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A little clarity for your next decision.
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Investor WorkspaceA little clarity for your next decision.
By Jerry Baker
A DST's projected hold period is a business-plan estimate, not a promise to return your money on a set date. The actual exit depends on the trust documents, property results, financing, and decisions by the parties with authority to sell. Plan for an earlier or later exit, and arrange any next 1031 exchange before the property sale closes.
A five-year projection can look like a five-year commitment when it appears in a neat table. It usually describes the period assumed in that particular forecast. Ask what legal right, if any, requires a sale or a payment at the end of that period.
Do not apply one universal hold range to every DST. Read the offering's private placement memorandum, or PPM, and trust agreement. A current business plan, a legal end date, and a loan maturity date can be three different dates.
Delaware law generally gives a statutory trust continuing existence unless its governing instrument provides otherwise. The governing instrument can state events that lead to dissolution. The word “DST” by itself does not establish a five-year, seven-year, or ten-year term. [1]
I want an investor to know what the plan assumes and what the documents require. Those questions sound similar, but the answers can be very different when a loan comes due or a sale falls through.
| Clock | What it describes | Question to ask |
|---|---|---|
| Projected hold | The sale timing used in the business plan and returns model | What conditions support that date? |
| Trust term | Events or limits stated in the governing documents | Can the term change, and who has that power? |
| Loan term | When financing matures or payment terms change | What happens if the property has not sold? |
Also ask when your own investment period begins. A sponsor may have bought the property before your subscription closes. A forecast measured from property acquisition will not match a forecast measured from each investor's entry date.
Use actual dates where possible. “Year five” is less useful than a date range with a stated starting point. Confirm whether the forecast includes time for marketing, the buyer's review, closing, and distribution of net proceeds.
Revenue Ruling 2004-86 used a trust with a stated ten-year life or earlier property disposition. That was one set of facts used to analyze federal tax treatment. It does not require every DST to hold real estate for ten years. [2]
Read the trust agreement to identify the party with sale authority. That may involve a trustee, an asset manager, and required approvals. Calling the whole group “the sponsor” can hide important differences in roles.
Delaware's statute lets the governing instrument define management powers and many voting rights. Do not assume every investor can demand a sale, or that every trust gives investors identical rights. Your own rights come from the applicable documents and law. [1]
Ask whether a sale requires investor consent, lender approval, an independent review, or another condition. Ask what rights apply to a sale to an affiliate. A statement that the investment is passive does not answer those questions.
Even when investors have some voting rights, that does not mean you can obtain cash whenever you want it. A vote can take time, a buyer may not appear, and a proposed price may be unacceptable. Control rights and practical liquidity are separate issues.
An earlier sale might follow a strong offer, completed work, improved leasing, or a change in the owner's view of the market. It might also result from a problem, such as a loan issue or a need to reduce risk. The timing alone does not tell you whether the outcome is favorable.
Ask what the proposed sale produces after debt and costs. Compare it with the risks and potential cash flow of continuing to hold. The answer should consider what is known now, not simply repeat the original forecast.
An early exit can also create work for you. You may need to decide whether to pay tax, plan another exchange, or consider a different permitted transaction. The next investment may have different costs, income, risks, and availability.
Do not assume faster is always better. An early sale with a strong net return may be useful. An early sale forced by distress may return less than your original investment. Review the dollars, dates, and reasons together.
A sale may take longer if buyers offer less than expected, financing is harder to obtain, a major tenant is leaving, or property work remains unfinished. A purchase contract can also fail during the buyer's review.
A longer hold can give the property time to improve, but improvement is not certain. It can also bring more repair costs, weaker cash flow, or added financing pressure. Ask for an updated plan with the costs and risks of waiting.
Rent can keep coming in while investor payments fall or stop. The trust still has debt payments, property bills, reserves, and other costs to fund. Ask whether the delay changes the cash-flow forecast. What supports the new amount?
Review the legal authority for an extension. If the trust has an end date, find out what the documents require before that date. A term extension, a restructuring, and a slow winding-up process are different events with different consequences.
Line up the major lease dates beside the loan schedule. A large tenant's renewal may influence buyer demand. A near-term vacancy can affect expected income, sale value, and the lender's view of the property.
The OCC's guide to real estate lending tells banks to review the whole loan. That includes cash flow, leases, value, debt payments, and the repayment plan. Those same factors can help you assess a property sale. [3]
Check whether the loan has interest-only payments that later begin to include principal. Review any prepayment charge or defeasance requirement. An attractive sale price can look less attractive after the cost of retiring the debt.
