Learn
A little clarity for your next decision.
Loading your learning library…
Investor WorkspaceWelcome, there!Log Out
Investor WorkspaceA little clarity for your next decision.
By Jerry Baker
Buying a leveraged DST usually gives you a tax share of property debt without making you sign the mortgage note. The loan and offering documents state who owes the money, who guarantees it, and what the lender must approve. Review those terms along with the debt needed for your 1031 exchange.
The word “assume” can cause confusion. In a direct property purchase, an approved loan assumption may put a new borrower under an existing loan. In a DST purchase, the investor generally buys an interest in a trust that already holds real estate and its financing.
Revenue Ruling 2004-86 describes an owner who places real estate in a DST. The trust takes on the old loan and lease. Later buyers purchase shares in the trust. Under the ruling's facts, they are treated as owning shares of the real estate for federal tax. [1]
That tax treatment and the legal mortgage obligation are different things. Your tax share of debt does not, by itself, mean you signed a personal promise to repay the lender. Nor does it mean the debt has no effect on your investment.
When I review a leveraged offering, I want both questions answered: what debt is allocated to the investor, and who owes what under the actual loan?
Ask for a simple chart showing the property owner, borrower, lender, guarantor, trust manager, and any master tenant. Do not assume that a shared brand name means these are all the same company.
The trust is the borrower in the IRS ruling. An actual offering may have more parties or a portfolio of properties. Read its structure before describing every obligation as a single loan owed by a single entity.
The lender provides the money. A loan servicer may collect payments, review reports, and process requests. The sponsor creates the offering, but that role alone does not prove it guarantees the loan or your investment.
A guarantor is a party that promises to cover obligations stated in a separate agreement. The promise might be broad, limited to certain losses, or triggered only by named events. Ask who signed it and what resources that party has.
This chart makes later questions easier. If the property struggles, you need to know which party can act, which party must consent, and which party has promised support.
With a nonrecourse loan, the lender generally looks to the assets pledged to it for repayment. It cannot freely pursue other assets of the borrower or guarantor. But the loan can have exceptions. The OCC's lending guidance describes carve-outs for certain acts or failures to act. Some can trigger broader liability. [2]
Common subjects include fraud, misuse of funds, certain bankruptcy actions, and prohibited transfers. The actual wording controls. A carve-out guaranty signed by a sponsor affiliate is not automatically a guaranty signed by each passive investor.
Delaware law generally limits a DST owner's personal liability in the same way it does for a corporate shareholder. But the trust's governing document can provide otherwise. That exception matters. Read the trust agreement and any other promises you are asked to make. [3]
Even when an investor has no personal mortgage liability, foreclosure can wipe out the invested equity. Lost distributions, sale expenses, and tax consequences may also follow. “Nonrecourse” describes legal recovery rights. It does not describe a loss-free investment.
I would not accept a broad “you cannot lose more than this” statement without reviewing the actual documents and any other agreements involved.
In the common passive DST structure, each investor does not apply for a separate share of the mortgage like a homebuyer. That can reduce the personal loan process. It should not become a promise that no information, consent, or background review can ever be required.
The sponsor and broker still need your purchase forms and other required facts. They must check who you are and whether you can make this investment. They may need the source of funds and the name of the proposed owner. Those tasks differ from approval for a personal mortgage.
A lender may also have rules about changes in ownership or control. For example, Fannie Mae's multifamily guidance calls for lender consent before a transfer unless the loan documents expressly allow it. That is one program's rule. It is not a rule for every DST. [4]
Ask which approvals are already in place for the offering and which remain for your purchase. If you plan to use an LLC or trust, provide its documents early. Avoid treating “no personal mortgage application” as “no closing requirements.”
A short loan summary should make the obligations clear without replacing the full documents. At a minimum, I want these items side by side:
| Term | What to confirm |
|---|---|
| Balance | Current principal and projected balance at sale |
| Rate | Fixed or variable, index, spread, floor, and any cap |
| Payments | Interest only or principal and interest; dates when payments change |
| Maturity | When the remaining balance is due |
| Extensions | Available options, conditions, fees, and deadlines |
| Early exit | Payoff limits, costs, notices, and transfer approvals |
| Security | Which property, accounts, or other assets secure repayment |
Use the loan's current documents and amendments. A brochure issued before closing may show proposed terms. Confirm that the funded loan matches them, and ask about any change that affects cash flow or timing.
Also record the date of the summary. A fixed rate can stay the same while the loan balance, reserves, or remaining term changes.
Loan-to-value divides debt by a stated value. But the lender's value, purchase price, and total investor offering price may differ. A percentage without its denominator can hide that difference.
Consider a hypothetical property bought for $10 million with a $6 million loan. Debt is 60% of the purchase price. Suppose investors fund $5 million of equity, including costs and reserves, for an $11 million total offering capitalization. Debt is about 54.55% of that total.
