As you enter a Delaware Statutory Trust (DST), you begin earning money from the income-generating activities of the underlying properties. However, there is a chance that your DST holds assets across multiple states. This reality presents a few complexities, such as how state income tax is filed and paid.
Since you’re “sourcing” income as a nonresident for an asset outside of your own state, you are required to pay income tax. How do you go about this scenario? What are the steps the DST sponsor takes to prevent bureaucratic complexity? Realized 1031 shares the process below, as well as tips to avoid common pitfalls. Let’s take a closer look!
To answer this question, we must first clarify how the IRS recognizes DSTs. This investment vehicle is separate from the investors and is not a taxpayer entity since income passes through. This allows the trust to avoid entity-level federal income tax.
However, the tax treatment is different for investors. Each investor is treated as a disregarded owner of their pro-rata share of the underlying property. The DST entity is “disregarded” in favor of treating the investor as if they owned a piece of the building directly.
In a multiple-state DST, the structure allows each investor to be treated as a direct owner of the underlying assets. You pay the state-level taxes, and the sponsor’s role is to simply report the financials through the grantor letter. In other words, the sponsor doesn’t withhold tax. This is true in most states. There are exceptions, of course. In California, the Franchise Tax Board requires the DST sponsor (or trustee) to withhold a percentage of the income allocable to nonresident investors. This ensures the state receives its share of taxes upfront.
Each nonresident beneficial interest holder must file and pay income tax for each state where a DST property belongs. The rules for each state are different, with some not requiring income tax at all. Others, like California, charge up to 13.3% for those who belong to the highest tax brackets.
The more states the DST has properties in, the more complex income tax payments can become. Thankfully, some DSTs do offer composite returns, especially if they have properties in several states. This additional service allows the DST to file one single return for the investors, offering convenience by trading off tax benefits and deductions.
Given the complexity of income tax for multi-state DSTs, it is easy to get trapped in pitfalls that could lead to tax complications. Here are the steps to take to avoid these issues.
Multi-state DSTs add complexity to your investment, especially if you’re earning income from a state where you’re not a resident. Some states have withholding requirements; others do not. Some do not have income tax at all. Solutions like a composite return help streamline the filing process as opposed to doing it state by state, although there are certain trade-offs. Whatever the case, working with your CPA and sponsor is critical to navigating this requirement, ensuring that you’re filing correctly, avoiding tax penalties, and protecting your investment.
Sources:
https://taxfoundation.org/data/all/state/state-income-tax-rates/
https://accountinginsights.org/dst-tax-reporting-for-real-estate-investors/
https://www.irs.gov/pub/irs-drop/rr-04-86.pdf
https://www.ftb.ca.gov/forms/2025/2025-588-instructions.html