Beneficial Interest (DST)

Delaware law calls the interest personal property, while federal tax law looks through it to the building.

The Delaware Statutory Trust Act sets the default terms. Under 12 Del. C. section 3805, a beneficial owner holds an undivided beneficial interest in the trust's property and shares in profits and losses in proportion to that interest. The interest is personal property 'notwithstanding the nature of the property of the statutory trust,' and the owner has no interest in specific trust property unless the trust agreement says so. Section 3803 gives beneficial owners the same limitation of personal liability as stockholders of a Delaware corporation.

Federal tax law starts from the opposite direction. Section 1031(a)(1) covers only real property, and Reg. section 1.1031(a)-3(a)(5)(i) lists certificates of trust or beneficial interests among the intangibles that are not real property for section 1031.

Rev. Rul. 2004-86 bridges the gap. Because the trustee had no power to vary the investment, the trust was an investment trust taxed as a grantor trust, and an owner of an undivided fractional interest in such a trust 'is considered to own the trust assets attributable to that interest for federal income tax purposes.' The investors' exchange was therefore treated as real property for an interest in the building, not for a beneficial interest.

A hypothetical $1,000,000 interest in a trust with $10,000,000 of equity is a 10% share of everything the trust owns and owes.

Hypothetical: a DST raises $10,000,000 of equity and buys a net-leased building for $20,000,000 with a $10,000,000 nonrecourse loan. You exchange into $1,000,000 of interests, 10% of the equity. For tax purposes you are treated as owning 10% of the building subject to 10% of the loan, and your return carries 10% of the rent, interest and depreciation.

How your share of the trust's loan counts toward replacing the debt you paid off at sale is covered at whether a DST loan counts as replacement debt. Run your own numbers with your CPA before you rely on any split like this one.

Ownership stops at the economics. In the ruling, the trust agreement limited the trustee to collecting and distributing income, and barred new contributions, new leases except on the tenant's bankruptcy or insolvency, and any renegotiation of the debt. You cannot direct the trustee or sell a slice of the building on your own.

It bites when you want out, because the interest is an illiquid security rather than a deed you can list.

The Delaware Act makes a beneficial interest freely transferable unless the governing instrument says otherwise, and the trust agreement in Rev. Rul. 2004-86 provided that interests were freely transferable but not publicly traded on an established securities market. A DST interest sold under Regulation D is also a restricted security under Rule 502(d), which cannot be resold without registration or an exemption. See DST illiquidity and exits.

It also bites at the next exchange. When the trust sells the building, you are treated as selling your share of real estate and can exchange again; if your interest is instead contributed to an operating partnership, what you receive is a partnership interest, which Reg. section 1.1031(a)-3 does not treat as real property. For the full picture read what you own in a DST and DST like-kind qualification.