State Sourcing of DST Income for Nonresidents (and When Composite Returns Make Sense)

Investing in a Delaware Statutory Trust (DST) gives you access to income from several underlying properties within the DST. This structure offers benefits such as enhanced diversification and revenue from institutional-grade assets. Tax-deferral benefits, at the federal level, are also applicable when you finish a 1031 exchange through a DST.

As you earn monthly distributions from the profits of the DST operations, you’re also beholden to income tax at both the federal and state levels. The latter presents a problem when DST properties are scattered across multiple states.

How do you go about DST income tax in such a scenario? Realized 1031 shares insights below, including strategies you can use, like composite returns. Let’s take a closer look!

What Is State Sourcing for DST Income?

DSTs own assets across multiple states. As these properties earn income, investors who own DST interests “source” their profits from the state where each respective property sits. Every state has its own rules regarding income taxes. For example, Texas doesn’t levy income tax at all. Other areas, like California, charge up to 13.3% for those within the highest brackets.

Filing income taxes for each property under the DST becomes challenging due to this variance, particularly for nonresidents of the state. You may face a patchwork of filing obligations, which takes effort, time, and money to handle. Many investors fail to anticipate this complexity, especially if they are too focused on the federal tax-deferral benefits.

Understanding Composite Returns

One solution for nonresident investors is called the composite return, which is essentially a group filing mechanism. This type of return is a joint state income tax filing made by the sponsor on behalf of all nonresident investors. The DST pays the tax collectively, eliminating the need for individual filings. You also enjoy other benefits, like the following.

• Reduced paperwork
• Centralized payment
• Compliance assurance
• Peace of mind, especially for those who are part of large DSTs

There are certain trade-offs to keep in mind. Primarily, composite returns follow the highest applicable marginal rate. This means that you forfeit the ability to claim personal deductions, exemptions, and tax credits.

When Do Composite Returns Make Sense?

Not all situations call for leveraging composite returns — they make the most sense in scenarios like the following.

• DST Owns Assets Across Several States: Composite returns would be helpful to investors, rather than juggling multiple filings.

• Your DST Interest Is Small: In this case, the trade-offs are minimal compared to the expense of hiring multiple accountants for each state.

• You Live in a No-Income-Tax State: If your home state doesn’t tax DST income, joining a composite return can prevent mismatched credit issues or double reporting.

• It’s an Included Service: Many DSTs already offer composite returns, especially if they own multi-state assets. This added perk helps simplify investor participation and ensures compliance.

Final Thoughts on Managing DSTs With Multi-state Properties

Since DSTs typically own several properties across multiple states, filing income tax for each state becomes a bureaucratic nightmare for investors. Composite returns can serve as a comprehensive and streamlined solution, but you’ll be sacrificing a few tax benefits. As such, it’s important to consider whether your situation can benefit from composite returns. Always check with your tax advisor to determine if such a strategy can help you save more and maximize your investment.

Sources:

https://www.thetaxadviser.com/issues/2014/mar/tpm-mar2014/

https://taxfoundation.org/data/all/state/state-income-tax-rates/

https://www.delawareinc.com/blog/what-is-a-delaware-statutory-trust/