When the IRS created rules allowing the Delaware Statutory Trust (DST) ownership structure to be used as an acceptable “like-kind” 1031 exchange investment option, they mandated that the sponsor of the DST could not refinance the property or request additional funds from investors during the holding period. DST sponsors were also prohibited from negotiating new leases.
If unforeseen circumstances occur that would require additional funds, e.g., loss of a major tenant, DST sponsors were provided with an option to convert the DST structure into a Limited Liability Company structure termed a “Springing LLC.” This LLC structure allows DST sponsors added flexibility to raise additional funds, renegotiate current loans terms, obtain new loans, or enter into new leases.
Consequences of a Springing LLC
The Springing LLC acts as a safety net to provide an additional tool to a DST sponsor to protect investor interests and help avoid a negative outcome. However, when a property is converted from a DST to an LLC structure, investors generally no longer have an option to complete a 1031 exchange unless all the investors in the Springing LLC invest in a new 1031 replacement property. Since this option can be difficult to accomplish, DST sponsors strive to convert the Springing LLC structure back into a DST structure as soon as practical.
The Springing LLC not only provides additional options to protect investor interests that are not permitted under the DST structure, but it also provides added security to lenders and can reduce risks of a loan default or foreclosure.
It is important to note that since the creation of the 1031 DST structure in 2004, the Springing LLC option has rarely been used. During our firm’s history dating back to 2003, we have only been aware of several situations that required converting a DST into a Springing LLC. However, the existence of this option is analogous to having an insurance policy that is only needed in the event of an unforeseen emergency.
To learn more about DSTs and the 1031 exchange process and how it may work with your portfolio, please contact us to schedule a consultation.
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