Take a little peek at what exactly is a DST.

What is DST?

Delaware Statutory Trust Act (DSTA) was passed in 1988. It was the first legislation of its kind across the United States. It trumps the disadvantages and flaws of the Common Law Trust on various grounds. Greater freedom of creating a trust is safeguarded in the legislation. Although other states have followed and enacted their own versions of DSTA, the Delaware version continues to evolve and appears to take the lead. Over the years, it has gained its popularity steadfastly in the United States. In 2004, DSTs were approved for 1031 Exchanges. It proved to be a massive boost for its prevalence. Per NES Financial data, almost $1billion growth of scrutinized 1031 sales in association with DST investments was recorded between 2017 and 2018.

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 most states which are still running common law trusts, Delaware is one of the few states in the United States that operates trust matters under a comprehensive legislation. In brief, “common law trusts” means the legal rules and principles of trusts are produced from court cases, whereas “statutory trusts” are directly rooted from the statutes enacted by a state legislature. When conflicts arise between statutes and case law in a specific legal question, the statutes must prevail. Therefore, it is a much easier task for a Trust holder to get his or her question answered within a few pages of statutes than reading through hundreds of cases. In the State of Delaware, the Delaware Court of Chancery is in charge of enforcing the terms in the agreements between trustees and beneficial owners (see 12 §§ 3804).

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    Benefits of DST

    There are numerous benefits to having a DST. The primary ones are listed below:

    Liability

    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”. This statutory footing maximizes the protection over the investor’s properties under DST. Beneficial owners may participate in management, or effectively control the statutory trust by directing the trustees, without taking on any personal liability (see 12 §§ 3806(a)).

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    Expediency

    DST empowers a Trustee like a general manager to make decisions about the properties. In contrast, other conventional property investment methods normally require every investor to consent for a single change or remedial action about the property. Such a process could go on for days or weeks. It puts DST standing out as a highly efficient tool to adapt to changing situations.

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    Size

    It is fairly easy and inexpensive to create a DST. No annual fees or franchise taxes are required by the State of Delaware.

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    Flexibility

    DST enjoys the principle of freedom of contract (see 12 §§ 3823(b)). It permits the parties to create flexible relationships that can tailor to their business needs in the DST Trust Agreement. Moreover, DST allows other persons to manage the Trust, including the DST’s beneficial owners. Such a management arrangement can be manifested in the Trust Agreement.

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    Cost

    It is fairly easy and inexpensive to create a DST. No annual fees or franchise taxes are required by the State of Delaware.

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    Eternity

    A DST is a separate legal entity (see 12 §§ 3801(i)(2)). Although DST deals usually last between five and ten years in practice, it will not terminate or dissolve by beneficial owner’s affairs, such as death, bankruptcy, or dissolution. Additionally, being a separate legal entity enables DST to appear as an independent party in a legal document with a third-party. Consequently, any liabilities incurred under DST’s name can only limit to DST itself.

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    Eternity

    Trust agreement can be structured by choice so that the DST could enjoy various efficient tax treatment most appropriate to investors’ business needs.
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    Certainty

    Because DST is a statutory trust, the DST Act provides comprehensive framework for legal reference. It expressly stipulates the authorization process and rules of governing.
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    Others

    The trust agreement does not have to be drafted in English and no approval is required from any authority in Delaware for the submission of such agreement. This could be a major attraction for business organizations or private trust holders.

    Access to Confidential Information

    In general, DST investors do not participate in the management of the trust itself. The trust is operated by the appointed Trustee. However, subject to reasonable standards as may be established by the Trustees, DST Title 12 ss 3819 provides limited rights for beneficial owners to obtain and inspect the following documents “from the statutory trust from time to time upon reasonable demand for any purpose reasonably related to the beneficial owner’s interest”:

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    Copies of the governing instrument, certificate of trust, and all amendments, together with copies of any written powers of attorney.

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    A current list of the name and last known business, residence, or mailing address of each beneficial owner and trustee.

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    Information regarding the business and financial condition of the statutory trust; and

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    Other information regarding the affairs of the statutory trust as is just and reasonable.

    However, such a right to access confidential information by a beneficial owner is not absolute. The trustee can withhold requested documents “for a period of time” as he or she deems reasonable. By withholding such documents, the Trustee must act in good faith in the best interest of the statutory trust. Any demands of document access from the beneficiaries must be in writing and state the purpose of such demand.

    The legal authority from the court pertaining to this right can be found in Grand Acquisition LLC v Passco Indian Springs DST, C.A. 12003- VCMR (Del. Ch. Aug. 26, 2016). It is interesting to observe that the Court resorted to LLCs and LLPs cases to interpret the rights stipulated in section 3819 of DST Title 12. In brief, the court would only apply section 3819 if the trust agreement specifies. Otherwise, the beneficiaries can access the Trust’s books and records based on the terms laid out in the trust agreement. In other words, the terms in the trust agreement related to the beneficial owner’s right to inspect the Trust’s records and books trump the owner’s statutory rights derived from DSTA. Additionally, the Court also affirms that the trustee bears the burden of proof if he wields “improper purpose defense”. The trustee has to demonstrate proof of probable harm to the trust by releasing requested documents to the beneficial owner.

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    Choosing Properties

    Generally, short-term capital gains are taxed as ordinary income according to federal income tax brackets. The long-term capital gains tax rate in 2020 is 15% for the bracket between $53,601 and $469,050, and 20% for $460,050 or more. Therefore, the combination of DST and 1031 Exchange can be a powerful tool for ambitious investors to defer their capital gains tax. For the purpose of the 1031 Exchange, choosing appropriate DST can be critical. Although the range of replacement properties under the 1031 Exchange scheme is wide, only investment real estate qualifies for a 1031 exchange. It is known that any properties held for business purposes for a period of one year are covered under 1031 Exchange. With that being said, properties invested by the DST for the purpose of 1031 Exchange should satisfy the property requirement aforementioned. Proceeds from the investment real estate sale do not have to be invested fully in one DST property. It would be wise to distribute it across multiple DST properties. Such a diversified portfolio by taking advantage of DST’s fractional ownership feature can surely minimize the investment risks.