Is a Delaware Statutory Trust (DST) a Legal Entity?

Is a Delaware Statutory Trust (DST) a Legal Entity

Formed under the laws of the State of Delaware, a Delaware Statutory Trust (“DST”) is an independent legal entity. As an independent legal entity, DSTs have many advantages that make it an appealing investment vehicle for various investors. Because of this, DSTs have proven to be a flexible and useful entity for numerous applications, including, but not limited to a real estate investment vehicle through the use of 1031 exchanges.

How is a
Delaware
Statutory Trust Formed?

A DST is formed by the filing of a certificate of trust with the Secretary of State of the State of Delaware and the adoption of the governing documents. The only requirement is that the certificate provide the name of the DST and the name and address of the Delaware trustee. The minimal requirements make DSTs easy to form.

Furthermore, despite being formed under the laws of the State of Delaware and the requirement of a Delaware trustee, DSTs are likely managed by out of state co-trustees and its managers. As a result, DSTs are accessible for various investors in and outside of the State of Delaware.

Additionally, DSTs are able to hold title to real properties located outside the State of Delaware. This feature adds to the attractiveness of DSTs for investors looking to take advantage of 1031 like-kind exchanges.

What Determines the Actions of a Delaware Statutory Trust?
The actions of a DST, through its trustee and managers, are governed by the trust document. The trustor of a DST is given extraordinary freedom to draft the governing documents in accordance to its goals and preferences. This freedom is acknowledged in the language of the Delaware Statutory Trust Act (“DSTA”) and by the courts of the State of Delaware.

The DSTA does, however, contain default provisions that might apply if a DST’s governing documents are silent on the provision in question. Nevertheless, the provisions contained in a DST’s governing documents will trump the default provisions contained within the DSTA. As such, drafters of a DST’s governing documents must explicitly incorporate the default provisions of the DSTA. Likewise, drafters should also make clear if a default provision of the DSTA is to be excluded.

Additionally, there is no requirement that the trust document be recorded or filed with the Secretary of State of the State of Delaware. As such, this allows DSTs to have confidentiality and can keep many details of the trust documents from becoming public information. This might be a great advantage for those creating the DST.

Is a Delaware Statutory Trust always an independent legal entity?

The DSTA was recently amended to allow for DST to opt out of being recognized as an independent legal entity. Under the DSTA, as amended, a DST may opt out of this status if the certificate of trust and the governing documents explicitly provide that the DST will not be a separate legal entity. As a result, investors may need to do their due diligence in checking with the DST and/or its documents to determine if the DST is an independent legal entity.

It should be noted that the designation of whether a DST is an independent legal entity or not continues for as long as the certificate of trust is valid. This, however, is subject to the actual language of the certificate of trust and/or governing instruments.

How are the Liabilities of a Delaware Statutory Trust Allocated?
The liabilities of a DST are similar to that of limited liability entities and corporations. While the DST may incur debt and liabilities as an independent legal entity, the beneficial owners enjoy the same protections as stockholders of a corporation. In order words, the beneficial owners of a DST will not be personally liable for the debts and liabilities incurred by the DST.

Additionally, the trustees and managers of a DST are generally not personally liable for the acts and obligations of the DST. There may be some exceptions to this general rule if it is determined that the trustees and/or managers acted without good faith and fair dealing.

Furthermore, a beneficial owner’s interest in a DST is protected from the judgment creditors of other beneficial owners. This means that if a judgment is entered against one of the beneficial owners, the judgment creditor cannot go after the DST’s assets, so long as the assets are held by a bank or trust company. This is also true if a beneficial owner files for bankruptcy. If a beneficial owner files for bankruptcy, the trustee will not be able to make the DST’s assets as part of the bankruptcy estate. This bankruptcy protection, however, also requires that the the assets are held by the bank or trust company.

How are Delaware Statutory Trust Taxed?

DSTs have the flexibility to be structured as corporations and partnerships in addition to trusts. As such, the structure of a DST will determine the tax consequences and benefits.

As for the beneficial owners, each will receive an end of year statement showing the pro-rata share of the DST’s income and expenses. These pro-rata portions of income and expenses are treated the same way as other rental or investment properties that a beneficial may also hold. Additionally, beneficial owners are able to take advantage of possible depreciation deductions to help shelter the income received from the DST.

Another thing to keep in mind is that depending on where the DST held real properties are located, beneficial owners may need to file separate state income tax returns. This requirement of filing a separate state income tax is only needed if the state where the property is located is in a state that has income tax. As a result, this would not be needed if the property was located in Texas or Florida since both states do not have income tax.

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