They’re known as the “Seven Deadly Sins.” They are limits set on the power of a DST trustee by IRS ruling 2004-86.
We mentioned the IRS ruling 2004-86; so, what’s that all about? OK, —Here it is:
1. Once the offering is closed, there can be no future capital contributions to the DST by either current or new beneficiaries. To allow further contributions would dilute the original investors’ percentages of ownership.
2. The trustee cannot renegotiate the terms of any existing mortgage loans, nor can it obtain any new mortgage financing from any party except when a property tenant is bankrupt or insolvent. If a trustee were allowed to assume greater liabilities (and thus increase risk), it would be doing so without the consent, and possibly to the dissatisfaction, of the beneficiaries.
3. The trustee cannot enter into new leases or renegotiate existing leases except when a property tenant is bankrupt or insolvent. DSTs operate best when their invested properties are under long-term leases to credit-worthy tenants. These types of leases mean the investment may offer greater protection.
4. The trustee cannot reinvest the proceeds from the sale of its real estate. The IRS ruling requires that all proceeds from a DST investment should be distributed to investors. It is they who have the right to determine how to reinvest the capital.
The trustee is limited to making the following types of capital expenditures with respect to the property: (a) expenditures for normal repair and maintenance of the property; (b) expenditures for minor non-structural capital improvements of the property, and (c) expenditures for repairs or improvements required by law. The trustee cannot make a major upgrade to the property, such as adding new units to a complex or building a clubhouse; there is no assurance that costs for this would be recouped at the time of sale. Less major value-added upgrades like upgrading apartment interiors or adding a dog park or a fitness center are permissible.
5. All cash, other than necessary reserves, must be distributed to the investors on a current basis. DST trustees are allowed to keep a reserve of cash for repairs or other unexpected expenses. They are required, however, to make distributions to beneficiaries within the expected time frame.
Any cash held between distribution dates can only be invested in short-term debt obligations. A short-term debt is considered the equivalent of cash because it can be readily re-converted to cash for distribution to investors. So now that I’ve listed all these, I’ll tell you the Sponsors that offer the DST property are, as you can well imagine, all over these points.
Governed of course by Delaware State Law, if a DST Trustee/Sponsor that violates any of these restrictions the DST is allowed to convert into a Limited Liability Company (LLC). The consequences of the “springing LLC” is primarily that the investor cannot 1031 exchange out of the LLC. This is a safety net to protect investors as the investors would then have voting rights relative to the decisions made in the operation and management of the property. This includes the decision to sell the property. At the same time, they remain free from any liabilities associated with ownership that extend beyond the amount that they have already invested.
*** DST investments are illiquid, highly speculative and like all real estate, may involve substantial risks. DST owners do not maintain control over management decisions and are subject to additional IRS regulations. Potential tax benefits must be weighed against the costs and fees associated with a DST investment and its management.
By Don Meredith, President of Tactical Income Inc.
Author of The DST Revolution –1031 Exchange into retirement mode. 2nd Edition
Contact Don Meredith of Tactical Income, to learn more about Delaware Statutory Trusts (DSTs) and 1031 Exchanges at: don@lightpathcapital.com or (619) 726-6100.
Securities through LightPath Capital, Inc., Member FINRA/SiPC, 1560 E. Southlake Blvd., Suite 100 Southlake, TX 76092 925-899-1709 Direct 214-734-2957 Office