How Do Seven Deadly Sins Govern DSTs

How Do Seven Deadly Sins Govern DSTs

By | January 27th, 2020|DST|0 Comments

DSTs are an exceptional investment vehicle. They not only offer you better monthly returns but also help you diversify your investment portfolio. DSTs provide investors hassle-free income and are managed professionally under the supervision of a trustee. To ensure that Trustees do not misuse their authority, the Internal Revenue Ruling 2004-86 introduced seven deadly sins that limit the Delaware Statutory Trust (“DST”) trustee’s power. These Seven Deadly sins are elemental for the proper functioning of a DST, and in case of non-compliance, there are severe consequences for both the DST and its beneficiaries.

 However, if followed correctly, these regulations provide the required security and assurance to the beneficiaries by ensuring that the trustee disburses funds accurately to beneficiaries and does not expose the DST’s assets to unnecessary risks. Let’s review the seven deadly sins drafted by the ruling and understand how does it help you.

1. Once a DST offering is closed, no future equity contribution is permitted to the DST, either by current or new beneficiaries.

When you acquire beneficial interests in a DST, you get a percentage of ownership in that DST, as per your investment amount. If a trustee accepts additional contributions to the DST after the offering is closed, your ownership percentages would be reduced and will negatively impact your claim to the DST’s assets. Yes, there could be few occasions when DST and the investors can benefit from additional contributions; however, the risk of further losses is mostly higher than the possibility that the increase in investment might turn the under-performing DST into a profitable DST.

2. The Trustee of the DST is restricted from borrowing any new funds or renegotiating the terms of the existing loans.

Once you decide to invest in a DST, the sponsor will disclose the loan amounts due. You should follow due diligence and understand the liabilities and how they would impact the returns before finalizing the investment. Trustees are not permitted to assume greater obligations because it can lead to a significant impact on the beneficiaries’ interests.

3. The Trustee is not allowed to reinvest the proceeds from the sale of its investment real estate.

This ruling mandates that all proceeds earned by the DST is distributed to the beneficiaries rather than be reinvested. IRS prohibits a trustee from reinvesting proceeds on behalf of the DST’s beneficiaries, ensuring that beneficiaries determine when and how to reinvest or use the capital gained from their investment in the DST. Mostly when the assets of a DST are sold, the DST sponsor will formulate a new DST offering, allowing beneficiaries to reinvest their capital with the sponsor. However, it is under the investor’s discretion to agree or cash out and reinvest elsewhere.

4. The Trustee is limited to making capital expenditures concerning the property to those for (a) standard repair and maintenance, (b) minor non-structural capital improvements, and (c) those required by law.

This ruling allows trustees to maintain the real estate property and its value reasonably, but it prohibits the trustee from risking the beneficiaries’ investment to enhance the property when there is no assurance that the cost of the upgrade will be recovered at the time of sale.

5. Any liquid cash retained in the DST between distribution dates can only be invested in short-term debt obligations.

Investments in short-term debt obligations are permitted as such advances can be easily claimed back into cash and is available for distribution to the beneficiaries at the distribution time. Short-term debt obligations, are low-risk and has the potential to increase the value of the DST benefitting the beneficiaries.

6. All cash, other than necessary reserves, should be allocated to the beneficiaries on a current basis.

DSTs are authorized to keep cash reserves to support unexpected expenses such as repairs and property management. However, they are required to distribute earnings and proceeds to all the beneficiaries within the specified timeframe. This limits the trustee from spending outside of permissible expenditures. It also preserves the beneficiaries’ rights to get their income regularly and use it as per their own liking.

7. The Trustee is not allowed to renegotiate the current leases or enter into new leases.

DSTs operate optimally when they have invested in long-term lease properties with creditworthy tenants on a triple-net basis. A master-lease structure to hold student and senior housing, multifamily, hospitality, and self-storage facilities are also perfect for DSTs. IRS prohibits a trustee from renegotiating existing leases or opting for new leases, ensuring that the trustee doesn’t change the terms of the DST or risk the investment. The ruling does allow for exceptions to be made in the case of a tenant bankruptcy or insolvency.

Bottomline

These seven deadly sins are in place to allow DSTs to qualify as suitable investments for a tax-deferred 1031 exchange. DSTs though, are excellent investment vehicles; it is essential to complete due diligence and choose the right kind of DST for better and secure returns.

We have been assisting investors with profitable and successful 1031 Exchanges for the past 15 years. If you are planning to sell your property and defer capital gains tax, please consult our advisors at 888-993-2835.or email.. info@1031xchange.com. and ensure peace of mind for all your investment needs.

 

“Our tax-deferred 1031 exchange programs can save millions in taxes, increase investor equity, and compound annual cash flow distributions and returns”