A DST is a separate legal entity created as a trust under Delaware statutory law. The law permits a very flexible approach to the design and operations of a DST. However, to use a DST in a Section 1031 syndication program, it must comply with the requirements of IRS Revenue Ruling 2004-86 and must also (if the DST's property is debt financed) meet lender requirements. To satisfy these requirements, each of our DSTs must:
Unlike a TIC transaction, there is no need to set up individual single member limited liability companies (SMLLC) for each investor. Each investor owns a beneficial interest (BI) in the DST, which shields the investor from any liabilities with respect to the property. This ownership arrangement is much simpler than a TIC arrangement for investors to understand, and saves the investors substantial money with respect to the formation costs and annual fees.
There are also substantial governance differences between a TIC transaction and a DST transaction. Unlike a TIC transaction, which requires the investors vote unanimously for all major decisions, a BI holder in a DST is not permitted to vote. This eliminates the concern over the "rogue investor." Because there is a single borrower — the DST — and not 25 or 30 separate SMLLC borrowers as in a typical TIC transaction, there should be no need for the sponsor to have to collect, or for the lender to have to review, investor tax returns, financial statements, and credit authorizations.
In addition, because the investors have no role whatsoever in the management of the DST or its real estate, the investors should not be required to execute any nonrecourse carve out indemnifications or guaranties.
Generally, a TIC structure is limited to 35 investors or less. This is a product of both Revenue Procedure 2002-22 relating to permitted TIC deal structure and from the fact that lenders wish to limit the amount of individual loans they are making in a TIC deal. There is no such limitation on the number of permitted beneficiaries in a DST deal, and because DST deals involve only a single borrower, lenders should be indifferent to the number of investors in a DST deal. A DST will permit a beneficiary to do a tax free exchange on its pro rata share of the DST property when it is sold. Since a DST transaction is less complicated and the lenders have better protection from potential bad acts of the investors, the availability and terms of financing are much more favorable for DST transactions than TIC transactions.
IRS Revenue Ruling 2004-86, which forms the basis for DST transactions, sets forth prohibitions on the powers of the trustee, which have become known as the "seven deadly sins." They are:
Because of these restrictions, the only types of real estate transactions that will work in a DST are a "master lease" transaction, in which the master tenant takes on all leasing and other property operation responsibilities or, a triple-net long-term lease to quality tenant.