Use of Master Lease to Address Limitations of the Delaware Statutory Trust (DST)

In order for a DST to qualify for favorable tax treatment, certain restrictions are placed on the trustee regarding its operation of the property. One limitation of the DST is that the trustee cannot enter into new leases or renegotiate the current leases. If the property is subject to a long-term triple net lease with a credit-worthy tenant this may not be a problem. In this situation, the DST could lease the property to the tenant directly and simply provide a property manager.

However, the DST will most likely use a long-term Master Lease to an affiliate of the sponsor if the property has a short-term lease, or other characteristics make it probable that the property may need to be re-leased while it is held by the DST. Under Revenue Ruling 2004-86, the lessee of the property held by the DST can sublease the property and then renegotiate subleases or enter into new subleases. Thus, the Master Lease structure allows the master lessee (sponsor affiliate) to re-lease the property and renegotiate leases. The DST itself would not be able to do that.

According to Rev. Ruling 2004-86 the following are considered the “seven deadly sins” of a DST structure:
1) Sell real estate and use proceeds to acquire new property
2) Renegotiate an existing lease
3) Enter into a new lease
4) Renegotiate an existing loan or borrow additional funds
5) Accept additional capital contributions from existing investors
6) Invest money of the DST in anything other than short-term government obligations
7) Make improvements to the real estate other than minor, non-structural modifications and those required by law

Delaware Statutory Trusts Possess Risks
Delaware Statutory Trusts are not without their risks. As with any type of real estate investment, investors may be subject to high vacancy rates and loan defaults. DSTs are also not sole-ownership investments. A Delaware Statutory Trust is a more passive investment made up of multiple owners and ultimately controlled by the master tenant (the sponsor). Also, the structure has limited usefulness for properties with multiple tenants or large capital improvements needing to be made. It is important for investors who may be considering the Delaware Statutory Trust strategy to consult with an experienced Delaware Statutory Trust professional, and to obtain competent legal and tax advice.
Upon thorough evaluation, the Delaware Statutory Trust structure may be a viable investment alternative for qualified real estate investors. But only your tax adviser and lawyer can tell you if it's right for you.