A DST offers investors tax deferral, passive ownership, and diversification, but requires careful due diligence due to market risks and structural complexities.
When clients sell appreciated real estate, one of the first questions they ask is, “Is it possible to defer the gain?” While traditional Section 1031 exchanges remain a valuable tool in this regard, many investors are turning to Delaware Statutory Trusts (DSTs) as a powerful, passive alternative that allows taxpayers to defer gains while maintaining access to high-quality real estate.
What is a DST?
A Delaware Statutory Trust (DST) is a legally recognized trust structure that allows multiple investors to co-own institutional-grade real estate. Each investor holds a beneficial interest in the trust, and the trust itself owns the property. DSTs are eligible for Section 1031 exchange treatment under IRS Revenue Ruling 2004-86, meaning taxpayers can exchange into a DST to defer gain on the sale of real property.
Why consider a DST?
DSTs are especially appealing to investors that are looking to:
- Defer eligible gains: Similar to a traditional Section 1031 exchange, reinvesting proceeds from a property sale into a DST allows for deferral of federal, and sometimes state, taxes.
- Achieve passive ownership: DSTs are professionally managed, allowing investors to avoid the headaches of property management, tenant issues, or regular maintenance.
- Diversify real estate holdings: DSTs can hold large commercial portfolios that include apartment complexes, industrial parks, or medical offices, which individual investors might find difficult to acquire independently.
- Resolve timing issues for Section 1031 exchanges: DSTs can serve as valuable backup or replacement “property” when dealing with tight 45-day identification windows or if a primary exchange target falls through.
- Reach estate and trust planning goals: For trusts and estates looking to simplify administration or preserve generational wealth, DSTs provide a stable and tax-efficient strategy.
Who might benefit most from a DST?
- Investors who want real estate exposure without personal liability for loans or management
- Retirees who are looking to move away from active property management
- Trustees or beneficiaries of inherited real estate
- Those selling highly appreciated investment property with no intention to reinvest directly in another property
While DSTs offer a compelling strategy for gain deferral and portfolio diversification, they are not without risk. Like any investment, returns are not guaranteed. Recent volatility in the office sector, for example, marked by delayed asset class recovery, office space reductions, and shifts in rental class (Class A to Class B or C), has exposed some DST investors to cash traps. In such cases, covenant violations in cash management agreements allowed financial institutions to restrict distributions, underscoring the importance of careful due diligence.
DSTs also come with structural complexities, including illiquidity, limited investor control, and reliance on sponsor performance. Accreditation requirements may apply as well.
How CLA can help
At CLA, we understand both the potential and the pitfalls of DSTs. With thoughtful planning and a clear-eyed view of market dynamics, DSTs can still be a powerful tool for clients seeking a passive investment approach.
If you’re considering a real estate sale or navigating a Section 1031 exchange, let’s explore whether a DST aligns with your goals and how it can benefit your investment portfolio.