Can Non-Accredited Investors Invest in a DST?
Most Delaware Statutory Trust offerings used for 1031 exchanges restrict purchases to accredited investors. A non-accredited investor may be eligible for a particular DST only if the offering documents and securities exemption permit it. For example, a private offering under Rule 506(b) may accept a limited number of sophisticated non-accredited purchasers, but the issuer is not required to accept them. An offering under Rule 506(c) may sell only to verified accredited investors.
Not qualifying for a DST does not prevent someone from completing a 1031 exchange. Direct real estate and some tenant-in-common arrangements may provide other replacement-property paths, depending on the transaction structure, the investor’s goals, and the applicable securities rules.
Key point: Accreditation determines access to certain securities offerings. It does not determine whether someone may complete a 1031 exchange.
Why Most 1031 DST Offerings Require Accreditation
A DST is a legal trust structure. When beneficial interests in a DST are offered to investors, those interests are generally securities. The offering must be registered or qualify for an exemption from registration. Many private real estate offerings rely on Rule 506 of Regulation D, but Rule 506 contains two different paths.
Rule 506(c)
A Rule 506(c) offering may sell only to verified accredited investors. The issuer must take reasonable steps to verify that each purchaser qualifies. General solicitation may be permitted.
Rule 506(b)
A Rule 506(b) offering may include unlimited accredited investors and up to 35 non-accredited purchasers who satisfy the sophistication standard. General solicitation is prohibited, additional disclosure obligations apply, and the issuer may still choose to accept only accredited investors.
The SEC’s Rule 506 overview explains these two exemptions. The practical result is that a person should never assume a DST is available merely because federal law allows some non-accredited participation in a Rule 506(b) offering. The private placement memorandum, subscription agreement, sponsor policy, broker-dealer requirements, and investor’s financial sophistication all matter.
It is also important to separate DST tax treatment from securities eligibility. IRS Revenue Ruling 2004-86 explains when a beneficial interest in the type of DST described in the ruling may be treated as an interest in real property for Section 1031 purposes. That tax treatment does not remove the securities-law requirements that apply to the offering.
How the Accredited Investor Test Works
For individuals, the most common ways to qualify as an accredited investor are:
- A net worth over $1 million, individually or with a spouse or partner, excluding the value of the primary residence.
- Income over $200,000 individually, or $300,000 with a spouse or partner, in each of the prior two years, with a reasonable expectation of reaching the same level in the current year.
- Certain professional credentials held in good standing, currently including the Series 7, Series 65, and Series 82 licenses.
Other paths exist for certain directors, executive officers, general partners, knowledgeable employees of private funds, family-office clients, and qualifying entities. The SEC’s current accredited investor criteria should be used instead of older summaries that list only income and net worth tests.
A licensed securities professional or attorney can help determine whether the purchasing person, trust, retirement account, or business entity satisfies the requirements of a specific offering. A qualified intermediary facilitates the 1031 exchange but does not determine securities eligibility or investment suitability.
What Non-Accredited Investors Can Consider in a 1031 Exchange
A non-accredited investor may still exchange qualifying investment or business real estate for other qualifying real property. The investor must satisfy the same 1031 rules and deadlines that apply to any other exchanger. The replacement choice should be evaluated separately from the tax mechanics.
Directly Owned Replacement Property
An investor may purchase another rental home, apartment building, commercial building, industrial property, investment land, or other qualifying real estate. Professional property management can reduce daily landlord work without changing the investor’s direct ownership. Direct ownership may also provide more control than a DST, but it can require more time for property selection, financing, inspection, and ongoing oversight.
Review the site’s 1031 exchange rules and requirements before the relinquished property closes. The exchange normally must be arranged before closing, potential replacement property must be identified within 45 days, and the replacement property generally must be received within 180 days or by the applicable tax-return deadline, whichever comes first.
Tenant-in-Common Ownership
A tenant-in-common, or TIC, arrangement allows two or more owners to hold undivided fractional interests in the same real property. A properly structured TIC interest may qualify as replacement real property for a 1031 exchange when the ownership arrangement is respected as co-ownership rather than a partnership. IRS Revenue Procedure 2002-22 lists conditions the IRS considers when deciding whether to issue a ruling on that distinction.
TIC does not automatically mean non-security. A deeded TIC interest standing alone generally is not a security, but a sponsored TIC program packaged with management, leasing, financing, or other arrangements may be an investment contract under federal securities law. FINRA Notice to Members 05-18 states that TIC interests offered with those arrangements generally are securities. If the TIC is a security, its offering exemption may limit whether a non-accredited investor can participate.
Learn how tenant-in-common investments are structured and review any current TIC property information only after confirming the eligibility rules for the specific offering. Availability, minimum investment, financing, voting rights, fees, and transfer restrictions vary by property and sponsor.
Other Direct Real Estate Structures
A non-accredited investor may also consider directly purchasing a fractional interest with a small group, acquiring one or more smaller properties, or buying a property subject to a professional management agreement. Each option presents different title, financing, control, liability, and management issues. Interests in partnerships, stocks, bonds, and REIT shares generally are not replacement real property under Section 1031, even when the underlying business owns real estate.
A Hypothetical Planning Example
Assume an investor expects to sell a rental property for $900,000 and does not meet the accredited-investor criteria. The investor wants less day-to-day management but has not yet selected replacement property.
A broadly advertised Rule 506(c) DST would not accept that investor because all purchasers in the offering must be verified accredited investors. The investor could ask whether any suitable Rule 506(b) offering accepts sophisticated non-accredited purchasers, but should not build the exchange plan around an exception that may not be available.
Before the sale closes, the investor could instead compare a directly owned net-leased property, multiple smaller rental properties managed by a third party, and a TIC interest whose tax and securities structure has been reviewed by the appropriate professionals. The investor would then coordinate the exchange documents and deadlines with a qualified intermediary. This example is hypothetical. It illustrates the need to verify both offering eligibility and 1031 qualification before relying on a replacement option.
Questions to Ask Before Choosing a Replacement Property
- Is the interest real property for Section 1031 purposes? Confirm the tax structure with the investor’s tax adviser or attorney.
- Is the interest a security? If so, identify the registration exemption and the purchaser requirements.
- Does the offering accept non-accredited investors? Review the offering documents instead of relying on a general website description.
- Who makes investment recommendations? Securities recommendations and suitability analysis should come from an appropriately licensed professional.
- What control will the investor retain? Compare voting, leasing, financing, management, sale, and partition rights.
- How liquid is the interest? Do not assume a ready resale market exists for a DST or sponsored TIC interest.
- What are the total costs and risks? Review sponsor compensation, brokerage costs, property-level debt, reserves, tenant concentration, projected distributions, transfer restrictions, and possible loss of principal.
- Can the transaction meet the exchange deadlines? Confirm identification language, closing timing, financing, and backup options before day 45.
Plan Around the Offering, Not the Label
Being non-accredited does not make a person ineligible for a 1031 exchange, and the word TIC does not guarantee access to a particular investment. The controlling documents and legal structure determine whether the interest may be offered to the investor and whether it may qualify as replacement real property.Start the review before selling the current property. Early planning creates time to verify investor eligibility, compare direct and fractional real estate, complete due diligence, and prepare backup replacement choices without depending on an unavailable DST.
Start Planning Before Your Sale Closes
If you are planning a 1031 exchange and are unsure which replacement-property formats may be available without accredited status, discuss your replacement-property options with the 1031 Exchange Place team before your sale closes. The team can explain its qualified intermediary services and help you coordinate with the tax, legal, real estate, and securities professionals responsible for the other parts of the decision.