently means they serve investors as a passive investment strategy. Again, all that’s needed from investors is to contribute money to a DST of their choosing. In return, the trust will allocate the money accordingly. For some, the passive nature of DSTs is the perfect retirement strategy; for others, it’s a significant drawback. If for nothing else, some people like to choose where their money is being invested. Therefore, investors who are particularly adept within the real estate industry and know how to navigate the market well may find that investing in their own strategy is better.
Not Every Investor Qualifies
Unfortunately, a great deal of investors won’t qualify to invest in a Delaware Statutory Trust. In fact, only accredited investors can contribute to a DST; that means participants must have a net worth of at least $1 million. Additionally, investors must also prove they made at least $200,000 in each of the last two years. Once investors have proven they are accredited, they will also be expected to meet minimum contributions, which are typically somewhere in the neighborhood of $25,000
Delaware Statutory Trust Vs. Tenants-In-Common
Not surprisingly, those who are new to the concept of a Delaware Statutory Trust have a hard time differentiating it from its concurrent real estate counterpart: tenants-in-common. Both concepts are centered on the idea of co-ownership. However, the two are actually quite different. Whereas a Delaware Statutory Trust will typically have several investors place capital in an actively managed trust, tenants-in-common is a legal term used to describe an arrangement between two or more parties who share ownership in a single real estate asset.
Summary
Investing in real estate is nothing, if not diverse. Few industries, for that matter, award investors with more vehicles to make money than the housing sector. As a result, far too many wealth-building opportunities go unnoticed, and Delaware Statutory Trusts are no exception. Often overlooked, a Delaware Statutory Trust can elevate qualifying investors’ portfolios to an entirely new level. Investors may gain access to one of the most under-appreciated strategies ever in converging unique tax-sheltering advantages, passive income, and an actively managed portfolio of cash-flowing real estate assets.
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The information presented is not intended to be used as the sole basis of any investment decisions, nor should it be construed as advice designed to meet the investment needs of any particular investor. Nothing provided shall constitute financial, tax, legal, or accounting advice or individually tailored investment advice. This information is for educational purposes only.
