Many baby boomers with highly appreciated real estate investments may be approaching retirement and looking for more passive investment possibilities. Passive, professionally managed ownership may allow them to focus on other aspects of life about which they have always been enthusiastic but never had the time.
Important Points to Remember
Delaware statutory trusts allow for a sort of 1031 exchange, making them an ideal structure for real estate passive investing. This investment instrument allows up to 499 investors (and often more) to share a property, such as a large residential or hospital facility. This allows investors to buy professionally managed properties without having to manage them themselves, but it comes with hazards.Investing that is passive
Many elderly investors are looking for the "Terrific Ts," which allow them time, travel, and teeing off, rather than dealing with the "Terrible Ts"—toilets, trash, and renters. Some seasoned investors have turned to real estate investing strategies such as a tenant in common 1031 exchange to achieve these objectives. Common 1031 exchanges have long allowed investors to acquire high-quality, professionally managed properties that are occupied by long-term tenants with little or no property management duties. The majority of these investors were able to achieve various types of ownership while deferring taxes by using a 1031 exchange.Statutory Trusts in Delaware
Although Delaware statutory trusts (DSTs) are not new, they have become a popular investment vehicle for both passive 1031 exchange investors and direct (non-1031) investors due to recent tax legislation. DSTs are created as trustee truststrust and are drawn from Delaware statute law as a separate legal entity that qualifies as a tax-deferred transaction under Section 1031. DSTs received an official revenue judgment from the IRS in 2004 on how to create a DST that would qualify as replacement property for 1031 exchanges. The DST can own 100 percent of the fee simple interest in the underlying real estate under the revenue ruling (Rev. Ruling 2004-86).What Are Delaware Statutory Trusts and How Do They Work?
The property is acquired under the DST umbrella by the real estate sponsor firm, which also serves as the master tenant, and the trust is opened up to potential investors to purchase a beneficial interest. Investors have the option of depositing their 1031 exchange earnings into the DST or purchasing a direct interest in the DST. A professionally managed, potentially institutional-quality property could be beneficial to DST investors. A 500-unit apartment building, a 100,000-square-foot medical office building, or a shopping mall leased to investment-grade tenants could represent the underlying property. The majority of DST investments are assets that ordinary small-to mid-sized accredited investors would not be able to afford. They can, however, acquire this form of asset by combining funds with other investors. Investors familiar with the tenants in common (TIC) investing strategy may see some parallels in the DST concept. However, it is critical to grasp the differences. A DST normally has between 99 and 499 investors (or more), with each investor possessing a beneficial interest in the trust, which owns the underlying asset. A TIC may have up to 35 investors, each owning an undivided, pro-rata portion of the title to the property. 34Ownership of DST vs. TIC
The DST structure has two distinct advantages over the TIC idea. Because a DST is not limited to 35 investors, the minimum investment can be substantially lower, often as little as $100,000. The DST's second important benefit is that the lender only makes one loan to one borrower: the DST's sponsor. The lender can fund up to 35 different loans in a TIC investment, one for each investor. However, in times of financial difficulty, the DST provides greater security to lenders because the sponsor, who is the underlying responsible party, has been thoroughly vetted by the lender. Be aware that a larger number of investors and shares may or may not protect your investment; rigorous examination of the controlling partner or sponsor is recommended. In this business, there are a lot of criminals.The Dangers Involve
DSTs aren't without their drawbacks, either. Investors may face high vacancy rates and loan defaults, as with any real estate investment. Investors who are considering the DST strategy should get advice from a seasoned investing professional as well as qualified legal and tax counsel. For qualified real estate investors, the DST structure may be a feasible investment option, but only your tax adviser and a lawyer can tell you if it is good for you.