For real estate investors completing a 1031 exchange, finding suitable replacement property within the required timeframe can sometimes be one of the most challenging parts of the process.
One option investors may encounter during their search is a Delaware Statutory Trust, commonly called a DST.
A properly structured Delaware Statutory Trust may potentially serve as replacement property in a 1031 exchange, allowing an investor to acquire a fractional beneficial interest in institutional or other investment real estate rather than purchasing an entire replacement property individually.
But DSTs are not appropriate for every investor, and not every Delaware Statutory Trust automatically qualifies for Section 1031 treatment.
Before considering a DST as part of a 1031 exchange, investors should understand how these investments work, how the IRS has addressed certain DST structures, what the potential advantages and risks may be, and which professionals should be involved in the decision.
Important: Rally Point Title Agency and Rally Point 1031 Exchange Services LLC do not provide tax, accounting, legal, financial, securities or investment advice and do not recommend specific DST investments, sponsors or investment products. Investors should always consult their CPA or accountant regarding the tax consequences of a 1031 exchange and whether a particular transaction is appropriate for their individual circumstances. Investors considering a DST should also speak with their attorney and an appropriately licensed financial or investment professional when applicable.
What Is a Delaware Statutory Trust?
A Delaware Statutory Trust, or DST, is a legal trust structure created under Delaware law.
In the real estate investment context, a DST may own one or more pieces of real estate while multiple investors own beneficial interests in the trust.
Rather than purchasing an entire apartment building, medical facility, industrial property, multifamily community or other investment property directly, an investor may purchase a fractional interest in a DST that owns the underlying real estate.
The trust itself holds title to the property.
The individual investors own beneficial interests in the DST.
For certain properly structured DSTs, those beneficial interests may potentially be treated as interests in the underlying real property for federal tax purposes, which is what can make a DST 1031 exchange possible.
Can a DST Qualify as Replacement Property in a 1031 Exchange?
Potentially, yes.
The IRS addressed a specific Delaware Statutory Trust structure in Revenue Ruling 2004-86. In that ruling, the IRS concluded that the DST described in the ruling was classified as a trust for federal tax purposes and that a taxpayer could exchange qualifying real property for an interest in that DST without recognizing gain or loss under Section 1031, provided the other requirements of Section 1031 were satisfied. Read IRS Revenue Ruling 2004-86
That ruling is an important part of the reason DST interests are frequently discussed as potential 1031 exchange replacement properties.
However, investors should not interpret the ruling to mean that every DST qualifies for a 1031 exchange.
The structure and activities of the trust matter, as do the facts of the individual exchange.
This is one of the reasons investors should have their CPA, accountant, attorney and other appropriate advisors review a proposed transaction before moving forward.
How Does a DST Work in a 1031 Exchange?
The overall exchange still needs to satisfy the applicable requirements of Section 1031 of the Internal Revenue Code.
Generally, Section 1031 allows qualifying real property held for investment or productive use in a trade or business to be exchanged for other qualifying like-kind real property held for investment or business purposes.
The IRS explains that Section 1031 currently applies to qualifying real property, rather than personal or intangible property, and that property held primarily for sale generally does not qualify. Review the IRS Like-Kind Exchange Guidance
In a typical delayed exchange, the investor sells the relinquished investment property and a Qualified Intermediary (QI) facilitates the exchange and holds the exchange proceeds.
The investor then identifies qualifying replacement property within the applicable identification period.
If an appropriate DST interest qualifies as replacement property and is properly identified, exchange funds may then be used toward acquiring that interest as part of the 1031 exchange.
The fact that the replacement property is held through a DST does not eliminate the other requirements of the 1031 exchange.
Why Do Some Real Estate Investors Consider DSTs for a 1031 Exchange?
One reason investors explore Delaware Statutory Trust 1031 exchanges is that a DST provides a different ownership structure from purchasing and managing an entire replacement property individually.
An investor may be able to purchase an interest in a larger real estate asset or portfolio rather than independently acquiring the entire property.
DSTs may also appeal to investors who are considering moving away from the day-to-day responsibilities associated with directly owned rental or commercial real estate.
For example, an investor who has spent years dealing with tenants, maintenance calls, property management decisions and capital improvements may be interested in exploring a more passive ownership structure after selling a property.
A DST may also provide access to certain types or sizes of investment real estate that an individual investor might not otherwise purchase independently.
However, those characteristics should not be interpreted as a recommendation to purchase a DST.
Whether a DST is appropriate depends on the investor's financial circumstances, tax position, objectives, risk tolerance, liquidity needs and many other considerations that are outside the role of a Qualified Intermediary.
Rally Point cannot determine whether a DST is a good investment for you. That conversation should take place with your accountant or CPA and the appropriate licensed financial professionals.
DSTs and the 45-Day 1031 Exchange Identification Deadline
Timing is another reason DSTs frequently come up during conversations about 1031 exchange replacement property.
In a typical delayed 1031 exchange, an investor generally has 45 days from the transfer of the relinquished property to identify potential replacement property.
The investor generally then has up to 180 days from the transfer of the relinquished property to receive the replacement property, subject to the applicable tax-return-due-date rule.
