In short
The SEC's income, net worth and license tests for accredited investors, how the primary residence is counted, and what verification under Rule 506(c) involves.
An accredited investor is a person or entity that meets one of the tests in SEC Rule 501(a). For an individual, that usually means income over $200,000 (or $300,000 with a spouse) in each of the last two years, or net worth over $1,000,000 not counting your home. DSTs and the other private offerings used as 1031 replacement property are sold under Regulation D, so the sponsor will ask which test you meet and, under Rule 506(c), will verify it. Here are the tests, the residence rule that trips people up, and what verification looks like.
The three tests for individuals
17 CFR 230.501(a) lists the categories. Three apply to natural persons:
- Net worth. Individual net worth, or joint net worth with a spouse or spousal equivalent, over $1,000,000, with the primary residence excluded as an asset (paragraph (a)(5)).
- Income. Individual income over $200,000 in each of the two most recent years, or joint income with a spouse or spousal equivalent over $300,000 in each of those years, with “a reasonable expectation of reaching the same income level in the current year” (paragraph (a)(6)).
- Professional credentials. Holders in good standing of certain licenses the SEC has designated (paragraph (a)(10)). The SEC’s own summary names the Series 7, Series 65 and Series 82 licenses. “Knowledgeable employees” of a private fund also qualify for that fund’s offering (paragraph (a)(11)).
“Spousal equivalent” is defined in the rule as “a cohabitant occupying a relationship generally equivalent to that of a spouse.” You only need one test. Most sellers of investment real estate meet the net worth test, which is why it matters how the house is counted.
How the primary residence is handled
Paragraph (a)(5) does three things with your home. The residence itself is not an asset. The mortgage on it is not a liability, up to the home’s fair market value. Two exceptions pull debt back in: any amount of residence debt above the home’s value counts as a liability, and any increase in residence debt taken on within 60 days before the securities purchase, other than to buy the home, counts as a liability. The second rule stops a seller from drawing a home equity line to fund the investment and ignoring the draw.
A hypothetical: a couple owns a home worth $900,000 with a $500,000 mortgage, rental property equity of $800,000, retirement accounts of $350,000 and $50,000 in cash. The home and its mortgage drop out. Net worth for the test is $1,200,000, and they are accredited. If they had drawn $100,000 on a home equity line 30 days before subscribing, that $100,000 counts as a liability and the figure falls to $1,100,000, still over the line. Run your own numbers with your CPA, and keep the statements that show them.
Entities, trusts and family offices
The entity tests in the same rule include an organization or trust with total assets over $5,000,000 that was not formed for the purpose of buying the securities (paragraph (a)(3)), any entity owning investments over $5,000,000 (paragraph (a)(9)), an entity in which all of the equity owners are accredited (paragraph (a)(8)), and a family office with at least $5,000,000 in assets under management together with its family clients (paragraph (a)(12)). If your rental is held in an LLC and the LLC will buy the DST interest, the sponsor will usually look through to the members under paragraph (a)(8). Our page on DST accredited investor rules covers trusts and IRAs.
Rule 506(b) and Rule 506(c): the difference is who checks
Both rules sit in 17 CFR 230.506. Under Rule 506(b) the issuer may not use general solicitation, may sell to an unlimited number of accredited investors, and may sell to “no more than” 35 non-accredited purchasers who have enough knowledge and experience to evaluate the investment. The SEC’s 506(b) summary adds that non-accredited purchasers must receive disclosure comparable to a registered offering. In practice you self-certify by questionnaire.
Under Rule 506(c) the issuer may advertise, but “all purchasers” must be accredited and the issuer must take “reasonable steps to verify” that status. The SEC’s 506(c) summary notes that the securities remain restricted and that Form D is filed within 15 days after the first sale. Our page on reading a DST private placement memorandum and Form D shows where the exemption is stated.
What verification looks like under 506(c)
Paragraph (c)(2)(ii) of the rule gives four non-exclusive safe harbors:
- For the income test, IRS forms reporting your income for the two most recent years, such as Form W-2, Form 1099, Schedule K-1 or Form 1040, plus your written representation that you expect to reach the same level in the current year.
- For the net worth test, documents dated within the prior three months: bank, brokerage and similar statements, certificates of deposit, tax assessments and appraisals for assets, and a consumer credit report for liabilities, plus your written statement that all liabilities are disclosed.
- A written confirmation, dated within the prior three months, from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant that they have taken reasonable steps to verify your status.
- For someone who bought in the same issuer’s earlier 506(b) offering as an accredited investor, a certification that they still qualify.
The third route is the quietest. A letter from your CPA or attorney means you do not hand tax returns to a sponsor. Ask for it early; a 45-day identification deadline is not the time to be gathering three months of statements.
What to do now
- Decide which test you meet and pull the documents for it: two years of returns for the income test, or current statements for the net worth test.
- If you prefer not to share returns, ask your CPA or attorney for a verification letter dated within the last three months.
- Ask each sponsor whether the offering is 506(b) or 506(c) and what they will accept; see who can sell a DST for the licensing side. Then start your exchange plan.
