Which is Right For You?

DST Vs TIC Property Investing

Friday, March 15th, 2019

Investors analyzing passive real estate investments are frequently faced with making the choice between investing in a Delaware Statutory Trust (DST) or purchasing part of a tenant in common property (TIC). This situation often occurs on the acquisition or replacement side of a like-kind 1031 tax deferred exchange.

Real estate investors look for passive replacement property because – while they enjoy the many financial and tax benefits that investing in real estate provides – they’re tired of the responsibilities that come with day-to-day management of real estate. DSTs and TICs also allow the investor to own part of a large, investment grade property that he would otherwise not have access to.

Two types of proportional ownership structures

There are two types of fractional ownership structures recognized by the IRS for use in 1031 tax deferred exchanges: Delaware Statutory Trust and Tenant in Common. Prior to 2004 only property that was solely owned or part of a TIC qualified for the tax deferral benefits 1031 exchanges provide. But in 2004 a favorable IRS ruling allowed the use of DSTs – with specific restrictions – in a like-kind 1031 exchange.

Since that time the use of tenant in common structures in 1031 tax deferred exchanges has decreased while the use of Delaware Statutory Trusts in 1031s has increased. There are pros and cons to each structure, and real estate investors should carefully consider which of these two types of proportional real estate ownership is right for them.

TIC or Tenant in Common: the pros and cons

A TIC, or tenancy in common investment, is real estate that is co-owned with other investors. TIC offerings are marketed by real estate professionals, oftentimes as pre-packaged offerings, and are typically not considered to be securities.

By default, the ownership percentage of a TIC is proportional, with each investor directly owning an undivided percentage of the property pro rata to this or her equity investment.

For example, if Bob has $750,000 to invest and locates a $1.5 million property to purchase, he may ask his friends Joe, Mary, and Jane to each invest $250,000 as tenants in common. Bob would directly own 50% of the property while Joe, Mary and Jane would each directly own 16.666667%.

Advantages of TICs

There are several advantages to owning property as a tenant in common:

Access to owning potentially investment grade, institutional quality commercial real estate for a fraction of the cost of 100% ownership – the “bigger is better” concept.
Independent third-party property management and leasing teams are typically employed by the TIC owners to professionally manage the asset
An investor can trade into a TIC property with a 1031 exchange and can, likewise, trade out into another 1031 exchange

Disadvantages of TICs

Tenant in Common Agreements requiring owners to take an active part in decision making is also one of the biggest drawbacks to a TIC, especially for real estate investors seeking a truly passive, hands-off investment. TICs require unanimity to sell, refinance, replace the asset manager, replace the property manager and establish lease rates and approve all leases. This is difficult to achieve, especially under time constraints in working with selling the property or leasing to a new tenant. Absent unanimity time kills deals and deals have been lost to foreclosure because 100% agreement was not achieved.

The lenders are now keenly aware of the issues in managing the TIC approval process and as a result most lenders prefer to not work with TICs, but will consider lending to a TIC group with up to 10-12 TICs.

DST or Delaware Statutory Trust: the pros and cons

Under a Delaware Statutory Trust each investor holds title to the real estate through a beneficial interest in the trust and not through direct ownership as with a TIC structure.

Advantages of DSTs

DST investors also have access to owning investment grade commercial real estate. However, because Delaware Statutory Trusts are entities, investors also benefit from several advantages unique to DSTs that are not found with TICs:

Completely passive investment as all major property decisions are made by a trustee of the trust or asset manager, not by the owners – in other words, no decisions made by investors throughout the hold period
Investors are shielded from potential liability because they own beneficial interests in the DST and not the real estate itself
Financial institutions can make loans to the DST entity directly without each individual investor having to qualify for the loan

Garver National HQ is a property acquired by NAS Investment Solutions as a Delaware Statutory Trust. The property is managed by National Asset Services. Its single tenant is Garver, an employee-owned, award-winning company with more than 800 employees located in 34 offices in 13 states.

