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Delaware Statutory Trust: What It Is and How it Benefits Investors

With the possibility of the 1031 tax deferred exchange being eliminated by President Biden’s American Families Plan, investors are researching other ways to defer paying their capital gains.

The Delaware Statutory Trust (DST) is a legal entity used in real estate investing that allows a number of investors to pool money and hold fractional interests in the holdings and assets of the trust. The DST gives investors limited liability while also providing pass through income and cash distributions.

In 2004 there was an IRS ruling that allowed ownership interests in DSTs to qualify as like-kind property for use in a 1031 exchange, ultimately allowing sellers of real estate to defer their capital gains.

To explain how it works, let’s take an individual investor named John. John wants to unload a retail center he owns but wants to avoid paying capital gains tax. John can sell his investment property and roll the proceeds from the sale into a DST through the purchase of a fractional investment, thereby deferring the capital gains tax and allowing him the opportunity to become a passive investor and avoid day-to-day real estate management.

Another attractive quality of DSTs is that financing is obtained by the trust as a whole, meaning that individual investors don’t need to qualify or take responsibility for the loan. DSTs remove the liability but provide a number of loan benefits; the loan meets the 1031 exchange debt reduction principle requirements, and investors receive 1098’s which can be used to apply their portion of the loan interest payments to their tax write-offs.

I foresee DSTs gaining momentum, especially if the Biden administration eliminates or significantly restricts 1031 Exchanges. DSTs are ideal for investors that want to avoid capital gains exposure and also want to transition to a passive investment role, rather than an active investment management role.

Justin Langlois, CCIM is a Commercial Real Estate Investment Advisor with Stirling Properties servicing Baton Rouge, Louisiana and surrounding markets. Please reach out to Justin to discuss your real estate investment strategies.

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