The History of Delaware Statutory Trusts

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Commercial real estate has long been seen as an “alternative” investment option with significant barriers to entry, inaccessible to the average investor. The high costs, lack of readily available property information, and risks associated with buying individual properties have meant that only the most well-off individuals and institutions, such as life insurance companies, endowments, pension funds, family offices, and extremely high-net-worth individuals, have been able to enter the space. Enter: Delaware Statutory Trusts. 

The advent of Delaware Statutory Trusts (DSTs) has started to change the landscape and make commercial real estate a more accessible investment option. DSTs allow individuals to invest fractionally in a trust which holds one or more commercial real estate properties. The sponsor of the DST then oversees the day-to-day management of the properties within the trust on behalf of its collective investors. 

Through this structure, DSTs have made it possible for a broader range of investors to invest in commercial real estate and benefit from its potential returns. By pooling resources and spreading the risks of property ownership, DSTs have reduced the barriers to entry and increased access to this valuable asset class. As a result, more and more investors are turning to DSTs as a way to diversify their portfolios and tap into the growth potential of commercial real estate. 

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The History of DSTs

Trusts have been a popular tool for wealthy Americans to transfer property from one generation to another, offering tax and security benefits not available through other methods. Delaware, known for its pro-business and tax-friendly policies, has a long history of recognizing business trusts and is home to many Fortune 500 companies. 

In 1988, Delaware solidified its common law around trusts by becoming the first state to establish the Delaware Statutory Trust (DST) as a secure legal entity. The 1988 Delaware Business Trust Act provided clear guidelines for trust operation, giving investors the assurance they needed to invest with confidence. Trust income, including capital gains, have been tax-free in Delaware for decades, regardless of the residency of the trust owner. This makes Delaware an attractive option for those seeking to take advantage of the state’s trust tax provisions. 

While other states have introduced trust legislation, Delaware continues to be a favored location for trustees due to its comprehensive and well-defined laws governing business entities. The state’s Court of Chancery and Supreme Court have gained a reputation for excellence and are known for efficiently resolving business-related disputes with fairness and promptness. The vast body of Delaware case law serves as a valuable resource for those seeking guidance on trust-related matters. 

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The Delaware Statutory Trust Act (DST Act) was introduced in 2002, replacing the Delaware Business Trust Act. The DST Act explicitly authorizes the creation of Delaware Statutory Trusts and provides clear rules for their internal operations. The Act recognizes DSTs as a separate legal entity with the ability to conduct any lawful business or purpose. The death, incapacity, dissolution, termination, or bankruptcy of a beneficial owner will not result in the dissolution of the DST unless specified in the Trust Agreement. Additionally, DSTs are permitted to secure financing under their own name, rather than under the names of individual investors. 

The DST Act also offers substantial protection to investors by limiting their personal liability. This protection, along with the broad indemnification provisions, provides peace of mind for investors investing in DSTs and ensures that potential liabilities are strictly limited. 

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Delaware Statutory Trusts vs. Tenant-in-Common

The 2002 DST Act offered a more streamlined and secure option for those looking to invest in commercial real estate. Prior to this, co-investing was often done through a tenant-in-common (TIC) structure, where each individual holds a fractional share of the property’s title, resulting in personal liability for any debt associated with purchasing or improving the property. With TICs, the process of underwriting each individual investor can be complicated, and decisions involving the TIC require unanimous approval among all co-investors, making decision-making difficult. The DST Act, on the other hand, made it easier to invest in commercial real estate, as financing is secured by the DST and not individual investors, and decision-making is less cumbersome. 

Despite the benefits of investing in a Delaware Statutory Trust (DST) over a tenant-in-common (TIC) structure, TICs remained popular until the mid-2000s. This was due to the 2002 IRS Revenue Procedure, which established guidelines allowing TIC real estate to qualify for 1031 tax-deferred exchanges. This resulted in a surge of investment in TICs, with almost $4 billion invested in 2007. However, the limitations and inefficiencies of the TIC structure soon became apparent. 

As a result, DSTs gained popularity, especially when the IRS adopted similar 1031 exchange guidelines for DSTs in 2004 through Revenue Ruling 2004-86. This allowed the beneficial interests of a DST to be treated as direct interests in replacement property for tax-deferred exchanges. The ruling was met with enthusiasm by real estate investors across the U.S. 

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Real Estate During the Great Recession 

The Great Recession, which occurred between 2007 and 2009, had a profound impact on the real estate industry. The financial crisis caused property values to plummet, and the real estate market became increasingly difficult for investors. At the same time, co-investment in real estate- both through TICs and DSTs- became increasingly popular as a way to reduce the risk associated with investing in a single property. 

Despite the uncertainty of the economic environment, many investors chose to move forward with co-investment opportunities. In some cases, this was due to a lack of alternative investment options. In other cases, investors were simply seeking a way to diversify their portfolios and reduce their exposure to the stock market. 

Regardless of the motivations behind it, the trend of co-investing in real estate continued throughout the recession. TICs, in particular, remained a popular option for those looking to defer capital gains tax. Meanwhile, DSTs gained popularity as more investors became aware of the many advantages they offer, including the protection from personal liability and the ability to diversify and help mitigate investment risk. 

Overall, the Great Recession reinforced the importance of diversification and risk mitigation strategies for many real estate investors. While the real estate market may have been volatile during this time, the trend towards co-investment in real estate proved to be a way for many to weather the storm. 

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A Future Outlook of Delaware Statutory Trusts 

The demand for DST investments may remain robust in the future. With a backlog of investors who have been holding off on listing their property for sale until after the pandemic, many may consider using 1031 exchanges and choose DSTs for investment. Additionally, more and more cash investors are turning to DSTs as a way to diversify their portfolios. Accredited investors seeking passive real estate investment opportunities may find DSTs to be an attractive option with its numerous potential benefits such as diversification of assets and locations. 

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General Disclosure

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication. 

1031 Risk Disclosure: 

  • There’s no guarantee any strategy will be successful or achieve investment objectives; 
  • All real estate investments have the potential to lose value during the life of the investments; 
  • The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities; 
  • All financed real estate investments have potential for foreclosure; 
  • These 1031 exchanges are offered through private placement offerings and are illiquid securities. There is no secondary market for these investments. 
  • If a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions; 
  • Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits

Perch Wealth is an investment firm specializing in real estate and alternative investments, offering an unparalleled opportunity for select investors to build diversification into their portfolios. 

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