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Mid Atlantic R eal E state J ournal Publisher ............................................................................Linda Christman Publisher ...............................................................................Joe Christman Section Publisher ................................................................Elaine Fanning Section Publisher ....................................................................Steve Kelley Senior Editor/Graphic Artist ................................................ Karen Vachon Office Manager ....................................................................Joanne Gavaza Contributing Columnists ............................................Tim Snodgrass, J. D. Mid Atlantic R eal E state J ournal ~ Published Semi-Monthly P.O. Box 26 Accord, MA 02018 (Mail) 312 Market Street, Rockland, MA 02370 (Overnight) Periodicals postage paid at Rockland, Massachusetts and additional mailing offices Postmaster send address change to: Mid Atlantic Real Estate Journal, P.O. Box 26, Accord, MA 02018 USPS #22-358 | Vol. 24 Issue 6 Subscription rates: $99 - one year, $198 - two years, $4 - single copy REPORT AN ERROR IMMEDIATELY MARE Journal will not be responsible for more than one incorrect insertion Toll-Free: (800) 584-1062 | MA: (781) 871-5298 | Fax: (781) 871-5299 www.marejournal.com The views expressed by contributing columnists are not necessarily representative of the Mid Atlantic Real Estate Journal
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To advertise, call 1-800-584-1062 Aldo Design Group..............................................14A All-Rite Construction............................................9B ALT Realty............................................................2B Ameribid..............................................................30C Auction Directory..................................................4A Azarian Group.....................................................25C Aztec....................................................................20C Bayshore Recycling...............................................9A Bennet Williams..................................................27A Bennett Williams....................................... 3,7B,10C Berger..................................................................18C BL Companies.......................................................8B Bohler Engineering...............................................6B Boyle Construction..............................................24C BR Kreider & Son.................................................3B Business Card Directory.....................................25A Bussel....................................................................6C Capitol Aerials.......................................................6A CBRE-DC. .............................................................4C Colliers...................................................................9C Descipio. ..............................................................21C DMR.....................................................................27C Earth Engineering Inc................................ 12A,11B Eastern Union.....................................................17C Entech....................................................................7A Fameco.................................................................28C Fowler............................................................18, 24A Fox Rothchild......................................................29C Gebroe-Hammer..................................................16C Gilbeaux Associates, PC.......................................6A Haftek CWS. .......................................................12A Harvey Hanna & Associates...............................27A HFF...................................................................... 1-C Hinerfeld. ............................................................27A Hutchinson Mechanical Services.........................8A IREM...................................................................23A JOTTAN Inc..................................................... 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By Tim Snodgrass, J. D. Delaware Statutory Trusts (“DST’s”) . . .” The Future of Fractional Ownership?”
D
e l awa r e S t a t u t o r y Trust’s (DST’s) became relevant to the 1031
fractional ownership market in 2004, with the assistance of some very focused professionals (lawyers and business persons), and the blessing of the Internal Revenue Service (see Revenue Procedure 2004-33). “What did the IRS say, and what does it mean to investors doing 1031 exchanges”? First of all, they said that a beneficial interest in a DST qualifies as a real property inter- est for purposes of IRC Section 1031. That means you can defer capital gain (as of today has gone form 15% to 20%, plus a 3.8% Healthcare tax) via a 1031 exchange, with a replacement property that is a beneficial in- terest in a trust. Prior to this Revenue Proce- dure, most fractional ownership replacement properties were done in Tenant in Common (TIC) structures. This is where the investor owned a fractional ownership in a larger property with other investors, with great pains taken under Revenue Procedure 2002-22 to ensure these ownership interest were NOT partnership interests for purposes of IRC Section 1031 (investors had to hold title, and have the benefits and burdens of real property ownership and control so as not to be construed as a partnership). While many of these structures allowed inves- tors to own a smaller part of a larger property. Under the stress of the downturn in 2008, many of those structures felt the pres- sure of some of the structural requirements mandated by the IRS under the Revenue Proce- dure, Specifically, in certain cir- cumstances it became difficult to handle disagreements between owners if all the investors in a TIC property did not agree with each other on how to proceed, especially when time was of the essence. What are the benefits of DST fractional ownership? There is only one borrower and closing statement, and investors do not have to sign “bad boy” carve outs from lenders, which required the investors and borrowers in previous TIC structures to state they would not act in a manner to cause a default under the
loan, thus the increasing the liability if they were to commit one of these acts. Commercial real estate lenders love this structure as they only have one “borrower” to deal with, and not up to 35 different borrowers (as was allowed under the Revenue Procedure). This is the case no matter how many investors are in a DST investment. There is only one Manager, or specifically, a Trustee for the property. Again, this is both a benefit and a burden. Distin- guished from a TIC investment, DST’s have a set Sponsor con- trolled Trustee, with the inves- tors being completely passive. In situations that require quick ac- tion, there is no logjam with any disagreements between manage- ment and investors. Manage- ment makes the decisions. There can be multiple proper- ties within the DST, thus creat- ing a “portfolio” within the DST. There are several Sponsors of DST investments in the market that take Net Lease or Multi family properties, with different credit profiles, and wrap them into one DST. Under the DST structure, investors can come in with much lower minimums, since the number of investors is not an issue any more. It used to be acceptable practice that lenders would not allow more than 35 investors under a TIC fractional ownership structure. Under a DST, combined with the newly enacted JOBS Act of 2012, there can be up to 2000 investors in a DST. This means lower minimums and the ability for investors to spread risk with their capital. Generally speaking, DST frac- tional ownership investments are structured with two types of commercial real estate, Net Lease properties (Retail) and Multi-Family properties (Apart- ments). Any property that is best
suited for properties subject to a long-term lease to a creditworthy tenant on a triple-net basis, and/ or can also successfully be used with a “master lease” structure. Other property types used in DST’s include university and senior housing, hospitality, and self-storage facilities. “What are the burdens of DST structure”? The Trustee cannot commit one of the “seven deadly sins” of DST ownership. They are as follows: A Trustee: (1) cannot receive new capital after an offering is closed; (2) cannot renegotiate or enter into new mortgage debt unless there is a tenant bankruptcy or insolvency; (3) cannot renegotiate any of its property leases or enter into any new leases unless there is a ten- ant bankruptcy or insolvency; (4) cannot reinvest the proceeds from the sale of its property; (5) cannot redevelop property, and in fact is limited to performing only normal maintenance and minor non-structural improvements unless it is required to do more by law; (6) must hold its reserves in short-term debt obligations; and (7) must distribute all cash, other than normal reserves, on a current basis. When issues arise that a DST cannot address due to the “seven deadly sins,” it automatically converts into an LLC. While this conversion inhibits investors’ ability to do future Section 1031 transactions, it allows property emergencies to be dealt with ap- propriately. As the commercial property recovery continues, and more in- vestors utilize IRC Section 1031 to defer capital gains, DST’s may be a viable solution for the future of fractional ownership. Timothy Snodgrass J.D. is president of AXXCESS Capi- tal. Axxcess Capital is a mar- keting Partner for Covington Realty. n
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