Delaware Statutory Trust (DST): How It Works in a 1031 Exchange

A Delaware Statutory Trust, or DST, is a trust formed under Delaware law that owns one or more properties. Investors buy beneficial interests in the trust rather than owning the real estate directly. A sponsor typically acquires the property, arranges financing, and manages the trust.

The tax interest in DSTs comes from Revenue Ruling 2004-86. In general terms, the IRS indicated that a beneficial interest in a properly structured DST may be treated as an interest in the underlying real estate, rather than as an interest in a business entity, for purposes of Section 1031. That is why a DST interest is sometimes considered as like-kind replacement property. Whether a particular structure and exchange qualifies depends on the facts and the current law.

The structure comes with real constraints. Investors are generally passive, with little or no control over management, leasing, refinancing or sale decisions. Interests are typically illiquid, and DST offerings are typically available only to accredited investors. Results depend on the sponsor, the property, the debt and the market, and none of it is guaranteed.

Traditionally, owners of investment real estate who wanted to defer gain on a sale have used a 1031 exchange, reinvesting proceeds into like-kind replacement property under strict identification and closing timelines and with a qualified intermediary holding the funds. Many exchanges involve buying another property directly.

Some owners, particularly those who no longer want to manage tenants, maintenance and financing, have looked at DSTs as a passive alternative. Others prefer direct ownership for the control it provides, and still others decide that a taxable sale, an installment sale under Section 453, or another approach fits their situation better. Each path has trade-offs.

Related planning topics often come up alongside a DST: depreciation recapture, the Net Investment Income Tax, estate and gift planning, and what happens when the trust eventually sells its property. A DST is one tool among several, and it is not a fit for everyone.

The right tax strategist may help you understand where a DST sits among your options and whether it is even worth considering given your goals, timeline and risk tolerance. A first conversation is generally about your situation: what you own, what you want to do with the proceeds, your need for income or liquidity, and your family and estate considerations. A strategist may also coordinate with your CPA, tax attorney and licensed financial advisor.

Useful questions to ask include: How does a DST fit within my overall exchange plan, and what are the alternatives? What are the identification and closing deadlines, and who handles them? What happens if the sponsor underperforms, the debt matures, or I need liquidity? How would depreciation recapture, the NIIT or my estate plan be affected? Be sure to ask how the strategist is compensated, and whether they are acting as a tax professional or are also tied to selling a product.

Be cautious of anyone who promises specific tax savings, returns or outcomes. A careful professional will emphasize economic substance, documentation and the risks. They will also steer you away from aggressive or promoted schemes, such as listed transactions and syndicated conservation easements, that tend to draw IRS scrutiny. A DST offering is made through its own offering documents, so read them carefully with your advisors. Nothing on this page is an offer or solicitation to buy or sell any security.