One of the most overlooked strategies for real estate investors involves the power of real estate for long-term estate planning. Specifically knowing how to utilize DSTs and UPREITS for long-term estate planning can be powerful tools for potentially preserving wealth and securing a financial legacy across multiple generations.
The Delaware Statutory Trust (DST) offers real estate investors a way to defer capital gains taxes via the 1031 exchange and the opportunity to step away from active property management and the infamous 3 T’s of Tenants, Toilets, and Trash. The Umbrella Partnership Real Estate Investment Trust (UPREIT) via a 721 exchange, on the other hand, provides a path to potentially greater liquidity and greater flexibility when it comes to legacy planning.
Both strategies have the potential to help investors minimize tax liabilities while also optimizing their potential investment returns. As a result, both strategies are important to understand for anybody focused on generational wealth and financial security.
This article will explore how these two options can work together to provide a potential blueprint for smarter long-term estate planning.
What Are Delaware Statutory Trusts (DSTs)?
Before we begin, let’s first look at exactly what is a Delaware Statutory Trust (DST). A DST is an ownership model which is eligible for a 1031 exchange-like-kind property, and in which co-investors can purchase fractional beneficial interests in the holdings and assets of a trust. At its core, the Delaware Statutory Trust allows for the creation of a legal entity that enables multiple investors to pool money to co-own fractional interests. The DST is a legal entity designed to hold title to investment-grade real estate, allowing multiple investors to own proportional shares in properties such as multifamily buildings, multi-tenant retail shopping centers, self-storage facilities, and net lease industrial facilities. Many of these types of DST offerings can be found on the Kay Properties & Investments online marketplace at www.kpi1031.com.
Since its adoption in 2004 as a 1031 exchange vehicle, the DST structure has gained great popularity among investors, and as a real estate investment tool, is expected to raise more than $5.5 billion in equity by the end of 2024.
What are Some Potential Benefits of Delaware Statutory Trusts (DSTs)?
Being an accepted and smart investment strategy for 1031 exchange investors, DSTs offer several other very important benefits to the structure that make it a popular choice for real estate investors.
Passive Investing
One of the most popular of these is the passive nature of the Delaware Statutory Trust structure. DSTs provide a passive investment approach, removing the need for direct property management, and offering significant benefits in long-term estate planning.
In a DST, the day-to-day care of the property is handled by a professional asset manager, who oversees all investor reporting, rental negotiations, and monthly distributions. Because many real estate investors have had their lives consumed with being pinned to real estate property management and/or asset management responsibilities, the passive nature of DSTs offers investors the opportunity to focus on what they truly love in life, whether that be their children, grandkids, travel, hobbies, or other endeavors (NO MORE 3 T’s – Tenants, Toilets and Trash!).
Tax Deferred Investing
Per section 1031 of the Internal Revenue Code, real estate investors—under specific guidelines—may potentially defer their capital gains tax, depreciation recapture tax, and other taxes (each investor should consult their own CPA/attorney since every situation is unique). Upon the sale of investment real estate, the proceeds would go to a Qualified Intermediary, then the investor must purchase real estate of equal or greater value and has 45 days to “identify” replacement property with a concurrent 180-day timeline to close. Through what’s known as the Internal Revenue Service’s Revenue Ruling 2004-86, DSTs have been recognized as vehicles for investors looking for like-kind real estate as 1031 exchange replacement property. In many cases, using a DST as part of a 1031 exchange can help investors defer more than 40% of taxable income.
By utilizing 1031 Exchanges, investors can strategically defer taxes, allowing the proceeds from property sales to remain invested and fuel compound growth potential. This not only potentially expedites the wealth-building process but also maximizes monthly income potential by ensuring more capital is actively invested as opposed to going to pay taxes. Then at the passing of the owner (s) of the real estate portfolio, the heirs are eligible to receive a step-up in basis and the potential for eliminating all of the deferred taxes.
Diversification:
Because of the ability to invest smaller amounts of capital into larger real estate offerings, investors have the potential to create greater diversification in their real estate portfolio. Please note, that diversification does not guarantee profits or protects against loss.