Disadvantages of DSTs

The entity structure of a Delaware Statutory Trust also creates several potential disadvantages for investors:

No “fresh cash” can be brought into the deal in the event of a major need for capital
Although lenders do not underwrite each DST investor or receive personal guarantees for loans, the property in the DST is used as loan collateral and is 100% at risk if conditions in the real estate market unexpectedly change
A DST must sell in no more than 10 years, it cannot refinance in the property to which it holds title

Further restrictions on DSTs used for 1031 exchanges

The IRS places several prohibitions on the power of DST trustees if the Delaware Statutory Trust is to be used with a 1031 tax deferred exchange. There are seven restrictions, sometimes referred to as the ‘Seven deadly sins of a DST’:

Once a DST offering is closed there can be no further contributions by current owners, new owners, or beneficiaries
Existing loan terms cannot be renegotiated, nor can new funds be borrowed, by the DST trustee
Sales proceeds from the investment real estate cannot be reinvested by the DST trustee
Capital expenditures can only be made by the DST trustee for normal repair and maintenance, minor non-structural capital improvements, or those required by law (such as items related to zoning codes)
Liquid cash held by the DST between distribution dates can only be invested in short-term debt obligations
All cash in excess of necessary reserves must be distributed to investors
New leases or renegotiations of current leases may not be entered into by the DST trustee

About the Author

Karen E. Kennedy's expertise spans various areas, including 1031 Exchanges, Delaware Statutory Trust (DST) structured investments, fractional interest ownership, tenancy-in-Common (TIC) owned properties, property acquisitions, portfolio management, and investor relations.

More about Karen E. Kennedy »

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Frequently Asked Questions

What is a 1031 Exchange?

A 1031 exchange is a swap of one real estate investment property for another in a specific way that allows for capital gains taxes to be deferred.
What are the advantages of a DST-Structured investment in commercial property?
There are numerous advantages to investing in a DST structured property offering.
- The purchase of DST interests is simpler, faster and does not require as many documents as buying sole ownership of a property.
- Capital Gains are deferred, if investment is for a 1031 Exchange
- No daily property management obligations that come with sole ownership
- Ability to create a diversified real estate investment portfolio
- Cash flow distributions
- Annual depreciation/tax deductions
- Appreciation upon sale of the property
- Upon the sale of a DST property, the investor may engage in a 1031 exchange, even if the DST interest was purchased without 1031 exchange proceeds.
- A DST is a pass-through tax entity, which is not subject to federal income tax, nor to the Delaware franchise or income tax.
- Because the DST is the mortgage borrower, the lender does not require individual DST investor guarantees, nor does the lender require investors to submit personal financial information to qualify for the mortgage loan.
- Investors with interest in a DST property are protected from property liabilities held by the DST. As a result, the maximum pre-tax loss (excluding income tax considerations) is equal to the amount invested in the DST.
Are there a minimum and maximum investment amounts to participate in a DST property offering?
- Yes; $50,000 to $100,000 are typical minimum investment amounts but this may vary from sponsor to sponsor.
- The maximum amount is contingent on the overall size of the DST offering and the discretion of the DST Sponsor.
Are DST-Structured properties commonly used for a 1031 Exchange?

