DST Legal & Structural Overview
A look into the legal framework of Delaware Statutory Trusts as defined by IRS Revenue Ruling 2004-86.
The "Seven Deadly Sins"
For a DST to qualify for a 1031 exchange, the IRS imposes strict limitations on the powers of the trustee. These are often referred to as the "Seven Deadly Sins." The trustee cannot:
- Dispose of the property and acquire new property.
- Accept additional capital contributions to the trust.
- Renegotiate the terms of existing loans or borrow new funds.
- Reinvest the proceeds from the sale of its real estate.
- Enter into new leases or renegotiate existing leases (with some exceptions).
- Make more than minor, non-structural capital improvements.
- Have cash held between distributions invested in anything other than short-term government obligations.
Why This Matters
These restrictions are in place to ensure the DST remains a passive investment vehicle. They protect the investors' 1031 exchange status but also mean the trustee has limited ability to react to changing market conditions. This highlights the importance of investing with experienced and reputable sponsor companies.
The Legal Framework of Delaware Statutory Trusts
The Delaware Statutory Trust (DST) is a legal entity created under the Delaware Statutory Trust Act, which provides a flexible framework for business organizations. The DST structure has become particularly valuable in real estate investments, especially for 1031 exchange purposes.
Delaware Statutory Trust Act
The Delaware Statutory Trust Act (DSTA) was enacted in 1988 and has been regularly updated to maintain Delaware's position as a premier jurisdiction for business entities. The Act provides significant flexibility in structuring the governance and operation of trusts, making it an attractive vehicle for various commercial transactions, including real estate ownership.
Key Legal Components of a DST
Trust Agreement
The trust agreement is the foundational document that establishes the DST and outlines its purpose, powers, and limitations. It defines the relationships between the trustee, beneficial owners, and any other parties involved in the trust's operation.
Trustee
The trustee holds legal title to the trust property and is responsible for managing the trust in accordance with the trust agreement. In a DST, the trustee's powers are typically limited by the "Seven Deadly Sins" restrictions established by IRS Revenue Ruling 2004-86 to maintain 1031 exchange eligibility.
Beneficial Owners
Investors in a DST are considered beneficial owners, holding beneficial interests rather than direct ownership of the underlying real estate. These beneficial interests represent a proportional share of the trust's ownership and entitle holders to a corresponding share of income, tax benefits, and appreciation.
Legal Characteristics of DSTs
- Limited Liability: Beneficial owners typically enjoy limited liability protection, similar to shareholders in a corporation or members in an LLC.
- Pass-Through Taxation: DSTs are generally treated as grantor trusts for federal income tax purposes, providing pass-through taxation to beneficial owners.
- Bankruptcy Remoteness: DSTs can be structured to be bankruptcy remote, protecting the trust assets from the potential bankruptcy of the sponsor or other beneficial owners.
- Transferability: Beneficial interests in a DST can be transferred, subject to securities laws and any restrictions in the trust agreement.
Legal Considerations
- Securities law compliance
- IRS Revenue Ruling 2004-86 compliance
- Accredited investor requirements
- Private placement memorandum (PPM)
- Trust agreement provisions
- Master lease agreements
Related Resources
DST Legal Structure Components
Trust Formation
- • Delaware Statutory Trust Act
- • Certificate of Trust filing
- • Trust agreement execution
- • Trustee appointment
- • Trust purpose definition
- • Entity classification election
Offering Documents
- • Private Placement Memorandum
- • Subscription Agreement
- • Operating Agreement
- • Risk Disclosures
- • Financial Projections
- • Due Diligence Materials
Regulatory Compliance
- • Securities Act of 1933
- • Regulation D exemptions
- • Accredited investor verification
- • SEC filing requirements
- • State blue sky laws
- • FINRA regulations
Frequently Asked Legal Questions
How is a DST different from a Limited Liability Company (LLC)?
While both entities offer limited liability protection, a DST has a more rigid management structure with a trustee making all decisions. Unlike an LLC, a DST must adhere to the "Seven Deadly Sins" restrictions to qualify for 1031 exchange treatment. Additionally, DSTs typically cannot raise additional capital or refinance properties after the offering is closed.
Are DST investments considered securities?
Yes, DST investments are typically considered securities under federal and state securities laws. They are usually offered as private placements under Regulation D of the Securities Act of 1933, requiring proper disclosures through a Private Placement Memorandum (PPM) and limiting offerings to accredited investors.
What happens if a DST property needs major repairs?
Due to the "Seven Deadly Sins" restrictions, a DST has limited ability to make capital expenditures. Most DSTs establish significant reserves at closing for anticipated repairs. If unexpected major repairs are needed beyond available reserves, the DST may need to convert to a "springing LLC" structure, which would terminate the 1031 exchange benefits for future exchanges.
How are beneficial interests in a DST transferred?
Beneficial interests in a DST can be transferred, but they are subject to securities law restrictions and any transfer limitations in the trust agreement. Typically, transfers require trustee approval and may involve right of first refusal provisions. Additionally, the new beneficial owner must meet accredited investor requirements.