Neither percentage is the other one. The lender may use an appraised value for its own ratio. The investor needs the actual equity and debt allocation shown in the offering, especially when planning an exchange.
In that $5 million equity raise, a $100,000 investment is a 2% share. Two percent of $6 million debt is $120,000. Cash plus the debt share is $220,000 in this simple example. Confirm the actual figures with the sponsor and tax team.
Do not call the $220,000 your market value or tax basis without a separate analysis. Fees, tax rules, and valuation are different questions.
The OCC identifies cash flow, debt-service coverage, debt yield, and collateral value as parts of commercial loan analysis. A low interest rate is only one part of that review. The property must still support its obligations. [2]
Debt-service coverage ratio, or DSCR, compares net operating income with annual loan payments. With $900,000 of defined NOI and $600,000 of debt service, DSCR is 1.50. Income is one and a half times those payments.
If NOI falls to $660,000 while payments stay at $600,000, coverage falls to 1.10. Only $60,000 remains before other costs not already counted in the calculation. That is a much thinner margin.
Debt yield compares NOI with the loan balance. The original $900,000 NOI divided by $6 million of debt equals 15%. Debt yield is not an investor distribution rate. It says nothing by itself about your purchase price, fees, or tax return.
Read the definitions used in the loan. A covenant calculation can differ from the sponsor's forecast or the lender's initial underwriting. Ask which income, expense, and reserve items are included before comparing ratios.
Interest-only payments can leave more cash available in the early years. They also leave the principal unpaid. The OCC notes the tradeoff between lower current payments and greater repayment risk at maturity. [2]
On a hypothetical $6 million loan at 5%, annual interest is $300,000. If required annual debt service later becomes $390,000 with principal payments, cash available after debt service falls by $90,000, all else equal.
For a 2% owner, that difference is $1,800 per year before any other change. The principal paid down can increase the equity left at sale, but it is not cash that reached the investor during that year.
Review the payment schedule across the full expected hold. Do not compare an interest-only first year with another offering's amortizing year and assume the higher distribution means better operations.
For variable-rate debt, ask what happens after a rate cap expires. A cap may have its own price, term, and limit. A loan described as hedged today may still face future costs or exposure.
A loan covenant is a promise the borrower must keep. Financial covenants can address coverage, leverage, liquidity, and other measures. Reporting and property-related duties also matter. The terms vary by loan. [2]
Ask whether cash can be held in a lender-controlled account after a trigger. If so, identify the trigger, permitted uses, and conditions for release. A property can collect rent while less cash reaches investors.
Distinguish money held back from money lost. A reserve may still exist for repairs or debt payments, but that does not make it available for your living expenses. A projection should reflect required reserves and restrictions.
Ask what happens if a required report is late or insurance lapses. Not every default begins with a missed mortgage payment. Also ask whether a stated breach can be cured, how long the borrower has, and who pays the cost.
The practical question is what could interrupt distributions before an actual sale or foreclosure. A lender's protection can preserve collateral while reducing the cash investors receive.
Lenders review rent, empty space, costs, tenants, and the state of the building. They need to know how the loan will be repaid. The OCC also covers appraisals, risks from pollution, and the strength of the borrower and guarantor. [2]
For an apartment property, ask how the forecast compares with signed leases and recent collections. For a single-tenant building, ask when the lease ends and what happens if the tenant leaves before the loan matures.
For a portfolio, ask whether one property secures only its own loan or supports debt on other properties too. Cross-collateral terms can connect risks that a list of separate addresses may not show.
Confirm the reserve plan for major repairs and tenant turnover. Then ask who can approve spending and whether the funds are actually available. A forecasted reserve contribution is different from cash already held.
A lender's approval is useful evidence, but its goal is repayment of debt. It is not a promise that the investor price is attractive, distributions will meet targets, or the equity will be repaid.
The qualifying trust in Revenue Ruling 2004-86 cannot freely renegotiate or refinance its acquisition debt. The ruling explains how broader powers can change its federal tax classification. Those limits make the original loan plan especially important. [1]
“We can refinance later” is therefore not a complete answer. Ask what legal structure would allow it, what approvals would be needed, and how investors' tax position might change.
Some trust agreements allow assets to move into a new LLC if certain conditions arise. A publicly filed 2025 DST agreement shows this springing-LLC feature. It is an example from that date. It does not mean every offering has the same terms. [5]
A conversion can affect future exchange choices and may require lender consent. It also cannot force a lender to make a new loan. Review the fallback plan as a change in structure and risk, not as a guaranteed rescue.
A projected five-year hold is not a promise to sell in year five. A loan maturity, by contrast, is a contract date when the remaining debt is due unless valid arrangements change it.