The Delaware Statutory Trust structure allows investors to diversify their 1031 exchange equity amongst multiple DST offerings, multiple DST sponsor companies, multiple asset classes, and multiple geographic locations. For example, instead of owning one $5 million dollar multifamily building in Southern California, investors can reinvest that $5 million of equity, utilize a tax-deferred 1031 exchange, and invest into a diversified portfolio of DST offerings consisting of: $1 million into a multifamily DST that has four multifamily communities with a total of 1,500 units and diversified amongst 4 distinct geographic locations, $1 million into a debt-free DST which owns a multi-tenant small bay industrial facility, $1 million into a debt-free net lease industrial facility subject to a long term net lease with a Fortune 500 investment grade tenant, $1 million into a debt free DST medical facility subject to a long term net lease with an investment grade dialysis provider and then $1 million into a self-storage facility DST.
As is evidenced in the above example, the diversification potential with a DST portfolio is tremendous compared to owning just one multifamily property in one location.
Estate Planning
The fractional interest aspect of DSTs allows owners to easily divide DST shares up any way they like. For example, an investor who owns 30 units in an apartment DST and 50 units in a DST portfolio of net lease properties might choose to give the apartment DST to one child and the net lease DST to the other child, or he can divide up the shares within each DST to give some of each to both children.
For investors who want to divide ownership more precisely by percentage of value, DST asset managers often can create an estimation of value for the date of the demise.
What Are UPREITs?
Section 721 of the Internal Revenue Code states that no gain or loss will be recognized when property is contributed to a partnership in exchange for an interest in the partnership.
Sometimes called the “two-step 721 Exchange Process”, when an investor sells an investment property with the intention of executing a 1031 exchange, the investor can use the proceeds funds to purchase an interest in a DST and hold for a period of time. Upon the DST going “full-cycle”, the investor can exchange their interest in the DST and contribute them on a tax-deferred basis into the 721 vehicle’s operating partnership in exchange for operating partnership units.
The term full-cycle refers to the complete lifecycle of the investment, from acquisition to eventual sale and distribution. This means that instead of selling property and triggering capital gains taxes, owners can contribute real estate to the UPREIT structure in exchange for operating partnership units.
Potential Benefits of the UPREIT for Real Estate Investors
Investors are attracted to the 721 UPREIT structure for a number of reasons. Some of these include:
Tax Advantages:
When a piece of real estate is sold (including a Delaware Statutory Trust), the investor is subject to paying capital gains on the realized appreciation along with other taxes. However, the 721 UPREIT exchange allows investors to defer capital gains taxes by exchanging interests in a Delaware Statutory Trust for shares of a 721-operating partnership.
Potential Diversification:
Many investors incur concentration risk by owning one property in a single market. The 721 UPREIT vehicle tends to own many assets diversified through different markets. Through the 721 exchange transaction, investors can achieve greater diversification by reducing concentration risk.*
Diversification does not guarantee profits or protect against losses.
Income Potential
Investors can potentially receive income generated through distributions to the holders of the OP Units. Over the course of time, the 721 vehicle will have the goal of increasing income potential to investors over time through accretive acquisitions and portfolio optimization. In addition, investors may also enjoy depreciation and other write-offs to help shelter distributions.
Appreciation Potential
Investors can potentially participate in potential appreciation realized at the individual asset level as well as at the enterprise value level. In many cases, the 721 vehicle will be positioned to take advantage of market opportunities via new acquisitions designed to enhance shareholder value. In addition, the 721 vehicles can be positioned to optimize the portfolio through select asset sales and subsequent 1031 exchanges into new opportunities with greater appreciation potential.
Liquidity Potential
The 721 UPREIT vehicle may also provide investors the option to liquidate a portion of their shares in combination with their tax planning strategies.
“Investors may find the UPREIT (Umbrella Partnership Real Estate Investment Trust) structure appealing because it allows them to contribute property to a REIT in exchange for operating partnership (OP) units, deferring immediate capital gains taxes. This structure provides access to the diversification and liquidity of a REIT, enabling investors to participate in a professionally managed, potentially income-producing real estate portfolio without the responsibilities of direct property ownership. Additionally, OP units can often be converted into REIT shares or cash, offering flexibility and potential long-term growth opportunities,” said Chay Lapin, President of Kay Properties & Investments.
Comparing DSTs and UPREITs
Delaware Statutory Trusts (DSTs) and Umbrella Partnership Real Estate Investment Trusts (UPREITs) DSTs and UPREITs have the similar objectives of providing investors with a tax-efficient passive investment strategy that is centered around real estate.
Let’s break some of these differences down.
