The Other DST – Deferred Sales Trust: What You Should Know

By: Matt McFarland, Associate at Kay Properties & Investments, LLC

Many times, when researching the Delaware Statutory Trust structure as a potential 1031 exchange option, investors will come across another DST—the Deferred Sales Trust.  It can all be very confusing.  The Delaware Statutory Trust is an accepted part of the Internal Revenue Code under Revenue Ruling 2004-86 and has provided investors the ability to defer their taxes upon sale of an appreciated piece of investment real estate by 1031 exchanging into a passive, turnkey investment in which a professional asset manager (the DST sponsor company) does the management on their behalf.  Delaware Statutory Trusts have been in existence and a uniformly accepted part of the Internal Revenue Code for over 15 years.  Deferred Sales Trusts, the other DST…not so much. 

On its most basic level, a Deferred Sales Trust is set up as an installment sale.   A contract is set up where an investor sells appreciated real or personal property to the Deferred Sales Trust and the Deferred Sales Trust pays the investor a predetermined amount of money over a predetermined period of time.  This strategy supposedly allows investors to control both their capital gains tax exposure and reinvestment terms.  Although investors have been utilizing this legitimacy questioned strategy for quite some time, it still hasn’t generated a tax court decision1 and thus has major potential issues and ramifications for investors.  

Many people that are apart of the legal and 1031 exchange community do not believe this structure is legitimate for the purposes of deferring taxes via a 1031 exchange transaction.  We have seen and received tax opinions detailing the inability of a law firm to conclude the Deferred Sales Trust transaction would more likely than not qualify as an installment sale by the owner, posing a direct challenge to the validity of the structure and a major red flag tax issue that investors must be aware of.  

Furthermore, the California Federal Tax Board (FTB) stated publicly that they consider Deferred Sales Trusts abusive tax schemes and that they are pursuing sponsors and promoters as well as taxpayers who participate in them. 

Deferred Sales Trusts (DSTs) present a number of issues to be considered including3:

  1.  Set up fees that can be rather expensive to investors
  2. The need to incur the expense and challenges of creating a highly specific trust
  3.  Recurring annual costs that can be quite burdensome (annual filing fees, tax returns and large asset management fees)
  4. No guaranteed payment stream, rate of return or guarantee for preservation of principal (all are dependent upon the investments chosen by the trust which often time are higher risk investments to generate a higher return which is split between the investor and those setting up the trust)
  5. Transfer fees can be incurred when the property is transferred to the trust.

It is important that a client consults with their own tax and legal advisors before making any investment decisions and especially before participating in a Deferred Sales Trust.  Many investors are opting to utilize a more traditional approach of the 1031 exchange, which has been blessed by the IRS since 1921, and the Delaware Statutory Trust (which has been an IRS Revenue Ruling since 2004 under Revenue Ruling 2004-86).  Please reach out to us at www.kpi1031.com for any more information on the subject as well as any further information on 1031 exchanges and Delaware Statutory Trust investments.

About Kay Properties and www.kpi1031.com 

Kay Properties is a national Delaware Statutory Trust (DST) investment firm. The www.kpi1031.com platform provides access to the marketplace of DSTs from over 25 different sponsor companies, custom DSTs only available to Kay clients, independent advice on DST sponsor companies, full due diligence and vetting on each DST (typically 20-40 DSTs) and a DST secondary market.  Kay Properties team members collectively have over 115 years of real estate experience, are licensed in all 50 states, and have participated in over 15 Billion of DST 1031 investments.

This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please read the entire Memorandum paying special attention to the risk section prior investing.  IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax codes therefore you should consult your tax or legal professional for details regarding your situation.  There are material risks associated with investing in real estate securities including illiquidity, vacancies, general market conditions and competition, lack of operating history, interest rate risks, general risks of owning/operating commercial and multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, potential returns and potential appreciation are not guaranteed.

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