3 Investor Mistakes to Avoid with DSTs

In addition to current trends, tax-savvy real estate investors have witnessed a wave of sellers using a 1031 exchange (opens in a new tab) and Delaware Statutory Trusts (opens in a new tab) (DST) as their replacement properties. For investors looking to get started, however, there are three investor mistakes to avoid with DSTs.

DST (opens in a new tab) are passive interests in large institutional-grade real estate syndications. Real estate investors can choose from investments such as Amazon fulfillment centers, manufactured home parks, industrial buildings, retirement homes, self-storage, Class A apartment buildings, Walmart stores, FedEx buildings, medical buildings, hotels and other categories of commercial real estate. DSTs can provide immediate, passive income, growth potential, freedom from owner obligations, and no personal liability.

Why invest in a DST?

The concept is simple: sell today and guarantee a favorable price for your property, because real estate has appreciated considerably in recent years.

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Use the 1031 exchange and pay no tax if you follow the rules and use a qualified intermediary (opens in a new tab)and to be forever freed from the tyranny of landlord duties and responsibilities, often referred to as the terrible Ts (tenants, toilets and trash cans).

An estimated 10,000 Americans a day celebrate their 65th birthday in the United States, and DSTs are considered by many real estate investors to be a near-perfect solution to their real estate and financial planning needs.

DSTs are usually offered by large national real estate companies, many of which have a long history, reputation and track record. In addition, they are offered by registered investment advisers and dealers, and only to investors qualified by private placement memorandum.

DSTs have drawbacks

DSTs are not without pitfalls. Therefore, any savvy and prudent real estate investor should be aware of the pros and cons of these investments before allocating capital to a DST or any other investment.

DST Deadly Sin #1: Not assessing your personal cash needs.

Every investor, especially those who are retired or close to retirement, should assess their need for cash. Unfortunately, DSTs are not liquid investments and there is no credible secondary market for the resale of DSTs. Therefore, if an investor has not already resolved their own liquidity and liquidity reserve needs, a DST may not be an appropriate choice.

At a minimum, an investor can consider withdrawing some of the money from the exchange and putting those funds into a cash reserve account commonly referred to as a “boot”. Any sound and prudent financial plan recognizes the importance of liquidity as a top priority. Many real estate investors are real estate rich but “cash poor”, which can leave them vulnerable. Each investor should take stock of their balance sheet and ensure they have sufficient cash elsewhere if they choose full tax deferral, which requires transferring all proceeds from the sale into the new real estate investment, DST or otherwise, under the 1031 rules.

For this reason, some investors today choose to invest in QOZ (qualified opportunity areas (opens in a new tab)) instead of DST because the QOZ separates base and cap gains.

The investor is free to do what he wants with the base, including keeping the base in a safe liquid account rather than investing the base. This flexibility contrasts with the rules of a 1031 exchange for an investor seeking full tax deferral.

The QOZ can provide a shelter for capital gains, which can defer all taxes on the sale while the investor accesses their base for other planning or investment purposes. Additionally, some consider the QOZ to be better suited to their needs due to what they consider to be much more flexible and optional than a 1031 exchange. (opens in a new tab).

DST Deadly Sin #2: Wanting and expecting aggressive feedback from a DST.

DSTs are passive, institutional-grade, cash-flow stabilized real estate investments. Therefore, they are not “get-rich-quick” investments. Instead, they’re generally considered most appropriate for conservative investors who are willing to trade the possibility of “getting killed” for what they perceive as assurances of “not getting killed.”

DSTs are considered by many to be less risky than many other real estate investments. Therefore, they may have more conservative returns than riskier property investments involving lower quality assets, developments or syndicates which may lack the experience and track record that a conservative investor may seek.

DST investors should be comfortable with “singles” and an occasional “double”. Investors wishing to swing for fences regarding risk may be better served with other investment options more suited to their situation and their desire to work and take risks.

DST Deadly Sin #3: Neglecting to consider all of wealth.

A good wealth advisor with the training, skills, knowledge, team and experience to look at the full wealth management picture can be an invaluable resource for a real estate investor. I recently advised an investor who contacted our office looking for a DST solution. After further conversation, I learned that the investor had a large number of hanging passive losses on his tax return. In addition, the real estate investor would soon conclude on a property that would generate a significant capital gain. This real estate investor was “cash-poor”, real estate-rich and undiversified.

My advice was to ignore the DST and 1031 trade and use the sell as an opportunity to carry over those suspended losses and shelter the pending capital gain. The investor was quite surprised to learn that these basic skills, which covered all aspects of managing his wealth, his income and his taxation, could translate into advice that he found extremely valuable.

In summary, DSTs can be very useful and attractive to the right investor at the right time, provided that the investor’s entire wealth, tax and tax situation has been taken into account, discussed and analysed.

Daniel C. Goodwin, pension advisors (opens in a new tab) and AAG Capital, Inc. (opens in a new tab) are not lawyers and do not provide legal advice. Nothing in this article should be construed as legal or tax advice. An investor would always be advised to seek competent legal and tax advice for their own circumstances and state specific laws. Please visit our website at provident1031.com (opens in a new tab).

This article was written by and presents the views of our contributing advisor, not Kiplinger’s editorial staff. You can check advisor records with the SEC (opens in a new tab) or with FINRA (opens in a new tab).

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