If you’re a real estate investor who is actively building a portfolio, having the correct asset protection is essential. There are many details involved in forming a legal entity, and they all have their pros and cons, depending on who’s setting it up.
Let’s explore the top tips from The Beacon Group to review what a Delaware Statutory Trust is and how forming one can help you acquire additional properties in the future.
Disclaimer: Always consult a real estate attorney regarding any decisions to form a legal entity to make sure it is the best decision for your particular situation.
What is a Delaware Statutory Trust?
A Delaware Statutory Trust (DST) is a type of statutory entity created under the laws of Delaware for the purpose of business. Forming a DST is a strategy for investing in real estate in which multiple individuals can co-invest in a real estate property. This allows each individual investor more purchasing power – they have access to commercial properties that are much more expensive than what they could purchase individually. The DST as a whole is the property owner; the individual investors are beneficiaries and do not have personal liability. In addition, the task of managing the property and making material decisions is placed into the hands of a trustee.
Each investor in the DST will have fractional ownership or “beneficial interest” in the commercial property. No single investor is responsible for qualifying for the mortgage. In addition, an individual DST may hold several properties at once.
The DST provides an excellent way to diversify your investment portfolio and take advantage of financially beneficial opportunities, such as passive income. Additionally, DSTs are eligible for 1031 exchanges. The 1031 exchange is a tax deferment strategy recognized by the IRS according to Section 1031 of the Internal Revenue Code (IRC).
Section 1031 states that an investment property owner may sell one property and acquire a replacement investment property with the proceeds (a “like-kind” exchange). Section 1031 defers capital gains tax, depreciation capture, or ordinary income when this type of “like-kind” exchange occurs.
“Like-kind” means that the real estate properties are for investment or business purposes only. For example, if you sell an investment property for $1,000,000, you need to purchase a replacement investment property equal to that amount or greater to defer taxes. The major benefit of 1031 exchanges is that the investor can use 100% of the proceeds from the sale of their original investment property to purchase the replacement property, giving the investor more purchasing power.
There are rules to follow when doing a 1031 exchange, and they include but are not limited to:
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When an owner sells an investment property, the “like-kind” property (or properties) must be identified within 45 calendar days of closing, and the sale of the new replacement must be completed within 180 days.
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The investment property cannot be your primary place of residence.
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The money should never reach your hands. If it does, you will be responsible for paying capital gains.
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Cash from the sale of the property will be held by a qualified intermediary, and that intermediary will pay for the purchase of the new property with those funds. You are not the owner but a beneficiary of that investment.
Who can form a Delaware Statutory Trust?
Despite the name, anyone from any state can set up a DST. However, there are added benefits for those investing in high-tax states like California that make it more attractive over other legal entities. As discussed, the DST enables investors to pool their monies to acquire high-end real estate commercial properties that would otherwise be unattainable to them. Using the 1030 exchange method, investors can avoid paying the high capital gains tax in states like California. Plus, on the West Coast, DST investors have a wide range of potential properties available, from farmland to industrial spaces.
How does a DST differ from a series LLC?
Investors often purchase properties through series LLC corporations in an effort to protect their investments from legal claims or liability. A series LLC is a type of limited liability company where liability protection is provided across multiple “series” (assets). In this structure, each “series” is protected from liabilities that may arise with the other assets. Essentially, if litigation occurs against one of the assets, the others are protected.
A DST and a Series Limited Liability Company (LLC) share similarities in that they are both structured to protect your assets. The most significant difference between the two is in regard to your taxes.
When filing a series LLC, the parent LLC must file and include each series LLC underneath it. However, for a DST, the parent files on its own and passes the tax treatment onto each series. A benefit of setting up a DST for residents or investors in California is that they are easier and less costly to manage than an LLC.
With a series LLC, the beneficiary of the series LLC must pay an $800 franchise tax each year for the parent LLC and each series underneath it. Thus, if you have 10 series in a series LLC, you would pay $8,800 per year to manage them. This applies whether you’re a California resident or live out of state with an investment in California. You pay either way.
With a DST, there is an upfront set-up fee and no annual fee after that. For an investor who lives in California or owns properties there, it is a very attractive way to protect your assets.
The benefits of forming a DST
As already mentioned, a Delaware Statutory Trust is a smart way to protect your assets from you, the beneficiary, and each of your assets from the others. A DST legally distances you from each asset. Another benefit of a DST is the ability to keep your identity concealed. A search on any of your properties in a DST will show ownership as the name of the DST; your name will not be on record in a public search. Finally, compared to an LLC, a DST is easier to manage and doesn’t require annual fees.
Ready to get started?
If you are interested in DST investments and want expert guidance you can count on, look no further than The Beacon Group. The team is well-versed in 1031 exchanges and has the skills and expertise to help you build your investment portfolio. So, if you’re looking for a top-notch commercial real estate team in San Diego County, you’ve found the right place. Get started today!
*Header photo courtesy of Shutterstock
*Header photo courtesy of Shutterstock
