Can You Exit a Delaware Statutory Trust Early?

When you enter a Delaware Statutory Trust (DST), you get to enjoy benefits like passive income, hands-off involvement, and tax deferral — when paired with 1031 exchanges. These investment vehicles become powerful tools, but they do come with one key limitation: a lack of liquidity.

What happens if you need to cash out and leave the DST?

Can you exit a Delaware Statutory Trust early?

The answer to these questions is a complicated yes, and below, Realized 1031 has shared why.

Let’s take a closer look at the reasons and discuss possible alternatives you can try.

DSTs, Holding Periods, and 1031 Exchange Eligibility

We must first examine the nature of DSTs to understand why exiting is possible but difficult. These entities are trusts that hold title to real estate properties. When you invest in a DST, you acquire fractional interests in the assets managed by the DST sponsor. One of the biggest appeals is that DST interests qualify as “like-kind” property for 1031 exchanges, allowing investors to defer capital gains taxes.

However, DSTs have holding periods that make them illiquid from the get-go. Your capital remains tied up during this timeframe, which can last from five to seven years. Entering one comes with the expectation that you’ll remain committed until the DST dissolves.

Early Exit Is Possible But Difficult

In theory, you can sell your interest to another investor to exit the DST. This is one of several ways to leave the trust. However, selling your interest in a secondary market will prove difficult because there is no formal marketplace, and there are few willing buyers. Plus, you’ll also face SEC restrictions since DSTs are often offered as private placements under Regulation D, limiting their transferability.

One final drawback of early exit is immediate tax liability. It’s difficult to reinvest your DST interests into another 1031 exchange, and you’d be required to pay the deferred capital gains taxes.

Options for Exiting Early

Here are the avenues you can take if you have to exit a DST early.

• Sell Interest to a Secondary Market: As we mentioned, finding a willing buyer can be difficult. You may need to sell at a discount to attract investors, and you’ll typically need the sponsor’s approval for the transfer.

• Sponsor Buyback: In extremely rare cases, your sponsor may offer to buy back interests at a discount. Specific hardship scenarios are usually the only time this is allowed.

• Hardship Liquidation Request: Some DST sponsors include a hardship clause that allows early exit under extreme circumstances, such as medical emergencies or the death of an investor. Approval is at the sponsor’s discretion and may still involve fees or tax consequences.

More Liquid Alternatives

Given the lack of liquidity and difficulty exiting, DSTs may not be the best option for investors who foresee future cash needs. Finishing a 1031 exchange by directly acquiring a replacement property can help address your liquidity needs while still deferring capital gains. A 721 exchange offers similar benefits to DSTs, such as passive income and hands-off involvement, with a holding period that usually only lasts for a year. Finally, there are tenancy-in-common structures that provide more flexibility in some cases.

Wrapping Up: Leaving a DST Early

Yes, you can leave a DST early, but it’s a rare, complicated, and ill-advised practice that you’re better off avoiding. If you recognize future liquidity needs, alternatives like 721 exchanges or direct ownership of a 1031 exchange replacement asset may be better options.

Sources:

https://www.kppblaw.com/what-is-a-hardship-clause/

https://www.investopedia.com/terms/r/regulationd.asp

https://smartasset.com/investing/delaware-statutory-trusts-dsts

https://www.irs.gov/irb/2004-33_IRB