The Traditional DST vs The 721 DST

Carl E. Sera, CMT
Carl E. Sera, CMT
Managing Principal, Sera Capital
Carl Sera is a Chartered Market Technician and the Managing Principal at Sera Capital Management, LLC. He has over 14 years of experience in the financial services industry with a focus on investment management.

Most Traditional DST hold a single asset class and typically just a single property. Their expected holding period is approximately 5-7 years.  They are illiquid and carry approximately a 15% cost at initial purchase and 5% upon sale or disposition. The widely followed plan is the 1031 exchanger buys one or more Traditional DSTs and when they mature at different times in 5-7 years, the investor rolls over the original investment plus the profits into another Traditional DST.  The investor keeps doing this until they eventually pass away at which time their beneficiaries receive a stepped-up cost basis thus avoiding taxes altogether. The idea behind the Traditional DST is to defer, rollover, defer, rollover, eventually pass away and then avoid taxes. It was a state of the art “exit” strategy until the 721 DST came along.

While the Traditional DST model is an “exit” planning and estate management tool, the 721 DST is more appealing in almost every way. The proof is self-evident.  Today, there are billions of dollars invested in Public Non-Listed REITs and more money is flowing towards that form of ownership daily. Investors are voting with their money by investing their after-tax money into these vehicles and they do not invest their after-tax money into Traditional DSTs.  This means the Traditional DST while still an elegant solution has a better, bigger, stronger rival that when compared side by side can’t compete.

Why is the 721 DST more appealing than the Traditional DST?  First let’s find out how one works. We like to give 721 DST different names based on their function.  We sometimes call them Hybrid DSTs; other times we call them Convertible DSTs, other times Shape-shifter DSTs and other times we call them Final Destination DSTs.  Why four names?  Because a 721 DST acts exactly like a Traditional DST for the first 2-year period until it shape-shifts or converts into ownership of operating partnership units in a Public Non-Listed REIT. This REIT becomes the investor’s final destination and so this hybrid is part Traditional DST and soon after purchase, it becomes a REIT.

The question then is which model is better.  Is it better to rollover Traditional DSTs throughout a lifetime or is it better to just buy a 721 DST that in two years converts into a REIT? Let’s analyze key features and benefits and let’s also understand Sera Capital’s perspective. We still utilize Traditional DSTs for approximately 25% of our consulting practice clients because they still have a valid place but the remaining 75% recognizes the benefits of the 721 DST.  We are uniquely positioned to be able to provide both Traditional and 721 DSTs as well as Qualified Opportunity Zone funds and initially steer our clients into the appropriate solution between the three and then into specific investments.  Our fee is the same regardless of which solution fits best and so our clients can trust that our advice is non-conflicted.

But let’s focus on the Traditional Delaware Statutory Trust (DST) vs the 721 Delaware Statutory Trust (DST) once again.

  • Diversification – The 721 DSTs we recommend convert to Public Non-Listed REITs that hold as few as 50 diversified properties or as many as 250. They are spread out amongst all the major real estate asset classes and adjust their portfolios as the real estate climate changes. This level of diversification is unattainable with Traditional DSTs. It’s the stock market equivalent of holding a diversified portfolio vs a concentrated one.
  • Return Predictability – The 721 DST because it is diversified is more likely to provide investors with a “real estate index” rate of return which is typically in the 7-9% range since inception.  This contrasts with the volatility of returns seen in Traditional DSTs.
  • Risk Predictability – The 721 DST because it is diversified reduces risk since it is spread out over a large portfolio of holdings. This contrasts with the single property volatility or risk seen in Traditional DSTs.
  • Liquidity – The 721 DST offers the investor liquidity after 3 years and they maintain this liquidity until they die at which time, they receive a stepped-up cost basis just like the Traditional DST. Liquidity is critical as investors age because often they are incapable of making the Traditional DST rollover decision due to poor health or mental incapacity. This often ruins decades of tax planning as the investor receives taxable funds upon the sale of the Traditional DST.  Furthermore, with the 721 DST, beneficiaries have immediate full access to the decedents REIT while they must wait for the Traditional DST to complete its 5–7-year cycle which often leaves the estate unsettled or creates costly complications.
  • Cost or Fees – The 721 DST starts out as a traditional DST then converts to a Public Non-Listed REIT after 2 years.  The “all in” cost to buy into a 721 DST seldom exceeds 5% while the “all in” cost of a Traditional DST is approximately 15%.  To make matters worse, the Traditional DST may last an average of 5-7 years and so the 15% fee would need to be paid every 5-7 years, while the 721 DST is a one-time fee.  Lastly, the Traditional DST has approximately a 5% disposition fee every time.  This is a significant cost differential and if you are interested you can request our which is the best DST calculator to understand just how much this will affect your portfolio.
  • Regulatory Risk – The 721 DST gets its name from section 721 of the IRS code just as the 1031 exchange gets its name form section 1031 of the IRS code. Investors in real estate as well as investors in Traditional DSTs will be left with some tough choices and tax consequences should Congress eliminate 1031 exchanges.  The 721 DST eliminates this risk.
  • Simplicity and Certainty – The 721 DST is purchased once, and the investor never has to perform an additional 1031 exchange. Some people consider this a negative, we disagree.  Why do we disagree?  Because the average first time DST investor is 64 years old and has made the decision to move from active ownership to passive ownership. Once an investor decides to move to passive ownership, they don’t revert to active. While this may be a problem for younger investors, in our practice, we only recommend either Traditional DSTs or 721 DSTs if and only if an investor wants out of active management. If they want to stay active, we go out of our way to let them know that perhaps the DST route is not appropriate for them yet.
  • Gifting/Charity – The 721 DST because it is in units and is liquid soon after purchase is often used as an estate planning device to gift highly appreciated assets to children and charities.  This is not possible with Traditional DSTs since they only mature and provide liquidity every 5-7 years.
  • Retitling – The 721 DST just like the Traditional DST is often retitled for estate planning purposes. Often title is held in such a way that the owners want to separate their holdings because they have divergent interests.  With the 721 DST after a 3-year period from the initial purchase, the investors can go their separate ways.  If, for example, there are 2 investors in an LLC, one investor can retain the units and they could be titled in their name or trust while the other could sell their units and pay taxes on the gain.  This flexibility is not available under the Traditional DST.
  • Tax Planning/Tax Savings – The 721 DST lets you sell units after 3 years.  This is particularly useful when combined with a total portfolio perspective. Let’s suppose the investor has a loss from a stock sale or from the sale of another piece of real estate, they can sell the appropriate amount of their Public Non-Listed REIT to utilize this loss.  Thus, they create even greater liquidity and more flexibility.  This is not possible with a Traditional DST.
  • Income Supplement – The 721 DST lets you sell after 3 years.  Many investors find themselves in lower tax brackets as they journey thru retirement. 721 DSTs allow the possibility of the periodic sale of units to supplement your income at a lower tax rate than on the day of your initial purchase.  This is not available with Traditional DSTs.
  • Tax Free Access to Cost Basis – Some 721 DSTs, though not all, will allow you to access your cost basis tax free while others do not.  While this may seem like a tremendous benefit, we have seldom seen it used.  What we do see is investors borrowing against their units at rates that are often more attractive than the cash-on-cash yields on their investment.

To learn more about 721 Exchanges and 721 Delaware Statutory Trusts (DSTs)

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