Do not assume a DST can always refinance if a sale is delayed. The structure described in Revenue Ruling 2004-86 restricts renegotiation of its debt. Any extension, financing change, or move to another entity needs review under the documents and tax rules. [2]
A loan maturity is therefore a planning constraint, not a guarantee that investors will receive cash that day. A difficult outcome can include a distressed sale or foreclosure. Review the contingency plan before the loan deadline is close.
A property can meet its income forecast and still sell for less than planned. One reason is a change in the capitalization rate buyers use. A cap rate relates annual net operating income to property value; it is not the investor's cash distribution rate.
In a simple hypothetical model, $1 million of annual net operating income at a 5% cap rate implies a $20 million property value. At a 6% cap rate, the same income implies about $16.67 million. Actual value also depends on the property's facts and buyer underwriting.
If the property has $12 million of debt in both cases, gross equity before costs changes from $8 million to about $4.67 million. The cap-rate assumption can therefore have a large effect on investor proceeds even without an income decline.
Ask whether the projected sale uses a more favorable cap rate than the acquisition, and why. Also review less favorable cases. The OCC discusses the relationship among income, capitalization rates, value, and interest rates; none provides a guaranteed exit price. [3]
The same dollar profit over different periods produces different annualized returns. Suppose a hypothetical $200,000 investment pays no interim cash and returns $260,000 at sale. The total gain is $60,000, or 30%, in either case.
If that happens after three years, the compound annual return is about 9.14%. After seven years, it is about 3.82%. This example uses only an initial payment and one final payment. It is not a forecast of DST income or appreciation.
Real DST cash flows can arrive throughout the hold. Review the amounts and dates used in an internal rate of return, or IRR, calculation. Ask whether it includes investor-level fees and the final net proceeds. A longer hold can change both the cash received and the timing of that cash.
Do not compare an annual distribution rate with a total-return forecast as though they measure the same thing. A property can distribute cash for years and still return less than the original capital at sale. Income history and sale proceeds need to be evaluated together.
Start with the sale price, then work down to the cash left for investors. Subtract the loan payoff, selling costs, fees, and closing adjustments. Account for any reserves and unpaid bills as well.
For example, assume a hypothetical $10 million sale, $5 million loan payoff, $300,000 of selling costs, and $200,000 of other closing obligations. That leaves $4.5 million before any further holdback. A 2% share is $90,000 if that ownership share governs the distribution.
The $90,000 is not necessarily taxable gain, and it is not necessarily the whole investment result. You need your original investment, prior distributions, adjusted tax basis, and debt allocation. Cash in your account and gain on your tax return can differ. [4]
A sale can also close before all trust accounts are settled. Ask whether some funds will be retained for final bills, disputes, or reporting costs. Find out who authorizes the reserve and how later payments will be reported.
A trust may hold several properties. Its powers and plan determine whether it can sell them as a group or one at a time. Ask whether it can sell just one property. If so, how does the lender release that property from the loan?
One property's gross sale price may not equal cash available to distribute. A lender could require part or all of the proceeds to reduce debt. Other obligations or reserves may also affect the payment. Read the release provisions instead of assuming each sale produces a matching check.
Partial sales can create tax and exchange planning before the last building sells. Ask the CPA and QI to review each proposed transfer and any connected exchange structure. Do not wait for a letter that labels the whole investment “full cycle.”
If you sell several properties on different dates in one exchange, the first transfer starts the clock. Separate sales or payments do not give each property a new clock within that same exchange. [5]
If another exchange may fit, engage the QI and tax team before the sale closes. They need to confirm the structure, assignments, notices, and control of proceeds. Receiving sale cash personally and later sending it to an intermediary does not recreate a properly structured exchange. [5]
In a standard deferred exchange, the identification period ends 45 calendar days after the relevant transfer. The purchase period ends at the earlier of 180 days or the applicable tax return due date, including extensions. The periods run together; they are not added. [5]
Start your search early. That search is not the formal notice required by the tax rules. The notice must be signed, describe the property, and go to a permitted person on time. Limits on the properties you name also apply. Talking about a possible purchase does not meet those rules.
Review how much equity and debt the next exchange must address. Debt paid off in the sale remains relevant to the replacement calculation. Have the CPA reconcile costs and any cash you plan to take out. The next offering's minimum and debt allocation may differ from your current one.
Keep alternatives in mind, but do not assume any particular DST will remain available. A limited allocation or a pending review can change the plan. A valid backup needs both a workable closing path and proper identification.
A taxable cash exit may be appropriate if you need money or no suitable exchange fits. Obtain an estimate of federal and state taxes before deciding how much of the proceeds is available to spend. Prior deferral and depreciation can affect the result.
