By Alex Madden, Vice President with Kay Properties and Investments
There is a lot to read and learn about DSTs and 1031 exchanges. After speaking with many investors they are often interested to learn about these five niche DST facts:
DST Fact Number 1: IRS Revenue Ruling 2004-86: DSTs had been used for 1031 exchanges for many years prior to the IRS Revenue Ruling in 2004, but after ruling 2004-86 the IRS provided specific guidance on the use of DSTs in 1031 exchanges, thus providing authorization for DST exchanges when IRS guidance is met.
DST Fact Number 2: Springing LLC: Under certain circumstances a DST can be converted into an LLC. Certain limitations are provided on what a DST can, and cannot do. In the event that proactive steps are required to prevent a DST investment from significant loss a DST can convert into a LLC to take steps which a DST cannot. Examples include: renegotiating existing debt, obtaining new financing, and entering into new leases. Once a DST is converted to a LLC it could potentially be treated as a partnership for federal income tax purposes and investors could potentially lose the ability to 1031 exchange their property in the future. Understandably, the Springing LLC is generally regarded as a safety net to potentially protect the property if there was a negative situation. In the hundreds of DST offerings that Kay Properties has participated in we have only seen the springing LLC utilized by DST sponsor companies a handful of times however it is nice to have it available as a safety net for the property and investors.
DST Fact Number 3: UPREIT: An umbrella partnership real estate investment trust (UPREIT) uses the 721 Exchange as opposed to the 1031 Exchange to contribute a DST to a REITs operating partnership (OP) on a tax deferred basis in exchange for OP units . This is one possible exit strategy for DSTs. Investors are often provided a choice as to whether they would like to participate in the UPREIT using the 721 exchange, or go their own way using the 1031 exchange into more DSTs or into another property they would manage on their own.
DST Fact Number 4: 7 Deadly Sins – In order to meet IRS guidance a DST must avoid the following:
- No future contributions: Once a DST offering is closed there can be no additional contribution of capital by either current or new investors.
- Restrictions on Debt: The Trustee cannot renegotiate existing debt terms or initiate new secured loans from any party. Some exceptions apply. This is one reason why many investors prefer to invest in debt free DSTs.
- No reinvestment of proceeds: The choice of where to reinvest is retained by individual investors when the real estate is sold.
- Required Distributions: With the exception of reserves, all cash received by the DST must be distributed to investors.¹
- Limited Capital Expenditures: The Trustee may only have capital expenditures to cover the following:
- Normal repair and maintenance
- Minor non-structural capital improvements
- Those required by law
- Restrictions Investing Reserves: Any cash retained by the Trustee for reserves or between distributions dates may only be invested in short-term debt obligations.
- Restrictions on Leases: The Trustee may not renegotiate, or enter into a new lease. Some exceptions apply.
DST Fact Number 5: Lower Minimum Investments: Due to the higher number of contributing investors allowed into the DST structure (typically capped at 499 compared to 35 in the TIC 1031 structure) there is typically a lower dollar contribution minimum. Minimum investments are set by the DST sponsor company of the DST investment offering. The minimum investments are often either $25,000 or $100,000.
