Although Delaware Statutory Trusts (DSTs) are a powerful way for investors to capitalize on securitized real estate, DSTs are not without limitations. IRS Revenue Ruling 2004-86 imposed some prohibitions on the power of the DST trustee. These prohibitions must be followed in order for the investors to be treated as acquiring a direct interest in real estate for tax purposes and thus qualify for 1031 exchange benefits.
There are seven prohibited trustee activities.
- Once the trust offering is closed, no future contributions by existing or new investors is allowed.
- The trustee is prohibited from renegotiating any existing loan terms and can’t borrow new funds from anyone unless there is a loan default resulting from a tenant’s insolvency or bankruptcy.
- The trustee may not reinvest the proceeds from the real estate’s sale.
- There are limitations on capital expeditures related to the property, including only normal repair and maintenance, small non-structural capital improvements and any improvements required by law.
- Any cash or reserves held between distribution dates can only be invested in short-term debt obligations.
- The trustee cannot renegotiate existing leases or enter into new leases unless the tenant becomes insolvent or enters into bankruptcy.
- All cash, excluding needed reserves, must be distributed on a current basis.