If you are like most real estate investors looking to defer the payment of capital gains taxes, then finding the best 1031 exchange strategy will be your utmost concern. For most investors thinking of doing a 1031 exchange, they are always faced with the option of exchanging into a DST or a TIC. The reason is because of the freedom these two passive investment vehicles afford investors looking for a way to hands off the day-to-day management of their properties.
However, the questions on the mind of most investors are which should I go for? Which offers more benefits and is the right solution for my 1031 exchange investment? In this article, you’ll learn more about the TIC and DST 1031 strategy, and which is better for investors looking for less headache.
What is a DST?
The DST which stands for Delaware Statutory Trust is an IRS-backed legal entity that allows investors up to 499 to pool their resources together to purchase a beneficiary ownership interest in the assets of a trust. While there are several legal differences, a DST is similar in function to a limited partnership. The most notable characteristics of DSTs are that they are eligible for use in a 1031 exchange.
What is a TIC?
While Tenant in Common is similar to Joint tenancy, a TIC is a co-ownership agreement that allows multiple investors up to 35 individuals to pool their resources together to own a single joint property. Each investor owns an undivided (must not be equal) share in the property and benefit from the resultant proportionate share of the tax shelters, income, and growth.
Unlike a DST structure, investors in a TIC receive a separate property deed for their percentage of interest in the property and may have equal voting rights as the single owner. One of the key differences between a DST and TIC is that while investors in a DST are unable to transfer their beneficial ownership interest, co-owners in a TIC can do so without seeking the approval of other owners in the trust.
Similarities between DST and TIC Structure
- They are both managed by a professional management company hired by the sponsor
- Both DSTs and TICs can be used as a like-kind property in a 1031 exchange
- They are excellent diversification strategy since they allow for minimum investments
DST vs. TIC: Which One is better?
Below are some of the reasons why sophisticated investors prefer the Delaware Statutory Trust investment strategy over Tenants in Common.
- Easy Decision-Making Process
In a TIC structure, decisions regarding the sale of the property, or refinancing of the property must be unanimously agreed by all the parties involved in the TIC. Unfortunately, there have been instances where 98 percent of the investors are voting for the sale of the property and yet 2% are against it putting the entire sale process in jeopardy. That’s one of the reasons why so many TICs failed in the 2008-2009 period.
However, in a DST structure, the entire decision-making process is in the hand of the DST Sponsor. Only the Sponsor is charged with the responsibility of making decisions regarding the sale, maintenance, and all other vital aspects of the DST.
- Lower Minimum Investment when compared to a TIC
The DST structure allows for up to 499 investors which reduces its minimum investment amount when compared to TICs, which only allows for 35 investors. The typical DST minimum investment amount of $100,000 makes it possible for investors to diversify their investment across multiple DSTs at a single time.
For instance, if the potential property is a $50,000,000 multifamily with a loan to value ratio of 40%, the equity to be raised will be $30,000, and with only 35 investors allowed in a TIC, the minimum investment amount would be $857,142 compared to $60,120. For an investor with $2,000,000 looking to diversify their investment, they would only be able to in just two TICs.
The freedom associated with DSTs in terms of its lower minimum investment amount makes it a great investment vehicle for small scale real estate investors.
- Quick Closing
One of the downsides to investing in a TIC is its slow closing process which usually takes anytime between 45-60 days. This delay is due to the need for investors of a TIC to be approved and underwritten by a Lender.
When compared to a DST which closing process is usually finalized within 3-5 days, a TIC may not be a great option for investors faced with a 45 days identification timeline in a 1031 exchange. More importantly, investors in a DST do not need to be underwritten by a Lender since the sponsor is solely responsible for the financing and mortgage acquisition activities. As a result, the debt on DSTs is all non-recourse. The DST sponsor will go out and raise the debt and the rates that these institutions are getting are very good.
Lastly, you do not have to be an accredited investor to invest in a TIC, but you must be an accredited investor to invest in a DST.
We like to think of DSTs as TIC 2.0.