Basic Structure:
| Delaware Statutory Trusts | UPREITs |
| DSTs use a fractional ownership model where investors own a share of a property (or properties) held in a trust. Each investor is a passive owner, with the sponsor managing the asset.
|
UPREITs allow investors to contribute their property into a REIT in exchange for Operating Partnership (OP) units, deferring capital gains taxes and gaining access to the REIT’s diversified portfolio. |
Tax Deferral:
| Delaware Statutory Trusts | UPREITs |
| DSTs are used in 1031 exchanges to defer taxes on capital gains from a property sale. Internal Revenue Service’s Revenue Ruling 2004-86, DSTs have been recognized as vehicles for investors looking for like-kind real estate as 1031 exchange replacement property. | Contributing property to a REIT in exchange for OP units also defers capital gains taxes but doesn’t qualify directly under 1031 exchange rules. Rather, this strategy uses Section 721 of the Internal Revenue Code which states that no gain or loss will be recognized when a property is contributed to a partnership in exchange for an interest in the partnership. |
Ownership and Liquidity:
| Delaware Statutory Trusts | UPREITs |
| Investors of DSTs own a percentage of a specific property. This concept, often called “beneficial interest” allows investors to invest smaller amounts into larger properties than they might otherwise be able to. Liquidity is limited until the asset is sold or the DST goes full-cycle. | OP units can potentially be converted into REIT shares, providing liquidity and access to public markets if the REIT is publicly traded. |
Income Potential:
| Delaware Statutory Trusts | UPREITs |
| Investors typically receive regular potential income distributions from property rents. The income is tied to the performance of specific assets. | Investors may receive potential distributions tied to the REIT’s overall portfolio performance. In addition, investors may also enjoy depreciation and other write offs to help shelter distributions.
|
Diversification:
| Delaware Statutory Trusts | UPREITs |
| DSTs provide investors the potential for greater diversification by allowing investors to invest smaller amounts of money across different asset classes, geographic regions, and tenant mixes. | The 721 UPREIT vehicle typically owns many assets diversified through different markets. Through the 721 exchange transaction, investors can achieve greater diversification by reducing concentration risk.*
*Diversification does not guarantee profits or protect against losses.
|
Exit Strategy:
| Delaware Statutory Trusts | UPREITs |
| At the end of the holding period, investors can reinvest proceeds through a 1031 exchange or cash out (subject to taxes). | Investors may convert OP units to REIT shares or cash, offering flexibility but potentially triggering taxable events. |
Strategies for Integrating DSTs and UPREITs into Estate Planning
Investors can incorporate both Delaware Statutory Trusts (DSTs) and Umbrella Partnership Real Estate Investment Trusts (UPREITs) into estate planning by leveraging the underlying tax deferral opportunities found within each investment structure. By deferring capital gains taxes and reinvesting proceeds from a DST full cycle into a 721 exchange UPREIT, investors can benefit from reduced taxes, the potential for greater diversification and appreciation, and the ability to simplify asset distribution with a stepped-up basis for heirs.
In addition, DSTs and UPREITs also have the potential to complement traditional estate planning tools like trusts, wills, and power of attorney agreements to streamline the transfer of wealth to heirs. Step-up cost basis provisions minimize capital gains tax burdens for beneficiaries, preserving family wealth.
It is critical for investors to consult their Certified Public Accountant (CPA), tax attorney and family members before deciding to invest in either DSTs or UPREITs.
About Kay Properties and www.kpi1031.com:
Kay Properties helps investors choose 1031 exchange investments that help them focus on what they truly love in life, whether that be their children, grandkids, travel, hobbies, or other endeavors (NO MORE 3 T’s – Tenants, Toilets and Trash!). We have helped 1031 exchange investors for nearly two decades exchange into over 9,100 – 1031 exchange investments. Please visit www.kpi1031.com for access to our team’s experience, educational library and our full 1031 exchange investment menu.
This material is not tax or legal advice. Please consult your CPA/attorney for guidance. Past performance does not guarantee or indicate the likelihood of future results. Diversification does not guarantee returns and does not protect against loss. Potential cash flow, potential returns and potential appreciation are not guaranteed. There is a risk of loss of the entire investment principal. Please read the Private Placement Memorandum (PPM) for the offerings business plan and risk factors before investing. Securities offered through FNEX Capital LLC member FINRA, SIPC.