Those periods run concurrently.
For an investor who has sold real estate but is struggling to locate another individually owned property that meets their investment criteria, a DST may be one of the potential replacement-property options they discuss with their advisors.
But the existence of the 45-day deadline should never be a reason to rush into an investment without proper due diligence.
The exchange deadline is important.
So is understanding exactly what you are purchasing.
Can a DST Help an Investor Complete a 1031 Exchange With a Specific Amount?
Another characteristic of DST ownership is the ability to acquire a fractional beneficial interest rather than purchasing an entire property.
That can potentially provide investors with flexibility when attempting to structure the replacement side of an exchange.
For example, an investor may be evaluating how much equity needs to be reinvested, the value of the replacement property being acquired, existing or replacement debt, and whether any portion of the transaction could result in taxable gain.
Those calculations can become complicated very quickly.
There are common discussions surrounding reinvesting exchange proceeds, replacement-property value, debt and what investors often refer to as “boot.”
However, there is no one-size-fits-all formula that Rally Point should apply to an investor's personal tax situation.
An investor should have their CPA or accountant calculate the tax implications of the proposed exchange and determine what needs to occur to accomplish the investor's particular tax objectives.
The Qualified Intermediary facilitates the exchange.
The Qualified Intermediary does not replace the investor's accountant.
Are DST Investments Passive?
DST investors generally do not manage the underlying real estate in the same way they would manage a property they own directly.
The DST structure typically places responsibility for many operational and management functions with the sponsor, trustee, property manager or other parties associated with the investment.
That may appeal to investors who no longer want to personally oversee rental properties or other actively managed real estate.
However, the tradeoff is that the individual DST investor generally has far less control over the property than someone who owns real estate directly.
An investor typically cannot independently decide to refinance the property, change the property's management strategy, sell the building or make other major decisions simply because they own an interest in the trust.
That lack of control should be carefully evaluated before investing.
What Are the Risks of Using a DST in a 1031 Exchange?
A Delaware Statutory Trust is still an investment, and investments involve risk.
DST interests may be offered through private securities offerings. Depending on the particular investment, eligibility requirements may apply, including accredited-investor requirements.
Private placements can also carry significant risks.
The U.S. Securities and Exchange Commission's Investor.gov resource warns investors that private placements may be highly illiquid, can provide less disclosure than registered public offerings and can involve the potential for significant or even total investment loss. Read the SEC Investor Bulletin on Private Placements
DST investors should carefully investigate considerations such as the underlying property, tenants, lease terms, financing, sponsor, fees, projected holding period, liquidity limitations, potential distributions, exit strategy, market conditions and the investment's complete offering documents.
Past performance, projected income or anticipated appreciation should never be treated as guaranteed results.
The fact that an investment may potentially be used as replacement property for a 1031 exchange does not mean it is necessarily a good investment.
Tax treatment and investment suitability are two different questions.
That distinction is extremely important.
Is a DST the Same as a REIT?
No.
Although both may provide investors with exposure to real estate without directly purchasing and managing an entire building themselves, a Delaware Statutory Trust and a Real Estate Investment Trust (REIT) are not interchangeable.
This distinction is especially important in the context of Section 1031.
An investor should never assume that purchasing shares of a REIT will accomplish the same thing as acquiring a qualifying beneficial interest in a properly structured DST.
The tax characterization of the replacement property matters.
If the goal is completing a 1031 exchange, investors should discuss any proposed replacement investment with their CPA or accountant and other appropriate advisors before committing exchange funds.
Does Rally Point Choose the DST for the Investor?
No.
This is an important distinction between the role of a Qualified Intermediary and the role of an investment advisor.
Rally Point 1031 Exchange Services LLC can facilitate the exchange, prepare and coordinate the applicable exchange documentation, hold exchange proceeds pursuant to the exchange arrangement and coordinate the transfer of exchange funds for qualifying replacement property.
Rally Point does not analyze DST investments for suitability, recommend a particular DST sponsor, determine whether an investment is financially appropriate, project investment returns or tell an investor how much they should invest in a particular DST.
Those decisions belong between the investor and their own professional advisors.
If you are considering using a DST as replacement property, your CPA or accountant should be involved in the conversation. Depending on the investment, you may also need to work with an attorney and appropriately licensed securities or financial professionals.
What Should You Ask Before Considering a DST 1031 Exchange?
An investor considering a DST as 1031 exchange replacement property should understand both sides of the transaction.
From a tax perspective, the investor should ask their accountant whether the proposed transaction is expected to satisfy their individual 1031 exchange objectives, how much gain may be deferred, what happens if some proceeds are not reinvested, how debt affects the exchange, and how the transaction should ultimately be reported.
The IRS generally requires taxpayers to report a like-kind exchange using Form 8824, Like-Kind Exchanges. View IRS Form 8824 Instructions
From an investment perspective, the investor should understand the underlying real estate, anticipated holding period, liquidity restrictions, fees, financing, sponsor experience, tenant concentration, distributions, risks and potential exit strategies.
