DSTs (Delaware Statutory Trusts) have become popular vehicles for 1031 exchanging into. Investors only need to find the right DST rather than the right property, which can be difficult under strict time constraints.
But what happens once the DST is sold? For investors who want to continue deferring taxes, is the only option to cash out and invest in another DST or real property? Or can they keep the 1031 exchange going by exchanging into another DST?
Exiting a DST
DSTs are illiquid, which makes exiting before the established exit date difficult and expensive but not impossible. Holding the DST until the exit date published by the sponsor is called holding the DST for its full investment cycle.
DSTs generally have sale dates that coincide with the maturity of their loans. DSTs cannot refinance per IRS rules, so there is only one loan maturity date. Paying off the loan early usually means incurring high fees.
Once the DST is sold, it is similar to ending a 1031 exchange. The investor can enter another 1031 exchange or cash out and take the proceeds. The latter creates a taxable event in which deferred gains become taxable.
If the investor decides to sell their DST interest before the investment life cycle has been completed, they can take the proceeds and be taxed or do a 1031 exchange into another property/DST. The same 1031 exchange options are available as with real property 1031 exchange.
1031’ing Out of a DST
Nothing prohibits an investor from doing a 1031 exchange out of a DST. As discussed above, there are two ways to do it:
- Exit early from the DST, paying any associated fees, and 1031 into another property/DST.
- Wait for the full investment life cycle of the DST to complete, then 1031 into another property/DST.
Investors who do not want to manage property can go back into another DST via a 1031 exchange. This will continue to defer capital gains on their original investment.
Some investors may choose to cash out of the DST. While investors will have access to their funds in this scenario, they also end tax deferment on the property, triggering a taxable event. Taxes will be owed on deferred gains from the original property.
For those who want to cash out, it’s best to work with a tax specialist to fully understand the potential taxes that will be owed. The tax bill in such events can be large.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Costs associated with a 1031 transaction may impact investor's returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
No public market currently exists, and one may never exist. DST programs are speculative and suitable only for Accredited Investors who do not anticipate a need for liquidity or can afford to lose their entire investment.
