Investing in commercial real estate through a Delaware Statutory Trust can provide many benefits.
DST investors purchase fractional shares in a variety of institutional-grade commercial assets they likely wouldn’t be able to afford on their own, such as large multi-family apartment complexes, class A office buildings, or free standing retail buildings with large national franchise tenants. These assets can help diversify your real estate holdings, as well as potentially provide monthly income that can be sheltered from taxation through interest and capital depreciation deductions.
It’s important that investors understand how Delaware Statutory Trusts are taxed. In this article we’ll discuss DST tax treatment and potential tax issues investors should discuss with their accountants.
Common tax reporting methods for Delaware Statutory Trusts
Investors who purchase fractional shares of a Delaware Statutory Trust receive year-end operating statements denoting their pro-rata shares of operating expenses and rental income of all assets within the DST. You’ll get a form 1099 stating the amount of income, and your accountant will use that reported income on Schedule E of your return along with any other proceeds from commercial properties in your investment portfolio.
If purchasing shares of a DST to complete a 1031 exchange, the basis from your relinquished property carries forward into your new DST investment. If you’ve fully depreciated the relinquished asset, that’s the basis for your new DST assets.
Investors who had any unrealized basis in their original assets can still utilize depreciation deductions to shelter proceeds gained from their Delaware Statutory Trusts. That’s also true if their pro-rata shares of DST properties are of greater value than their relinquished asset.
What if your DST interests are in a different state?
Typically, you'll have to file a state tax return if you have income from DST investments in a different state, provided that state has an income tax filing requirement. Depending upon the assets within the Delaware Statutory Trust, you may have to file multiple state tax returns, which can add significant time and expense when your CPA prepares your tax return.
Distributions from DSTs are considered rental income in most cases and are taxed as such by each state. And since most states have different tax rules and regulations, investors should discuss potential DST tax implications with seasoned tax professionals.
DSTs are created as separate legal entities and qualify under Internal Revenue Code, Section 1031, as tax-deferred exchanges. If you are considering investing in a DST to complete a 1031 exchange to defer taxes on the sale of an investment property, you should consider consulting with professionals experienced in the exchange process to fully understand the tax ramifications of fractional ownership in a Delaware Statutory Trust.
