Investors who 1031 exchange into Delaware Statutory Trusts (DSTs) may wonder how to address their annual tax reporting requirements from this type of investment vehicle.
The good news is you’re likely quite familiar with the method of reporting any income derived from your DST beneficial interests in a DST since Delaware Statutory Trusts are taxed the same way as the income derived from rental properties.
In this article we’ll go over the tax reporting requirements for DSTs.
Tax Treatment of Investments in Delaware Statutory Trusts
A primary reason to complete a 1031 exchange into a Delaware Statutory Trust is to defer the capital gains and depreciation recapture taxes realized on the sale of your original investment property. Purchasing beneficial interests in a DST allows investors to roll over sale proceeds in the exact amount needed to satisfy their 1031 exchange requirements.
Delaware Statutory Trusts do not file annual tax returns, primarily because there are no additional franchise or income taxes levied on trusts formed in the State of Delaware. Taxation on income gained from trust assets is passed onto the trust’s shareholders.
Each individual shareholder in the DST receives a Form 1099 that details their pro-rata shares of income and expenses derived from DST assets. Generally, you can expect to receive a Form 1099 for each property that’s held under trust. This income is reported on Schedule E of your annual Form 1040 – the same process as any rental income derived from investment assets owned outside of a DST. This income typically is taxed at your nominal tax rate.
If your DST investments are spread out among multiple states, you’ll likely have to file state-level tax returns as well, unless your investments are located in a state that doesn’t levy a personal income tax, such as Nevada, Tennessee, or Wyoming.
Putting it all Together
Delaware Statutory Trusts don’t have to file a tax return because the State of Delaware doesn’t assess any taxes on statutory trusts formed in the state. Instead, the burden of taxation on income earned from trust assets and trust distributions is passed onto the trust’s shareholders.
The tax filing requirements for Delaware Statutory Trusts may lead to additional time and expense when your certified tax professional prepares your annual tax return. Any distributions received from investments in DSTs are considered standard rental income in most cases and are taxed as ordinary income.
Before completing a 1031 exchange to defer capital gains taxes on the sale of a relinquished property, you should consult with a tax professional who has experience in the 1031 exchange process in order to gain a clearer understanding of how fractional ownership in a DST may affect your particular tax situation.
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.
