REIT vs DST
The Money Machine of REIT
REIT is the abbreviation for Real Estate Investment Trust. The US REIT was created in 1960 by the enactment of the Real Estate Investment Trust Act. According to the data collected on Nareit, REIT takes up a significant portion of US overall real property investments. The total equity market capitalization of the FTSE Nareit All REITs Index is worth $1.4 trillion. In 2019 alone, the dividend income of $65 billion was distributed to the shareholders in relation to REIT activities. In addition, REITs raised $109.4 billion in public market offerings in 2019 and collectively own more than $3.5 trillion in gross assets across the US, with stock-exchange listed REITs owning over $2.5 trillion in assets. More than 516,000 properties in the US are owned by REITs. As a result, REITs’ investments across the US have benefited millions of Americans. More than 145 million Americans live in households with REIT investments through their 401(K) and other investment funds. Over the last 20 years, REIT total return eclipses the S&P 500 Index, other indices, and the rate of inflation.
Generally speaking, there are four types of REITs: Equity REITs, mREITs, Public Non-listed REITs, and Private REITs. The most common one in the market is Equity REITs which are publicly traded. Because most REITs are listed on major stock exchanges, individuals can invest by purchasing shares of a REIT just like buying stocks.
The dividends distributed from REITs are the primary methods for their shareholders to obtain their financial interests. Required by law, at least 90% of REIT’s income must be transferred to its shareholders. Shareholders then pay their income tax on the dividends they received. In other words, REIT dividends are taxed as regular income. The most common model of REIT’s revenue is from rent collection through leasing its purchased properties.
What Exactly is REIT?
The United States Code Title 26 provides the statutory definition to answer this question. In Section 856, it prescribes the qualifications of a corporation, trust, or association that can be considered as a REIT.
(see 26 §§ 856(a)(1));
(see 26 §§ 856(a)(5));
(see 26 §§ 856(c)(2));
(see 26 §§ 856(c)(3));
(see 26 §§ 856(c)(4)(A));
To be part of a REIT, investors can contribute through purchased shares. In other words, investors are usually the shareholders of a REIT. It signifies that the investors bear the limited liability of the debts of the REIT up to the value of their shares. Thus, the worst scenario for a REIT investor is to lose all the share money he or she puts in.
Incompatibility with 1031 Exchange
The 1031 Exchange is named after the Internal Revenue Code (IRC) Section 1031. Under section 1031, an investor enjoys capital gains tax deferral through a like-kind exchange of real estate properties for the purpose of business and investment. However, instead of real property, REIT is categorized as a security. Thus, by the strict definition of the 1031 Exchange, REIT is not qualified, since 1031 does not permit exchange between a piece of property and a security.
DST v REIT
The Delaware Statutory Trust (DST) is based under Chapter 38, Part V, Title 12 of the Delaware Code. The related statutes are from 12 §§ 3801 to 3862. Contrary to REIT, there are a host of advantages of choosing DST.
Most REITs are registered as corporations. The laws upon corporations are notoriously complex. For the purpose of regulation compliance, it almost always requires professional consultancy for any REIT activities. However, DST is mainly under the principle of freedom of contract, it enjoys almost no government restrictions. The trust agreement is the primary legal force behind the trust’s daily operations. Hence, the trust owners do not have to possess an extensive amount of legal knowledge about government regulations.
As for liabilities, the Delaware Statutory Trust Act (see 12 §§ 3805(b)) provides that “no creditor of the beneficial owner shall have any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the statutory trust”. It puts DST on the same level of protection as REIT over the investors.
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