Interests in Delaware Statutory Trusts are the primary investment method for fractional 1031 exchange investments at this time.
Are there any restrictions on a DST-Structured Investment?
- The IRS places several prohibitions on the power of DST trustees if the Delaware Statutory Trust is to be used with a 1031 tax deferred exchange. There are seven restrictions, sometimes referred to as the ‘Seven deadly sins of a DST’:
  - Once a DST offering is closed there can be no further contributions by current owners, new owners, or beneficiaries.
  - Existing loan terms cannot be renegotiated, nor can new funds be borrowed, by the DST trustee.
  - Sales proceeds from the investment real estate cannot be reinvested by the DST trustee.
  - Capital expenditures can only be made by the DST trustee for normal repair and maintenance, minor non-structural capital improvements, or those required by law (such as items related to zoning codes).
  - Liquid cash held by the DST between distribution dates can only be invested in short-term debt obligations.
  - All cash in excess of necessary reserves must be distributed to investors.
  - New leases or re-negotiations of current leases may not be entered into by the DST trustee.
How does an investment in a DST-Structured property differ from an investment in a TIC-Structured property?
- Like TICs, DSTs have multiple investors that purchase fractional interests and the investors share in the total financial performance of the underlying investment property. However, the primary differences between the two investment structures are:
  - A DST is not limited to a maximum of 35 investors required by Revenue Procedure 2002-22.
  - DST investors (Beneficiaries) are purchasing a beneficial interest in a trust and do not receive deeded property.
  - Beneficiaries in a DST are not necessarily required to form single-member Limited Liability Companies (LLCs).
  - Beneficiaries do not have voting rights or operational control of the property.
  - In a DST structure, there can be no cash calls or additional money invested into the property beyond typical maintenance and certain capital expenditure needs, unlike in TICs.
How a 1031 Exchange is Accomplished?
There are seven recommended steps common to most Section 1031 tax deferred exchange:

BEFORE YOU CLOSE ON THE SALE OF THE RELINQUISHED PROPERTY:

Step 1: Consider retaining the services of a certified public accountant or an attorney with tax deferred exchange experience to assist in planning for an exchange.

Step 2: Engage a Qualified Intermediary, or “QI,” (also called an Accommodator), being sure to name the QI as the principal in the sale of the relinquished property and in the purchase of the replacement property.

Step 3: Sell the relinquished property, making sure to include a cooperation clause requiring the buyer to cooperate with the seller’s 1031 exchange, and instruct the escrow officer or closing agent to order exchange documents from the QI.

AFTER CLOSING THE SALE OF THE RELINQUISHED PROPERTY

Step 4: Escrow closes on the relinquished property, with the closing statement showing the QI as the seller, and sales proceeds from the relinquished property are sent to the QI and placed in a separate segregated trust account.

FAILURE TO SEND SALES PROCEEDS DIRECTLY TO QUALIFIED INTERMEDIARY FROM ESCROW WILL RESULT IN INABILITY TO EXCHANGE.

Step 5: Within 45 calendar days of the close of escrow of the relinquished property the exchanger identifies one or more replacement properties and sends written notice of this to the QI.

Step 6: The exchanger executes a purchase contract with the seller of the replacement property, making sure the cooperation clause is included in the purchase contract, and naming the QI as the buyer of the replacement property.

Step 7: Within 180 calendar days of the close of escrow of the relinquished property, the exchanger instructs the QI to transfer funds to close escrow and sends 1031 exchange-related documents to the escrow company, and the sale closes with the closing statement showing the QI as the buyer on behalf of the exchanger.
- After the replacement property has closed escrow, the QI will send a final accounting statement to the exchanger. The statement will show that funds have come from one escrow directly into another, all without the taxpayer having constructive receipt of the funds.
- Real estate investors should note that although the qualified intermediary is indicated as the seller and buyer on the purchase contracts, the deed and title are always from the taxpayer to the buyer, and from the seller to the taxpayer.
What qualifies as a “like-kind” replacement property?
- The definition of a qualifying like-kind property is very broad, for both the sold property and the replacement property: real estate used for investment or business purposes. Personal use property is not eligible.
- Investment real estate (held for either appreciation or for rental) can be exchanged for real property used in a trade or business. Partial interests such as TICs or DSTs, are exchangeable with other types of real property.
How is a replacement property identified?

A like-kind replacement property is identified if it is designated as replacement property in a written document signed by the exchanging party and received by the QI before the end of the 45-day identification period. Every QI uses their own form of documentation. Please consult with your QI to determine the exact procedure they require.

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Authored By: Karen E. Kennedy

President & Founder • NAS Investment Solutions

Karen E. Kennedy's over-40 years experience spans various areas, including 1031 Exchanges, Delaware Statutory Trust (DST) structured investments, fractional interest ownership, Tenancy-in-Common (TIC) owned properties, property acquisitions, portfolio management, and investor relations. See Full Bio