Delaware Statutory Trust 1031 Exchange: How a DST Works as Replacement Property

What is a Delaware Statutory Trust?

A Delaware Statutory Trust is a legal entity formed under Delaware law that holds title to one or more income-producing properties, such as apartment communities, industrial buildings, medical offices or net-leased retail. A sponsor acquires the property, arranges any financing and manages the trust. Investors buy fractional beneficial interests and receive their share of net income, if any, and of any sale proceeds.

Why a DST qualifies for a 1031 exchange

In Revenue Ruling 2004-86, the IRS concluded that an interest in a properly structured DST is treated as a direct interest in real estate for Section 1031 purposes. That is why a DST interest can serve as like-kind replacement property for investment or business real estate you sell. The same ruling places strict limits on what the trust can do, covered below.

How DST interests are offered

DST interests are securities. They are generally offered privately under Regulation D, only to accredited investors, through a confidential Private Placement Memorandum (PPM) that details the property, financing, fees and risks.

How a DST fits into your 1031 exchange

A DST follows the same deadlines as any 1031 exchange. It changes what you buy, not the rules.

1. 1

   Sell through a Qualified Intermediary. Before your sale closes, engage a Qualified Intermediary (QI). Sale proceeds go to the QI, not to you. Taking actual or constructive receipt of the funds can disqualify the exchange.

2. 2

   Identify replacement property within 45 days. Your identification must be in writing, signed and delivered to your QI by midnight of day 45. DST interests are identified like any other real property. Most investors use the three-property rule (up to three properties of any value) or the 200% rule (any number of properties totaling up to 200% of the sale price), which is why many name backup options.

3. 3

   Match value and reinvest your equity. To defer the full gain, you generally must acquire replacement property of equal or greater value and reinvest all net proceeds. Any reduction in debt must be offset with new debt or additional cash. Many DSTs carry non-recourse financing arranged by the sponsor, so you do not personally qualify for or guarantee the loan.

4. 4

   Close within 180 days. You must acquire replacement property within 180 days of your sale or by your tax return due date (including extensions), whichever comes first. DST closings can often move faster than a direct property purchase, subject to offering availability, completed subscription documents and acceptance by the sponsor.

DST 1031 rules: the limits set by Revenue Ruling 2004-86

The same ruling that lets a DST qualify for a 1031 exchange requires the trust to stay passive. These limits are often called the "seven deadly sins." Once the offering closes, the trustee generally cannot:

1. Accept new capital from current or new investors
2. Renegotiate existing loans or take on new borrowing, except in a tenant bankruptcy or insolvency
3. Reinvest proceeds from the sale of trust property
4. Make capital improvements beyond normal repairs, minor non-structural improvements, or those required by law
5. Hold cash between distributions in anything other than short-term debt obligations
6. Keep cash beyond reasonable reserves; the rest must be distributed regularly
7. Enter new leases or renegotiate current leases, except in a tenant bankruptcy or insolvency

Why these limits matter to you

They make a DST simple to own, but they also limit how the trust can respond when a tenant leaves, a loan matures or the market shifts. Many sponsors use a master lease structure to manage leasing within these rules. Some DSTs also allow conversion to an LLC in a distress scenario, which can change your tax position. The PPM explains how each offering handles both.

Is a DST a fit for your exchange?

A DST tends to suit investors who want passive ownership and can commit capital for years. It fits poorly if you need liquidity or control.

DST pros and cons

Potential benefits

• No day-to-day landlord duties: the sponsor handles tenants, maintenance and operations
• Access to larger commercial properties that may be difficult to buy on your own
• Ability to spread capital across multiple properties, sponsors and regions (diversification does not ensure a profit or protect against loss)
• Potential monthly distributions, which are not guaranteed and may include a return of capital
• Non-recourse financing arranged by the sponsor that may help satisfy debt replacement

DST vs TIC vs direct ownership

All three can work as 1031 replacement property. The difference is how much control, liability and work you keep.

The right structure depends on your goals, timeline and tolerance for risk. Review any option with your own tax and legal advisors.

What a DST costs

DSTs carry upfront and ongoing costs that reduce what you receive. The estimated use of proceeds in each PPM shows them in detail.

• Upfront: selling commissions, offering and organization costs, and sponsor acquisition fees, generally deducted from your investment at purchase. Ask what share of your dollars actually goes into the property.
• Ongoing: asset management, property management and trustee fees.
• At sale: disposition fees and, in some offerings, a sponsor share of profits above a preferred return.
• Financing: loan costs and required reserves at the trust level.

What happens when a DST sells?

The sponsor decides when to sell. When it does, you choose what to do with your share.

• Exchange again: roll your proceeds into new replacement property, including another DST, through a new 1031 exchange with its own 45 and 180 day deadlines.
• Cash out: take your proceeds and pay the deferred tax.
• 721 exchange: some DSTs exit by contributing the property to a REIT's operating partnership in exchange for OP units. That can add liquidity options, but OP units are not real estate, so you generally cannot 1031 exchange them later.
• Hold for your heirs: under current law, heirs generally receive a stepped-up basis, which can eliminate the deferred capital gain. Talk with your estate attorney about how this applies to you.

What happens when you request a review

A review starts with your exchange, not a product.

1. 1

   Tell us about your exchange. A short form covering your timeline and investor status.

2. 2

   Talk with an advisor. Review your deadlines, equity, debt and goals, and whether a DST, direct property or a combination is worth evaluating.

3. 3

   Review offering documents. Once your accredited investor status is confirmed, and if a DST may fit, you can review the Private Placement Memorandum for any offering available to you, including its risks and fees.

4. 4

   Decide with your own advisors. We encourage you to review any investment with your CPA and attorney before you subscribe.

Frequently asked questions about DST 1031 exchanges