A Delaware Statutory Trust (DST) allows investors to put their money into a trust, which is then pooled with other investor funds. The trust then uses that money to invest in real estate. The trust’s real estate can generate income for the investors, also known as beneficiaries. That income must be reported to the IRS when tax time rolls around.
But trust sponsors don’t issue beneficiaries a Form 1065 Schedule K-1 or 1099 Form. In the IRS’ eyes, DST beneficiaries are real estate owners. As a result, trust sponsors issue a “substitute 1099” form, also known as a Form 1041 or “grantor letter,” to the beneficiaries. This document aligns with real estate ownership rules regarding reporting income taxes rather than standard investment reporting.
A DST is formed under Delaware state law, although properties held in a DST can be in any state. Each DST has a sponsor who creates the trust. The trust, in turn, holds assets and issues shares to investors/beneficiaries.
Each beneficiary owns fractional shares in the DST and receives a percentage of the trust’s net operating income based on how many shares they own.
In some cases, investors can use proceeds generated from the sale of investment property and acquire DST shares through a 1031 exchange. This is possible because the IRS regards DST shares as replacement property for a like-kind exchange.
Beneficiaries who receive income through their DST ownership receive a grantor letter from the trustee. The information in this document includes:
The investor/beneficiary fills out Schedule E (Form 1040) – “Supplemental Income and Loss” with information from the substitute 1099. DST investment proceeds are generally taxed as ordinary income.
A grantor letter is sometimes compared to Form 1065 Schedule K-1; these two documents have many similarities. Both are essential for tax-reporting purposes and help beneficiaries and investors accurately report their share of income generated by trusts. The main differences between these two forms are:
DSTs can offer investors access to investment real estate properties they might not be able to invest in on their own. Additionally, DST ownership can provide deductions and depreciations to help reduce income tax burdens.
But, investors must also report their taxable income to the IRS. This is accomplished by information from the substitute 1099, which is transferred to Schedule E. Adding to the complexity is the DST property or properties’ locations. If the trust’s properties are in different states, investors must file a return in each state (assuming that the state involved has income tax filing requirements).
In short, tax time is already stressful. Adding the DST income reporting requirement adds another layer of complexity. Because of this, it’s essential to work with a qualified tax professional to ensure that income connected with DST holdings is appropriately reported.