DST Benefits & Risks

Liquidity is one of the most important DST considerations.

DST interests are generally not publicly traded on an established securities market. IRS Revenue Ruling 2004-86 itself describes the interests in the DST considered by the ruling as not publicly traded on an established securities market.

Investors should not assume they will be able to sell a DST interest whenever they choose.

Many private placement investments can be difficult to sell, and FINRA identifies illiquidity as a material risk that firms should clearly disclose when discussing private placements.

A DST may therefore be inappropriate for money an investor expects to need in the near future.

Reduced management responsibility also means reduced control.

A directly owned property gives the owner significant authority over decisions such as leasing, refinancing, improvements, property management, and disposition.

DST investors generally do not have that same decision-making authority.

The structure is intentionally restrictive. Revenue Ruling 2004-86 explains that the trustee in the qualifying structure has limited powers and cannot freely vary the investments held by the trust.

For an investor accustomed to controlling every aspect of a property, that can be a significant adjustment.

A DST does not remove the normal risks associated with owning real estate.

The value and performance of the underlying property can be affected by factors such as:

• Vacancy
• Tenant defaults
• Changes in rental rates
• Property expenses
• Repairs and capital requirements
• Local economic conditions
• Interest rates
• Competition
• Changes in property values
• Natural disasters or property damage

A professionally managed property can still decline in value or generate less income than anticipated.

Investors may receive distributions from operating income generated by the underlying property, depending on the specific investment.

Those distributions can change.

Vacancy, tenant problems, unexpected expenses, financing costs, property damage, or other factors may reduce or eliminate available cash flow. Customized 1031's current disclosures specifically note the potential for cash flow distributions to be reduced or suspended when real estate experiences adverse events.

Projected distributions should therefore be viewed as assumptions rather than guarantees.

DST investors rely heavily on the sponsor and the parties responsible for managing the investment.

That makes sponsor evaluation an important part of due diligence.

Investors may want to consider factors including:

• Sponsor experience
• History with similar property types
• Acquisition discipline
• Financing approach
• Property management experience
• Fee structure
• Conflicts of interest
• Assumptions used in projections
• Planned exit strategy

The quality of the real estate does not eliminate the importance of the sponsor responsible for structuring and managing the investment.

DST investments can include a variety of transaction and ongoing expenses.

Depending on the offering, these may relate to acquisition, financing, brokerage, property management, asset management, disposition, and other services.

Those costs can affect overall investment performance.

Customized 1031's existing disclosures appropriately note that transaction costs and expenses can affect investor returns and may outweigh anticipated tax benefits in some circumstances.

Investors should review the offering documents carefully to understand how fees are structured and who receives them.

Leverage can affect both potential results and potential losses.

If a DST property has debt, changing interest rates, property performance, refinancing conditions, or a decline in value may affect the investment.

Financed real estate also carries the potential for foreclosure if obligations cannot be met. This is another risk identified in Customized 1031's existing disclosures.

Investors should understand both the amount of leverage and the terms of the financing associated with a particular offering.

Many DST offerings are structured as private securities offerings rather than publicly traded investments.

Private placements can differ materially from publicly traded securities. FINRA notes that many private placements may have limited liquidity and less comprehensive information available for valuation than investments traded in transparent public markets.

Investors should review the applicable Private Placement Memorandum and other offering materials before making an investment decision.

The fact that an investor qualifies to participate in a private offering does not mean the investment is appropriate for that investor.

A potential 1031 tax benefit should not be the only reason to select an investment.

Section 1031 treatment depends on satisfying applicable requirements, and the tax consequences of an exchange depend on the investor's individual circumstances.

Revenue Ruling 2004-86 applies to the specific DST structure addressed in the ruling and states that Section 1031 treatment applies when the other requirements of Section 1031 are also satisfied.

Investors should work with their own CPA or qualified tax professional regarding the tax consequences of an exchange and DST investment.