How to Exchange Real Estate For a Delaware Statutory Trust Property

Posted by Clay Schmidt on Feb 4, 2021


Many real estate investors are familiar with the tax benefits of a 1031 exchange. By exchanging one property into a “like-kind” replacement property, the investor is able to defer gains. However, 1031s come with some strict deadlines that can be difficult to meet. That’s where a Delaware Statutory Trust (DST) property comes in.

1031 Exchange Basics

A 1031 exchange allows an investor to defer gains on the sale of their investment property. A 1031 exchange can only be executed on investment property, which means that a primary residence does not qualify. Although, there are ways around that restriction. The property that is being sold is called the relinquished property. The one being acquired is the replacement property.

Investors have 45 days to identify a replacement property and 180 days to complete the 1031 exchange. Depending on available properties and the current market, identifying a property or properties that meet the 45-day deadline might not be possible. To meet the 45-day deadline, investors need a ready pool of “like-kind” properties to exchange into. 

Delaware Statutory Trust (DST) Basics

A DST is a trust that provides the benefits of direct real estate ownership without management responsibilities. A sponsor manages all properties in the DST and has full decision-making authority. Because the sponsor makes all decisions, investors do not have any voting rights. However, for investors who would rather own a passive investment, giving up voting rights and control of properties is worth it to own this type of investment.

Investors do not own properties in a DST since they do not hold title to any properties. However, property ownership benefits come from the pass-through nature of a DST. Income, expenses, and depreciation are all passed through to investors. Additionally, any debt taken on by the DST is non-recourse for investors. It is the DST, which is a single borrower, that is responsible for the debt on invested properties.

Instead of direct property ownership, investors own fractional shares in the trust. From a tax perspective, the IRS views ownership of these fractional shares the same as direct property ownership.

Exchanging Into A DST

Because the IRS views DST fractional share ownership just like owning direct real estate, this unique characteristic of the DST makes it eligible for a 1031 exchange. Exchanging from direct real estate into a DST is an upgrade for most investors. They are going from a single-family property (or similar) to commercial-grade properties that are professionally managed.

Many DSTs also invest in multiple properties. This can make meeting 1031 exchange deadlines much simpler. Instead of searching for a single property within the local area, investors are able to choose from multiple properties that they can exchange into. This removes a lot of the difficulty associated with meeting 1031 exchange deadlines.

Of course, exchanging into a DST means that investors still get the same 1031 exchange tax-deferred benefits, just as they do when exchanging from direct real estate into direct real estate. Going into a DST doesn’t change anything within the 1031 exchange process when compared to a direct-to-direct 1031 exchange. By working with your tax advisor, you can determine if a DST is a good investment for you.

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.

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