Pros and Cons of a Delaware Statutory Trust

February 15, 2023
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Last week, we talked about the tax advantages of Section 1031 exchanges. You can sell qualified assets like real estate and avoid taxation by purchasing like-kind property. Your heirs can also benefit from 1031 exchanges if the new property is passed onto them. Click here to read the full article.

Some real estate owners are looking to get away from property ownership and a simple 1031 exchange isn’t the best option. There may be other options to consider, including UPREITs, opportunity zone funds and Delaware statutory trusts. Today, we want to talk more about Delaware statutory trusts as another great tax-advantaged opportunity for savvy investors. 

What is a Delaware Statutory Trust?

The Delaware statutory trust property ownership structure allows investors to own a fractional interest in larger investment assets. More specifically, you can own interest in institutional-quality and professionally managed commercial property along with other investors. You are considered an owner of the property, which enables you to qualify for a Section 1031 exchange according to the tax code.

Owning part of a Delaware statutory trust may be a more attractive option to some investors compared to buying a higher-priced like-kind property and being sole owner—as is the traditional 1031 exchange approach. You (and your heirs) will get the same tax advantages without the burdens of owning/managing the property on your own.

Important Considerations

There are some important issues to understand when it comes to Delaware statutory trusts, which is why this investment strategy is not right for everyone.

First, is the issue of liquidity. Delaware statutory trusts do not have a secondary market. Your money is essentially locked up in the investment—usually for at least a specified period of time. It’s common to have a 10-year commitment, so this lack of liquidity or being able to sell your share could present a challenge.

Second, most Delaware statutory trusts require you to be an accredited investor and make a minimum investment. The trusts do due diligence on your status, but you must meet the requirements for accredited investor classification:

  • Your income is $200,000 or more (or $300,000+ with your spouse) over the past two years and you reasonably expect such income for the current year; or
  • Your net worth exceeds $1 million excluding the value of your primary residence

Another issue with Delaware statutory trusts is the lack of control over the property. Some investors may prefer a hands-off approach (let others handle the day-to-day management), while others want to have more say.

Protecting Your Investment in a Delaware Statutory Trust

If you didn’t have a mortgage on your sold 1031 property, you will want to consider investing in a non-leveraged Delaware statutory trust to reduce the risk of losing your investment. Some investors will use a Delaware statutory trust as a backup option within the Section 1031 45-day rule. Remember you have to identify up to three properties within 45 days of selling your original property. Many investors will name two like-kind properties and then use the Delaware statutory trust as a backup. Should the other properties fail, then the trust will preserve your tax-deferred status.

It can also serve as way to park your investment for awhile, until you find a better Section 1031 exchange opportunity. You can hold your money in the trust and avoid taxes for 7-10 years before performing another 1031 exchange for a different property that will better meet your needs and goals.

To learn more about Delaware statutory trusts, 1031 exchanges and other tax-advantaged property investment strategies, contact Illumination Wealth for a no-obligation introductory consultation.