Last week, we explored Real Estate Investment Trusts (REITs), which offer an easy way to invest in real estate without the headaches of managing properties. This week, we’re diving into Delaware Statutory Trusts (DSTs)—a lesser-known but highly valuable tool for real estate investors looking for tax advantages and diversification.
If you’ve ever sold an investment property, you know the capital gains taxes can be significant. Fortunately, there’s a strategy to defer those taxes: the 1031 exchange. While traditional 1031 exchanges typically involve purchasing another property, many investors are discovering that a DST can provide the same tax benefits without the burden of being a landlord.
What Is a 1031 Exchange?
A 1031 exchange is a strategy that allows real estate investors to sell an investment property and reinvest the proceeds into another “like-kind” property, deferring capital gains taxes. For example, if you own a rental property and decide to sell it, you can use a 1031 exchange to roll the proceeds into another income-producing property without immediately paying taxes on your gains.
However, traditional 1031 exchanges often require buying and managing new property, leaving you in the same position—acting as a landlord with all the responsibilities that come with it.
How Can a DST Help?
A DST can accomplish the same tax-deferral benefits of a 1031 exchange while eliminating the burdens of property management. When you reinvest into a DST, you’re purchasing a fractional interest in professionally managed real estate, such as commercial properties or apartment complexes. This means you continue receiving income but no longer have to deal with tenants, repairs, or upkeep.
DSTs vs. REITs: What’s the Difference?
Both DSTs and REITs provide access to real estate investments, but they serve different purposes and have unique features:
- Ownership: In a DST, you own a fractional interest in specific properties, whereas with REITs, you own shares in a company that owns and operates real estate portfolios.
- Tax Benefits: DSTs qualify for 1031 exchanges, allowing investors to defer capital gains taxes. REITs, on the other hand, do not qualify for 1031 exchanges.
- Liquidity: REITs are publicly traded and easy to buy or sell, making them more liquid. DSTs are long-term investments with limited options for early sale.
- Control: Both DSTs and REITs are professionally managed, but DST investors have no voting rights or decision-making authority, while REIT shareholders may have limited input via corporate governance.
- Income: Both options provide income, but DST distributions often come with tax deferral advantages when part of a 1031 exchange.
If you’re looking for passive real estate income and tax-deferral opportunities after selling a property, a DST may be the better fit. On the other hand, if liquidity is your priority, a REIT could be more suitable.
How Does a DST Work?
When you invest in a DST, you become a fractional owner in the trust, which owns one or more income-producing properties. Here’s what happens:
- Passive Income: The trust collects rental or lease income and distributes it to investors.
- 1031 Exchange Eligibility: DSTs qualify as “like-kind” property, so you can use them to defer capital gains taxes.
- Professional Management: Real estate experts handle all the operational responsibilities, freeing you from being a landlord.
Benefits of DSTs
- Tax Deferral: Like a traditional 1031 exchange, DSTs allow you to defer capital gains taxes, preserving more of your wealth.
- Hands-Off Investment: Say goodbye to landlord responsibilities—no more fixing leaky faucets or chasing down late rent payments.
- Diversification: DSTs often own institutional-grade properties, providing access to high-quality real estate investments.
- Lower Barriers: Fractional ownership allows you to participate in large-scale real estate deals with less capital.
Considerations and Risks
DSTs, like all investments, have potential risks to keep in mind:
- Illiquidity: DST investments are typically long-term and not easily sold before the trust’s term ends.
- Lack of Control: Investors cannot make decisions about property management or sales.
- Market Risk: Real estate markets can fluctuate, potentially impacting property values and income.
Who Should Consider DSTs?
DSTs are ideal for investors who:
- Want to defer taxes using a 1031 exchange.
- No longer wish to manage investment properties themselves.
- Value passive income from real estate investments.
- Seek diversification in institutional-grade real estate.
Key Takeaways
Delaware Statutory Trusts provide a tax-efficient way to invest in real estate, especially for those using 1031 exchanges. They offer the benefits of professional management, diversification, and passive income while removing the challenges of being a landlord.
Next Week, we’ll shift gears from real estate and dive back into the stock market, exploring options and option overlay strategies—powerful tools for managing risk and enhancing returns. Don’t miss it!
Warmly,
Jeff Perry
Partner, Quest Commonwealth
Co-Host of “Safe Money Mindset” on WXYZ-TV ABC Detroit
Author of Safe Money Mindset – Available on Amazon or DISCOUNTED HERE
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