Navigating the Complexities of Delaware Statutory Trusts
March 27, 2024
A Delaware Statutory Trust (DST) is a real estate investment vehicle structured as a separate legal entity. DSTs are considered securities under federal law and hold fractional interest. They are treated like direct property ownership for tax purposes, which meet the requirements of like-kind property and qualify as replacement property for a Sec. 1031 exchange.
It is imperative that real estate owners, developers and investors understand the structural intricacies and financial implications of DSTs so that they can reap tax benefits and properly account for the investment.
Breaking Down the DST Structure
A DST is an independent legal entity created under the provisions of the Delaware Statutory Trust Act, 12 Del. C. § 3801 et seq. (the DSTA), which provides flexibility regarding its governance, operations and purposes.
Similar to a Delaware LLC or LP, a statutory trust is primarily a creature of contract, governed first by its respective trust agreement and secondarily by statute. In lieu of applying the statutory defaults of the DSTA, Delaware courts will defer to the parties’ rights as agreed upon in a trust agreement. Because of their structure, DSTs, LLCs and LPs also have similar liability protection in that investors are shielded from property-related liabilities.
Under the DSTA, the trust is a separate legal entity, and no creditor of a beneficial owner has the right to possess any of the property belonging to the trust. In other words, creditors cannot go after individual beneficiaries by placing liens against the property. Additionally, DSTs are financed with non-recourse debt and the beneficiaries do not carry any personal liabilities under the loan.
DSTs are becoming more popular as an alternative for Section 1031 exchanges. It is critical for an entity to understand how a DST would be accounted for under GAAP before proceeding with an investment.
Accounting for DSTs
Accounting Standards Codification (ASC) 860, Transfers and Servicing, defines a beneficial interest as “rights to receive all or portions of specified cash inflows received by a trust or other entity, including, but not limited to, all of the following:
- Senior and subordinated shares of interest, principal, or other cash inflows to be passed-through or paid-through;
- Premiums due to guarantors;
- Commercial paper obligations; or
- Residual interests, whether in the form of debt or equity.
Entities must determine whether the DST is a beneficial interest within the scope of ASC 325-40, Investments – Other. Beneficial interests subject to the guidance in ASC 325-40 can be either: (1) beneficial interests retained in securitization transactions and accounted for as sales under ASC 860; or (2) purchased beneficial interests in securitized financial assets.
If the reporting entity has an interest in an entity, the first step in the analysis determines whether that entity is within the scope of the Variable Interest Entities Subsections in accordance with paragraph 810-10-15-14, Consolidation. If that entity is within the scope of the Variable Interest Entities Subsections, the reporting entity should first apply the guidance in those Subsections.
Variable interests are defined as the investments or other interests that will absorb portions of a variable interest entity’s (VIEs) expected losses or receive portions of the entity’s expected residual returns. Common examples of potential variable interests include beneficial interests.
Next, if the DST is not an investment that is consolidated, the reporting entity must assess whether it meets the definition of a derivative under ASC 815, Derivatives and Hedging. A derivative instrument is a financial instrument or other contract with all the following characteristics:
- Underlying, notional amount, payment provision;
- The contract requires no initial net investment; and
- Net settlement.
Furthermore, if the DST is not a derivative, the analysis would then focus on the beneficial interest a debt security under ASC 320, Investments – Debt Securities, or required to be accounted for as one under ASC 860. It should consider factors including, but not limited to the following:
- Involvement of securitized financial assets
- Contractual cash flows
- Credit quality
- Prepayment and other settlement terms
Let Us Guide You Forward
A Delaware Statutory Trust can be a powerful investment vehicle for real estate professionals, when wielded effectively. It is crucial to enlist a trusted advisor to guide you in capitalizing on all of the opportunities a DST can bring, as well as remaining compliant with accounting standards.
Cherry Bekaert can help your company grow and excel, regardless of the economic climate. Our Real Estate & Construction professionals can tailor a strategic plan to your business goals to cover objectives such as effective tax strategies, structuring developments and profitability analyses. We can help establish strong industry relationships for you, while staying ahead of trends to provide timely and actionable advice. Reach out to your Cherry Bekaert advisor to learn more about how our industry-driven insights can position your business for success.