Estate Planning and DSTs - Things to Consider

For families, business owners, and individuals Estate Planning is an extraordinarily complex and confusing process.

What makes this process so complicated? The choices, decisions, and consequences could potentially be beneficial to the next generation, or it could possibly be disastrous.

Continued below are Trust structure examples that are utilized by families and business owners wishing to pass assets to the next generations. For grantors and trustees of trusts, real estate can represent one of the assets inside of the trust. (Please note: CYNA 1031 Advisors are not attorneys and do not provide or are qualified to give legal advice or guidance.)

GRATS, CRATS, CLUTS, ILIT, PPLI, IDGT, Testamentary Trust, Generation Skipping Trust, QTIP, SLATS, DAPT, Dynasty Trusts, Marital Trust, Bypass Trust, and Family Limited Partnerships.

Perhaps some of these terms make sense to you?

Perhaps they make no sense at all…

What about a Delaware Statutory Trust (“DST”)? Could a DST be a part or included in a well-crafted estate plan? The answer is…it depends.

What is a DST?

A DST is a special purpose legal entity in which a sponsor company acquires property(s), obtains financing, holds title to the properties and acts as trustee to the trust. The investor (you) are the beneficiaries of the trust. So, you own a beneficial interest in the Trust.

DSTs allow for fractional ownership with multiple investors who share ownership in a professionally managed portfolio of properties.

• The Internal Revenue Code (IRC) Ruling 2004-86 allowed the DST structure to be used as replacement property and was deemed by the IRS as compatible
• DSTs beneficiaries receive their pro-rata share of the distributions

Key Distinction: Several of the above-named trusts can be customized, decanted, and revised in many situations. A DST cannot. A DST is a pre-packaged trust that is utilized as a 1031 exchange strategy.

What are the provisions in the tax code that all potential beneficiaries need to be aware of?

There are two numbers that are crucial: 45 and 180 – No Exceptions. The only exception is a Presidentially declared disaster area.

45 days - The client must identify all potential replacement properties that they would like to exchange into.

180 days – The client must close all transactions within 180 days.

In addition,

• 100 percent of the net proceeds MUST be reinvested into the replacement properties. Any proceeds not reinvested are considered taxable “boot”.
• Any mortgage or debt on relinquished property MUST be replaced with an equal or greater amount. (Most DST offerings have obtained financing, for which the beneficiaries (investors) do not have to qualify or apply for. The investor does not make loan payments and is not personally responsible or liable for the loan).
• If the replacement properties have less equity or debt than your relinquished property, the taxpayer has two choices:
• Come up with cash to close the gap.
• Pay “boot” on the difference.

Could a DST be part of an overall estate planning strategy?

Yes and no – it really all depends. To participate in a DST, properties utilized in a business, trade, or an investment must be sold. As per Internal Revenue Code Section 1031(a)(1) states “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.”

Unlike the Estate Planning Trust strategies listed above, a DST was NOT designed as an estate planning technique.

What makes it different? What are the disadvantages?

The Trustee of a Delaware Statutory Trust has limited powers and cannot engage in a number of actions* in order to protect the beneficiaries of the DST. A trustee must always administer a trust solely in accordance with the best interests of the beneficiaries. If the trustee were to engage in any of the prohibited activities the DST could be categorized by the IRS as a partnership and not a Trust and therefore it would be a taxable transaction**.

*Contact CYNA 1031 for specifics as it is beyond the scope of this blog post.

**Per IRS Revenue Procedure Section 301.7701-3.

What option do heirs have if a DST is part of their inheritance?

Potential Benefits and Options

If the primary beneficiary (investor) in a DST dies, then the contingency beneficiaries receive a step-up in basis. Once a DST sells the properties or the entirety of the Trust, the contingency beneficiaries can either take constructive receipt of the proceeds or conduct another 1031 exchange.

This could potentially lead to less decision making for Heirs as the trustee of the DST makes all decisions.

• The proceeds could be allocated on a Per Stirpes basis - as long as it is documented in the Estate Plan.

In addition, DSTs do provide Creditor Protection - the DST is a special purpose entity (“SPE”) provision that prevents any creditors of the beneficiaries (the investor) from reaching the properties of the DST. A DST owns 100 percent of the fee interest and is the sole borrower. The lender only makes one loan - regardless of the number of properties in the DST.

To discuss how a DST could potentially be an Estate Planning solution for clients that own real estate, please contact us.