What DST Liquidation Looks Like: Timing, Distributions, and Tax Reporting

A Delaware Statutory Trust (DST) has a defined holding period of 5 to 10 years, in which the investment will provide passive income and tax-deferral benefits. Once that’s over, the liquidity event occurs, wherein the sponsor dissolves the DST, sells the properties, and distributes the proceeds to beneficial interest holders.

Knowing what this future event will look like is critical for DST investors. If you’re aware of how exactly the liquidation process occurs, you’ll have a better exit strategy and can prepare ahead for any risks. In this blog post, Realized 1031 discusses key steps, like the liquidation timeline, income distribution, and tax reporting, to help you out.

DST Liquidation Timeline

The liquidation timeline can begin even before the DST holding period is over.

1. Before the holding period ends, the sponsor will conduct a market evaluation to determine the optimal time for property sales.
2. The sponsor will communicate with investors regarding the plans for the sale or full-cycle event, typically three to six months before the planned sale. This notification means you need to begin planning for your exit.
3. The sponsor sells the assets. However, the exact timeline will vary as sponsors will still depend on market conditions to ensure maximum profits.
4. The sponsor closes the sale and dissolves the trust. Net proceeds will then be distributed to the investors or holders of beneficial interest.

How Are Proceeds Distributed?

The funds you’ll eventually receive are the net proceeds, with the leftover mortgage debt, closing costs, and other expenses already deducted. The sponsor distributes the income to investors based on their ownership percentage. In most cases, the proceeds include the original capital and any appreciation from the properties.

One thing you have to consider is whether you will reinvest the proceeds into another 1031 exchange as a continuation of the cycle. If this is the plan, then you cannot have direct control of the distributed funds. The sponsor must coordinate with your qualified intermediary, as the latter is the only entity allowed to receive your funds from the liquidity event.

Tax Reporting Guide

When a DST liquidates, investors receive tax documents, such as Form 1099-S or Schedule K-1, that show sale proceeds and gains. Only if you choose to cash out will you need to file and pay capital gains taxes and depreciation recapture. If you choose to continue the 1031 exchange cycle, you must report through Form 8824, which is dedicated to like-kind exchanges. In this document, you’ll include the details of the replacement and relinquished property and how you met the transaction deadlines.

For partially-deferred exchanges, reporting the taxable income is required. This includes cash or mortgage boot, if applicable.

Next Steps to Prepare for the Liquidity Event

With this understanding of the DST liquidation process, you can better prepare for the full-cycle event. Make sure to consult with tax professionals and other DST experts to get in-depth ideas about the process, especially if you plan to continue exchanging for tax-deferral benefits. Reviewing your basis adjustments and prior depreciation schedules also helps you understand how much capital gains or depreciation you’re carrying over.

In Conclusion: What To Expect During DST Liquidation

Investors must treat DST liquidation not as an endpoint but as a crossroad. Understanding the timeline, how proceeds are distributed, and what tax forms to fill out and submit helps you plan before the full-cycle event occurs. This way, you can continue your 1031 exchange cycle or prepare for tax liability should you decide to cash out.

Sources:

https://www.irs.gov/forms-pubs/about-form-8824

https://calawyers.org/real-property-law/what-is-a-1031-exchange/

https://www.forbes.com/councils/forbesfinancecouncil/2023/08/22/understanding-the-delaware-statutory-trust-full-cycle-event/