Delaware Statutory Trust – Implication to Landowners & Farmers

The Delaware Statutory Trusts (DST) is a newer investment vehicle that allows real estate property owners, including farmers and ag landowners, to purchase tenants in common ownership in passive investment properties. DSTs are separate legal entities and are becoming a more popular choice for Internal Revenue Code Section 1031 exchanges. Revenue Ruling 2004-86 allows a DST to own 100% of a real estate asset and allows a maximum of 499 investors to own an interest in the trust. Delaware Statutory Trusts have many advantages over traditional real estate purchases and traditional 1031 Exchanges. Investments in Delaware Statutory Trusts can appear very similar to investments in a Real Estate Investment Trust (REIT). The trust owns the property but the investor is co-invested in the trust along with other qualified investors.

One of the major benefits of a DST is the ability to diversify your investment. Rather than simply purchasing one or maybe two replacement properties in a Section 1031 Exchange, the DST often invests in many different properties as part of the fund’s strategy. I often compare investing in a DST to investing in a mutual fund. Rather than purchasing a single asset (or single stock), a DST (or mutual fund) uses pooled funds from investors to acquire many different assets. Most DST’s have an asset class in which they focus (ex: multi-family, industrial, retail, etc) as well as targeted geography. However, within those asset classes, DST’s commonly purchase multiple assets which allows the investor to spread their risk over numerous properties.

More and more investors are attracted to Delaware Statutory Trusts because of their hands-off nature. It’s another advantage of a DST compared to other Section 1031 exchange assets. Rather than having to play landlord and collect rent each month from tenants, the DST is allowed to be the property manager and oversee property operations on behalf of the investors. Investors in a DST receive passive, hands-off, mailbox money. While some view the passive, hands-off nature of a DST as a benefit, others who want direct control over their investments might view this as a negative. Investors who are used to having total control of investments (either real estate or stock/bond investments) might not like the fact that a management group of experts in deciding which properties to invest in with their money.

As mentioned, Revenue Ruling 2004-86 officially allows interests in a Delaware Statutory Trusts to qualify as replacement property for Internal Revenue Code Section 1031 Exchanges. This code section allows real estate investors to defer paying taxes on the sale of a property by reinvesting the sale proceeds into qualified “replacement” property. Executing a 1031 exchange sounds very simple on paper, but challenges often exist in finding the right replacement property. To fully defer taxes on the sale, real estate investors must purchase replacement property equal to, or greater than the sales price of the sold property. For example, if a real estate investor sold a property for $750,000 without any associated mortgage, the replacement property must be purchased for at least $750,000 to fully defer taxes. The issue many investors face is finding replacement property that fits both their investment criteria and price point. Delaware Statutory Trusts can help solve these two issues. First, these funds typically only have a minimum investment, meaning that investors can easily roll all of their proceeds forward into the trust. Second, funds typically have a focused investment approach which enables real estate investors to pick which asset class and geography in which they want to invest, via the trust. For example, a specific DST might have a minimum investment of $50k and only invest in citrus groves in Florida or industrial development land in Texas. DST’s provide the real estate investor ease in completing a Section 1031 exchange. For further guidance on Internal Revenue Code Section 1031 exchanges and how they apply to land and agriculture, please read 1031 Exchanges: 5 Things That Landowners Need to Know."

Within the 1031 Exchange context, investing in a DST also enables investors with a small amount of proceeds to invest in A level, high-quality assets. 1031 Exchanges can apply whether an investor owns a duplex in a bad neighborhood or the top ag land in the area. Because DST’s pool funds together, investors who sell B or C quality assets can reinvest their proceeds in high quality, safer assets through a DST. As mentioned, DST’s often have low minimum investments which make them accessible for a wide range of real estate investors.

Even though DST’s are traditionally commercial real estate investment vehicles, there are some opportunities within the agriculture and land industry for real estate investors. First, farmers, ranchers, & landowners should consider a 1031 exchange upon the sale of their property as outlined in "1031 Exchanges: 5 Things That Landowners Need to Know." Additionally, funds received from a government or non-profit entity in exchange for a conservation easement also qualify for 1031 exchanges and thus, investment in Delaware Statutory Trusts. Many landowners and farmers who sell their land want to reinvest the proceeds into income-producing, safe investments that can provide needed cash flow for retirement. A DST is a great option for farmers and ranchers because they can provide hands-off, passive, and steady income.

One negative of Delaware Statutory Trusts is that the investment is very illiquid. It’s extremely difficult to dispose of your interest in the DST until the investment cycle of the fund is complete. Most DST offerings will outline the estimated investment period, which is the length of time in which the DST will hold the investment to achieve the maximum rate of return. Investors in a DST should understand that this is a long term investment. Because of the difficulty in disposing of the DST interest, investors should not view this investment as a rainy day fund or funds they can access in case of an emergency. Funds used in a DST investment are generally tied up & inaccessible until the fund’s investment period is complete.

In conclusion, farmers, ranchers, and landowners who are looking to generate future income should consider investing in a Delaware Statutory Trust. However, these investors should be aware of the long term nature of DST investments. The many benefits, including diversification, passive income, and 1031 exchange eligibility make DST’s attractive and appealing.

Tyler Davis is a CPA who works for SVN: Saunders Ralston Dantzler real estate as an asset manager. SVN: Saunders Ralston Dantzler is leading agricultural land brokerage based in Lakeland, FL. He also owns his own CPA Firm, Tyler Davis CPA where he provides tax preparation, consulting, and provision services. Tyler can be contacted at tyler.davis@svn.com.