1031 Exchanges and DSTs: A Passive Ownership Option for Real Estate Investors

For seasoned investment property owners, the 1031 exchange has served as a useful method for deferring capital gains taxes. It allows investors to sell a qualifying property and reinvest in a “like-kind” replacement, thereby maintaining tax-deferral benefits. But as portfolios mature and property management becomes more burdensome, many owners wonder: What’s next?

One potential option is the Delaware Statutory Trust (DST)—a structure that may appeal to those seeking tax deferral with reduced hands-on involvement. While not new, DSTs have gained attention for their ability to meet 1031 exchange requirements and provide professionally managed real estate exposure.

What Is a DST?

A Delaware Statutory Trust is a legally recognized entity that allows multiple investors to own fractional interests in large-scale real estate assets. Investors purchase beneficial interests in the trust, which owns and operates properties such as multifamily housing, medical facilities, industrial parks, or commercial buildings.

DSTs qualify as “like-kind” property for a 1031 exchange. This makes them a viable and IRS-recognized option for reinvesting proceeds from the sale of a relinquished property—without taking on the direct responsibilities of property ownership. However, DSTs are complex vehicles and may not be appropriate for all investors.

Why Consider a DST in a 1031 Exchange?

DSTs may offer an alternative to traditional real estate reinvestment in a 1031 exchange. Potential benefits include: 

• Defer capital gains taxes: Like other 1031 exchanges, a DST helps defer taxes on appreciated property when conditions are met.
• Reducing Management Burdens: Investors no longer have to screen tenants, schedule repairs, or oversee operations. Professional sponsors handle day-to-day property management.
• Diversify real estate exposure: DSTs often include large-scale, diversified properties in different geographies and sectors.
• Meet strict exchange deadlines: Finding a direct replacement property within the 45-day identification window can be stressful. Some DSTs are structured and available for quick acquisition, which may help meet timing requirements. That said, DST availability, pricing, and suitability vary and should be carefully evaluated.

How Advisors Can Leverage DSTs

For financial advisors working with property owners, DSTs represent a powerful tool in the planning toolkit. They offer a way to align real estate wealth with broader financial goals—retirement income, estate planning, and tax efficiency—without requiring clients to stay in active property roles.

Key advisory benefits include:

• Customization: DSTs can be matched to an investor’s income needs, risk profile, and time horizon.
• Continuity of tax deferral: DSTs maintain the 1031 exchange benefits, preserving tax efficiency without breaking the chain of deferral.
• Estate planning flexibility: Because beneficial interests in a DST are considered personal property, they are easier to divide among heirs than traditional real estate.

Risks to Consider Before Investing in a DST

While Delaware Statutory Trusts (DSTs) offer an appealing structure for certain 1031 exchange investors, they carry specific risks that should be carefully evaluated.

• Illiquidity: DST interests are not publicly traded and generally cannot be sold on a secondary market. Investors should be prepared for a multi-year holding period without early exit options.
• Loss of Control: Investors have no voting rights or decision-making authority over property operations, financing, or sale timing. All decisions are made by the DST sponsor or trustee.
• Sponsor Risk: The performance of a DST depends heavily on the sponsor’s experience, asset management strategy, and ability to navigate changing market conditions. There is no guarantee that the sponsor will meet projected performance targets.
• Market and Property Risk: As with any real estate investment, DSTs are subject to risks related to local market conditions, tenant vacancies, economic downturns, and property-specific issues.
• Tax Complexity: While DSTs may qualify as like-kind property under Section 1031, tax outcomes depend on the investor’s individual situation. A failed exchange or disqualification could result in immediate capital gains recognition.

Final Thoughts

For investment property owners looking to reduce active management responsibilities while maintaining potential tax deferral, a 1031 exchange into a Delaware Statutory Trust (DST) may offer a viable planning alternative. This approach can help align real estate holdings with evolving retirement, income, and estate objectives—especially for those transitioning from direct ownership.

As property portfolios and client goals grow more complex, strategies such as DSTs may play an increasingly important role within a broader Investment Property Wealth Management (IPWM) framework. Advisors who understand these structures are well-positioned to support clients in evaluating suitable options within a comprehensive financial plan.

The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.

Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.