Divorce can be a difficult time. The separation of two joined physical lives often brings about deep emotional turmoil. Divorce also brings about some tough decisions when it comes to dividing shared assets.
Fortunately for couples who own real property, there’s a vehicle called a Delaware Statutory Trust (DST) that can simplify the division of income-producing real estate and investment properties in a fair and equitable manner for both parties that keeps the wealth generated from these investments intact.
While we hope this never happens to your family, we hope if you ever find yourself in this situation that we can help make the division of physical property a bit easier.
Can a Delaware Statutory Trust Help me During Divorce?
A Delaware Statutory Trust can be beneficial in divorce for a variety of reasons. For starters, DSTs allow for tax-deferred investment via a 1031 exchange into a passive position in a large-scale, professionally managed property. This may alleviate a few common issues in this type of situation, namely tax implications and control of (no longer joint) assets.
DSTs provide the potential for returns through investment in commercial properties that may withstand inflation and alleviate the myriad hassles of property ownership, asset management, and lease negotiations. Other primary benefits include:
- Lower minimum investment threshold versus direct investment in commercial real estate
- Portfolio diversification through various types of commercial real estate in different geographical locations; however, investment properties still include risk of vacancy, distressed financing, or a reduction in cash flow
- Non-recourse debt
- Pre-packaging of 1031 co-ownership investment properties
But it is the two additional benefits of a DST – divisibility and potential liquidity via sale through secondary markets – that make them an important and useful tool for divorce planning.
What is a Delaware Statuary Trust?
A Delaware Statutory Trust is a separate legal statutory trust entity that is created by filing a Certificate of Trust with the Delaware Division of Corporations. There are many benefits of forming a DST, including limited liability, easy formation and maintenance, contractual flexibility, and – most significantly – favorable tax treatment.
DSTs are commonly used to issue debt or equity securities that are backed by trust assets, which include but are not limited to professionally managed and maintained real property. DSTs provide retail investors the opportunity to purchase fractional interests in commercial real estate as individual owners within the trust. Creating a Delaware Statutory Trust simplifies the divorce process because shares are divisible and allow for tax deferral treatment to each party upon the sale of these assets. Let’s focus on two main aspects of Delaware Statutory Trusts as they pertain to divorces:
- Potential liquidity
Delaware Statutory Trust: An Equal Slice of the Pie for All
Figuring out how to best divide jointly owned real estate can be an arduous and acrimonious process. One party may want to take the short-term benefits of liquidating and cashing out, while the other is eyeing the long-term benefits of holding onto the property. Other variables to consider include the location and nature of the property and potential sentimental attachments.
A Delaware Statutory Trust may solve these issues. Rather than sell the property and divide the proceeds – and pay stiff capital gains taxes – owners can liquidate their real assets and roll the proceeds over into a Delaware Statutory Trust via a 1031 exchange. This alleviates the burden of capital gains taxes, and both beneficiaries have the potential to receive regular income from the assets within the DST.
But perhaps the larger benefit of using a DST for divorce planning is that the DST portfolio is easily divisible into shares of virtually any increment. Since it is a security investment that is perfectly divisible, each beneficiary may receive proportional interests and is free to do what they want with their fractional interests of the DST. Parties can choose to hold their shares to maturity or try to sell them via a secondary market.
Liquidating a DST via a Secondary Market
One primary drawback of a DST is that it typically requires a lengthy time commitment ranging from two to 10 years before maturity. This time commitment renders the DST market relatively illiquid.
Historically, there’s been no easy way for beneficiaries of a DST to liquidate their shares. Although accredited investors have long been able to purchase shares of a DST from shareholders, there has not been a marketplace for shareholders to list their interests in a DST and explore a possible sale.
A secondary market is specifically for shareholders to list their shares and create a pathway to potentially liquidate their DST interests. After submitting basic information regarding their shares, owners receive an opinion of market value that is used to determine if a sale is the best course of action. Listed shares are reviewed by thousands of accredited 1031 exchange buyers, and owners are free to choose or reject potential offers. DSTs are still considered illiquid securities.
Although there can be no guarantee of a successful sale, in the event a buyer is secured, required paperwork can be seamlessly distributed and completed. Sales close through a secure third-party 1031 exchange qualified escrow account.
Some investors also prefer purchasing shares of a DST. While the typical minimum amount of DST shares listed on the secondary market is at least $100,000, DST interests may be listed under this threshold based on key metrics such as property type, performance, demand, and similar factors.
The takeaway here is that individuals who hold interests of a DST as a result of divorce proceedings now have an avenue to try and liquidate those shares if they choose. With proper planning, the sale or liquidation by one of the parties to the divorce has no financial impact on the other party, and all maintain the option to defer capital gains through future 1031 exchange.
Solving the Divorce Planning Puzzle
Divorcees who jointly own real property may be faced with difficult decisions. In such cases, access to 1031 co-ownership properties located in diverse geographical regions and a secondary market for beneficiaries who desire to try and liquidate their fractional interests in a DST may help solve problems. It’s important to note that beneficiaries who acquire shares of a DST as part of a 1031 exchange typically must hold shares for a minimum of two years before selling their interests. Parties who receive larger interests through divorce proceedings also can opt to sell a portion of their shares via a secondary market.
Ultimately, the decision to hold or sell depends upon the financial needs of each shareholder. We created a secondary DST marketplace to provide DST investors and beneficiaries with a potential exit opportunity and also to provide accredited investors with greater access to these types of investment opportunities.
These are the primary reasons why using a Delaware Statutory Trust simplifies divorce planning and potentially alleviates many of the difficult decisions divorcees face when tasked with splitting shares of real property.
There may be additional factors to be considered beyond the risks associated with Delaware Statutory Trust (DST) offerings being introduced to the primary market for the first time. These risks may include vacancies, distressed financing, or a reduction in cash flow.
Drew Reynolds is the Vice President of Real Estate Investments at Realized Holdings, Inc, an Austin-based real estate company. www.realized1031.com