And from an exchange perspective, the investor should make sure the Qualified Intermediary is involved before the relinquished property closes.
Can You Use More Than One DST in a 1031 Exchange?
Depending on the facts of the transaction and the applicable identification rules, an investor may potentially identify or acquire interests in more than one replacement property.
That could include multiple DST interests or a combination of directly owned real estate and qualifying DST interests.
However, investors must still comply with the replacement-property identification rules and other Section 1031 requirements.
Investors considering multiple replacement properties should coordinate closely with their Qualified Intermediary while also having their accountant review the tax consequences of the proposed structure.
Can You Combine a Traditional Property Purchase With a DST?
Potentially.
A 1031 exchange does not necessarily have to involve only one replacement asset.
For example, an investor might purchase a directly owned investment property and also consider a qualifying DST interest as another portion of the replacement-property strategy.
Whether that structure accomplishes the investor's intended tax result depends on the numbers and facts of the individual transaction.
Again, Rally Point cannot provide tax or financial advice regarding how an investor should allocate exchange proceeds.
Before deciding how much money should go toward a traditional replacement property, DST or any other investment, the investor should speak with their CPA or accountant.
Who Should Be on Your Team for a DST 1031 Exchange?
A 1031 exchange involving a Delaware Statutory Trust can involve several different areas of expertise.
The Qualified Intermediary facilitates the exchange.
The CPA or accountant advises the investor regarding tax consequences.
An attorney may provide legal guidance.
A licensed investment or financial professional may be involved in evaluating or acquiring the DST investment.
The title company and closing professionals coordinate the real estate portions of the underlying transactions where applicable.
No single professional should automatically be expected to perform all of these roles.
For investors, knowing who is responsible for what can help prevent confusion while the 1031 exchange deadlines are running.
Frequently Asked Questions About DST 1031 Exchanges
Can a Delaware Statutory Trust qualify for a 1031 exchange?
Certain properly structured DST interests may potentially qualify as replacement property for purposes of a Section 1031 exchange. IRS Revenue Ruling 2004-86 addressed a particular DST structure and concluded that an investor could acquire an interest in the DST described in the ruling without recognition of gain or loss under Section 1031 if the other requirements were satisfied.
That does not mean every DST automatically qualifies.
Is a DST considered real estate for a 1031 exchange?
Under the circumstances described in IRS Revenue Ruling 2004-86, the beneficial owners were treated as owning interests in the underlying real property for federal tax purposes.
The specific DST and transaction should be reviewed by the investor's professional advisors.
Can I use my 1031 exchange money to purchase a DST?
Exchange funds may potentially be used to acquire a qualifying DST interest as replacement property when the transaction is properly structured and all applicable Section 1031 requirements are satisfied.
Investors should coordinate with their Qualified Intermediary before acquiring replacement property.
Does Rally Point sell DST investments?
Rally Point Title Agency and Rally Point 1031 Exchange Services LLC do not provide investment recommendations or financial advice. Rally Point's role is to facilitate the applicable 1031 exchange and coordinate the exchange funds and documentation.
Is a DST a good investment?
That depends entirely on the investor, the particular DST and the underlying investment.
A Qualified Intermediary should not make that determination for an investor.
Speak with your CPA or accountant regarding tax considerations and with an appropriately licensed financial professional regarding investment suitability and risks.
Are DST investments guaranteed?
No investment should be assumed to be guaranteed. Real estate values, rental income, tenant performance, market conditions, interest rates and other factors can affect investment performance.
Investors should carefully review all offering materials and risk disclosures before investing.
Considering a DST for Your 1031 Exchange? Start the Conversation Early.
A Delaware Statutory Trust can potentially provide another avenue for investors searching for 1031 exchange replacement property, but it is important to understand what a DST is — and what it is not.
A DST is not simply a way to “park” 1031 exchange funds.
It is an investment in real estate with its own structure, risks, fees, potential benefits, restrictions and investment considerations.
The tax rules surrounding the exchange must also be followed independently of whether the replacement property is directly owned real estate or an interest in a qualifying DST.
If you are considering a DST 1031 exchange, involve your professional team early.
Speak with your CPA or accountant about your tax situation. Consult the appropriate legal and investment professionals regarding the DST itself. And contact your Qualified Intermediary before the sale of your relinquished property closes so the exchange can be properly structured from the beginning.
Rally Point 1031 Exchange Services LLC works with real estate investors and their professional advisors to facilitate 1031 exchanges and help keep the exchange process coordinated from the sale of the relinquished property through the acquisition of qualifying replacement property.
Important Disclaimer
Rally Point Title Agency and Rally Point 1031 Exchange Services LLC do not provide tax, accounting, legal, securities, financial or investment advice. Nothing in this article is intended to recommend a Delaware Statutory Trust, DST sponsor, securities offering, investment strategy or other financial product. The information provided is for general educational purposes only.
1031 exchanges and DST investments are fact-specific and may involve significant tax and investment consequences. Before proceeding, investors should consult with their own CPA or accountant regarding the tax implications of the transaction and, where appropriate, their attorney and appropriately licensed financial or investment professional.