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What are the limitations of DSTs?

Owning tangible property is more complex than owning a share of stock. DST investments come with certain risks and limitations, and investors should understand these key points before proceeding.  

Lack of liquidity. Owning real estate means owning an illiquid asset. A DST interest is highly illiquid and can’t be converted into cash. For this and other reasons, investors in DST investments must be accredited investors. Typically, this is an individual investor with $1 million or more of net worth.  

Lack of management control. Management is truly passive. DST sponsors professionally manage the asset. That means investors do not have direct decision-making authority.  

The Seven Deadly Sins of DST Investing

DSTs must operate according to seven key criteria in IRS guidelines. These have become known as the “seven deadly sins” among those who employ this strategy to defer capital gains. Investors receive an ownership percentage but relinquish voting and operational management privileges when they invest in a DST. The regulations, described below, were put in place to ensure the DST meets the IRS’ “like-kind” requirements:

• No additional equity contributions: Investors make a single equity contribution upon formation of the DST. Since capital calls are not allowed, all future expenditures must be capitalized upon formation. 
• No refinancing of debt: Mortgages placed on the property cannot be refinanced. 
• No reinvesting of sale proceeds: Any proceeds earned by a DST must be distributed to investors. It can’t be reinvested by the trustee.   
• Limits on capital expenditures: Normal repair and maintenance of the asset, among other things, are allowed. But unnecessary upgrades or other activities that could put investor money at risk are not.  
• Limits on cash investments: DST sponsors can only invest cash in short-term debt or another vehicle—nothing speculative—until it’s time to distribute to investors. 
• Cash distributions: The DST is required to distribute earnings and proceeds to investors within the agreed distribution date. 
• No new leases or renegotiations: Most DSTs use a master lease structure. This means the master tenant negotiates existing leases and enters new ones. This keeps the trustee from renegotiating a lease that could change the terms of the DST investment.