There are numerous advantages to investing in real estate. For instance, the opportunity to boost profits (and risk), using leverage and considerable tax benefits from “non-cash” expenses like depreciation. It also comes with the ability to defer capital gains taxes using the 1031-exchange. All these, among other paybacks, have long made real estate an appealing alternative for clever investors.
1031-exchange investors are currently benefiting from trusts that serve as tax shelters and reliable sources of income. Nevertheless, these trusts are far from being fully utilized. It could be that most investors are unaware of them. Or maybe they’re shying away because of the trusts’ alleged issues. Here’s what you need to know.
What is a Delaware Statutory Trust?
A Delaware statutory trust (DST) is a type of real estate investment structure. Here numerous investors pool money resources together and own an undivided fractional interest in the trust’s property. In simple terms, it is a legal entity for real estate investors to conduct business through the help of a trustee.
Through this arrangement, investors can acquire passive income, diversification, tax sheltering, and multiple income streams. For example, when it comes to earning passive income, investors trade their active roles for the individual tasked with managing the assets held in a trust — they don’t actively manage their investments. They only collect returns arising from their sponsors’ decisions.
On the other hand, as regards tax sheltering, investors can transfer the returns from their property sales into a DST using a 1031 Exchange. However, this prevents them from physically getting the incomes from their sales. The 1031 Exchange allows them to place their income in other investments to dodge capital gains and defer their tax obligations until they realize the profits.
Important things to note about these trusts
Although you might be excited about the pros and contemplating whether to invest in a DST, unfortunately, they have some restrictions.
1. They’re only accessible to the chosen few
Only accredited investors with a net worth of at least $1 million can participate in a DST. Investors must also show that they made at least $200,000 in each of the previous two years. Investors who’ve demonstrated they are accredited will have to make minimum payments, generally in the range of $25,000 to $50,000.
2. They are Sponsor Controlled
Because sponsors manage these trusts, they are a passive investing strategy for investors. Investors are only required to make financial contributions to a DST of their choice. In exchange, the trust will distribute the funds appropriately. For some, DSTs’ passive nature is ideal for retirement; for others, it is a considerable disadvantage.
If you prefer getting involved in your money, this is not a suitable investment for you. The object of the DST law is to prevent you from accessing your investment. If you’re not tolerant of such restrictions, you may feel suffocated.
This type of circumstance highlights the importance of locating a highly skilled real estate industry expert well-versed in market navigation to ensure that your investment is wise. One best option is Kay Properties, which has over 115 years of real estate experience and has participated in over 21 billion of DST 1031 investments.
3. You’ll be required to retain a property for years
To meet the requirement of the 1031 exchange, you’ll be required to retain your property for years. The average 1031 property by law is held for at least five years as a tax deferment strategy. This makes it difficult to quickly liquidate your real estate assets, especially in a financial emergency.
For this reason, they’re preferable for those looking to invest long term. If you’re a short-term investor, you ought to consider other alternatives.
4. New assets do not imply new money
All the finances that a similar new property will accrue comes with another challenge — you’re not allowed to pour any of your capital back into the DST itself. The law restricts new investors into the DST or the property from gaining financially while 1031 is in operation.
DSTs also have their downsides despite promising incredible benefits. As with any other investment in the real estate market, you could potentially face high vacancy rates and loan defaults. However, investors thrive in the industry by making smart and informed decisions.
It would be best if you consult an experienced investment specialist and seek competent legal and tax counsel. Now that you know what you stand to gain or lose by investing in a DST, it’s up to you to make that decision.