Some offerings plan for a Section 721 contribution to an operating partnership. That is not a cash sale followed by a new purchase. The structure, parties, terms, and tax rules determine whether it can work.
A qualifying property contribution for partnership interests generally does not trigger gain right away. There are exceptions. The IRS rule does not make every proposed roll-up tax-free. Changes in your debt share and other terms need tax review. [6]
Ask whether the route is optional, required under certain conditions, or merely possible. Also ask what you receive, how it is valued, what restrictions apply, and when a taxable event could occur. Partnership interests generally do not qualify as replacement property for a later 1031 exchange. [4]
Partnership units are not cash you can spend. Before you plan a major purchase, check when you could turn those units into cash. Read the rights, limits, and tax terms.
A sale can end one stream of income before the next investment starts paying. Ask when the old trust expects to make its last regular payment. Then review the new offering's start date, payment schedule, and any period with no forecasted cash flow.
For a simple planning example, suppose $200,000 earns a hypothetical 5% annual cash rate. That equals $10,000 a year, or about $833.33 a month. Three months without that payment leaves a $2,500 gap compared with a plan that assumes steady monthly income. This is arithmetic, not a promised rate or an estimate of what any DST will pay.
Funds held for the next purchase are not all income you can spend. Using exchange proceeds to cover living costs can change the exchange and tax result. Plan those bills with other cash, and discuss any planned withdrawal with the QI and CPA first.
Ask the QI how the exchange agreement treats interest on funds it holds. Do not assume those funds earn the same rate as the old investment. Also ask how any interest is reported and handled at the next closing.
I would rather discuss a short income gap in advance than let it drive a rushed purchase. An unsuitable investment does not become suitable because it starts paying sooner. Keep the income budget and the investment review connected, but give each its own clear check.
Match the investment to money that can remain tied up beyond the projected hold. Set aside separate resources for near-term bills, known purchases, and unexpected costs. The right amount depends on your circumstances, not a universal number in a marketing guide.
If your plan requires $150,000 for a family expense in exactly four years, a forecasted four-year property sale is not a reliable funding commitment. Consider how you would meet that expense if the sale took two more years or returned less than expected.
Buying investments in different years can spread potential exit dates, but it cannot schedule them. Several sponsors may sell in the same favorable market or face the same financing pressure. Staggered purchase dates are not the same as a ladder of bonds with fixed maturities.
A private-placement interest may be difficult to resell. Restrictions, required approvals, a lack of buyers, and uncertain pricing can prevent a quick exit. Do not make a secondary sale your only backup for a known cash need. [7]
Keep the original sale assumptions and compare each update with them. Watch the loan date, major leases, occupancy, expenses, capital work, and reserve balance. Ask why a projected exit moved and what changed in the supporting numbers.
Request a clear distinction among “considering a sale,” “listed,” “under contract,” and “closed.” A signed purchase agreement can still have conditions. An estimated distribution date can still depend on the closing and final accounting.
Update your own plans when circumstances change. Retirement, health, family needs, and other investments may alter what you want from the eventual proceeds. Let your adviser know before an exit notice forces a rushed discussion.
There is no single hold length built into the DST label. Review the specific trust term, sale authority, financing, and business plan. The ten-year facts in the IRS ruling are not a universal required holding period. [2]
No. A projection is an estimate. Ask whether the documents create any right to payment and what conditions apply. A sale can occur earlier or later, and the net amount can differ from the forecast.
Do not assume you can. Management and voting rights depend on the documents and law. Even a right to request or vote on an action does not ensure an immediate buyer or acceptable price.
No. More time could improve a sale outcome, but it can also bring costs and delay needed cash. Review the updated business case, financing limits, distributions, and alternatives rather than judging by the calendar alone.
The standard deferred-exchange clock is tied to transfer of the relinquished property, not the day you read an investor letter or receive a payment. Arrange the exchange before closing and confirm the exact dates with the QI. [5]
It typically involves receiving partnership interests rather than cash. Any later redemption or conversion has its own terms and tax effects. Do not treat a proposed contribution as a guaranteed liquid exit.
Confirm the expected transfer date, net proceeds, debt payoff, open conditions, and choices under the documents. Contact your CPA, QI if an exchange is planned, and investment adviser before closing. Keep formal decisions and instructions in writing.
Educational information, not an offer or a personal tax, legal, or investment recommendation. Examples are hypothetical and omit stated adjustments. Tax treatment depends on your facts and current law. Review your transaction with your CPA, attorney, and qualified intermediary. Real estate investments can lose value and may be illiquid.
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