Put the expected sale date and maturity on the same timeline. Add the end of any interest-only period, major lease expirations, rate-cap expiration, and deadlines for extension requests.
Ask about the cost of selling early. Payoff charges or other loan restrictions can affect the proceeds. Obtain an estimate for the actual planned date rather than assuming that the stated principal balance is the entire payoff.
If the exit assumes a buyer will take over the loan, ask whether the loan allows that transfer and what approval process applies. A favorable rate may help a sale, but it is not an automatic right belonging to any buyer.
Finally, stress the timeline. If a sale takes a year longer, can the existing terms accommodate it? If not, identify the required action and the party with authority to take it.
Imagine two otherwise identical properties with $5 million loans. Loan A charges a fixed 4% rate and comes due in three years. Loan B charges a fixed 5% rate and comes due in ten years. Both are interest only in this made-up example.
Annual interest is $200,000 for A and $250,000 for B. A leaves $50,000 more cash before other costs. That is real within the example, but it is not the whole choice. A also has a much earlier date when the full $5 million must be dealt with.
If the plan is to own the property for seven years, ask how A fits that plan. Is an earlier sale required? Is an extension available under terms already agreed to? Would a change of structure be needed? What costs or risks follow?
B costs more each year in this example. Its longer term may offer more time to carry out the plan, but that alone does not make it the better investment. Early-sale costs, property risks, and price still matter. The exercise is to compare the full debt path, not just the first year's payment.
A fire or other major loss raises loan questions as well as repair questions. Ask who controls insurance proceeds and who decides whether the building will be repaired. Confirm whether money would be held for work, used to pay debt, or handled another way under the documents.
Then ask how the property would pay bills while rent is reduced. Which reserves or insurance cover that gap, and what limits apply? Do not count the same reserve twice for both rebuilding and income support.
These are questions about the actual coverage and loan terms. A brochure's statement that the property is insured does not answer them. The review should connect the insurance, lease, trust powers, and lender's rights before treating any one of them as a complete solution.
Form 8824 tracks debt given up and taken on. It also accounts for cash, other property, and exchange expenses. Added cash can offset debt relief in that calculation. A new loan is not the only way to address the old mortgage payoff. [6]
Suppose a clean illustration starts with $600,000 of exchange cash and $400,000 of debt paid off. Ignore expenses and other adjustments. A replacement with $600,000 equity and $400,000 allocated debt totals $1 million.
If a suitable replacement instead has $300,000 of allocated debt, an added $100,000 of the investor's cash can close that value gap in this simplified case. The tax team must check the actual transaction and every other requirement.
Do not choose a weak property just because its leverage percentage fills a spreadsheet cell. Compare a suitable blend of investments, added cash, or a different plan. The goal is a defensible investment and exchange, not the highest possible debt allocation.
Request the current loan summary and risk disclosures. Ask for plain answers about terms that affect your share. Have a lawyer review the legal duties where needed. Keep the written answers with the offering you used to make your decision.
Confirm the exact cash subscription, ownership percentage, allocated debt, and purchaser name. Ask whether funding, sponsor acceptance, or any lender consent is still pending. A reservation is not proof that every condition has been met.
After closing, keep the debt information for tax reporting and future planning. Watch for reports about changes in coverage, reserve use, payment schedules, and loan maturity. Your role may be passive, but understanding the debt remains useful throughout the hold.
Usually you buy a beneficial interest while the existing borrower remains responsible under the loan. You may receive a share of debt for tax purposes. Confirm the legal borrower and any personal promises in the actual documents.
No. The lender can pursue the agreed collateral, and equity can be lost. The loan may also contain carve-outs or separate guarantees. Ask who is bound by them rather than assuming every party has identical protection.
A passive investor generally does not apply for a separate mortgage in the common DST structure. Still, subscription checks and loan transfer requirements vary. Ask what information and approvals your specific purchase needs before assuming there are none.
You generally cannot negotiate a separate mortgage within an existing DST loan. Review the offering's terms. Choosing among offerings or changing your allocation is different from changing the trust's debt contract.
They may use different values, such as the property price, appraisal, or total offering capitalization. Ask for the numerator and denominator. Use the actual allocated debt and equity amounts for your exchange review.
No. Lenders focus on repayment and their collateral. You still need to assess the equity price, fees, business plan, risks, and fit with your finances. A loan approval does not guarantee distributions or principal.
Do not assume so. The qualifying DST tax structure limits refinancing powers. A different structure may be available under the documents, but it brings legal, tax, and lending questions. Review that plan before investing.
Educational information, not an offer or a personal tax, legal, or investment recommendation. Examples are hypothetical and omit stated adjustments. Tax treatment depends on your facts and current law. Review your transaction with your CPA, attorney, and qualified intermediary. Real estate investments can lose value and may be illiquid.
Enter your approved email to explore investments, save your shortlist, and keep learning.