Real Estate & Tax-Deferral Strategies / 1031 Exchanges & DSTs
1031 Exchanges & Delaware Statutory Trusts
1031 exchanges and DSTs for property owners ready to step back
Selling a rental, commercial building, or land you've held for years can trigger federal capital gains tax, depreciation recapture, Indiana state income tax, and potentially the 3.8% net investment income tax. A properly structured 1031 exchange may allow you to defer those taxes by reinvesting into like-kind real estate. For investors who are done with tenants and repairs, a Delaware Statutory Trust (DST) can be one way to complete that exchange with passive, fractional ownership.
Key points
- Section 1031 applies only to real property held for investment or business use, not a primary residence.
- You have 45 days from closing to identify replacement property and 180 days to complete the purchase; the clocks run at the same time.
- A qualified intermediary must hold your sale proceeds. Touching the funds can disqualify the exchange.
- DST interests can qualify as like-kind replacement property under IRS Revenue Ruling 2004-86.
- DSTs are generally limited to accredited investors, are illiquid, and typically hold properties for five to ten years.
The 1031 exchange timeline
- Day 0
Relinquished property closes. Proceeds go directly to your qualified intermediary.
- Day 45
Written identification of replacement property due (3-property, 200%, or 95% rule).
- Day 180
Replacement purchase must close (or by your tax return due date with extensions, if earlier).
To defer all of the gain, the replacement property generally must be of equal or greater value, all net proceeds must be reinvested, and any debt paid off must be replaced with new debt or additional cash. Cash or debt relief you keep, known as "boot," is generally taxable.
Direct replacement property vs. a DST
| Direct property | Delaware Statutory Trust | |
|---|---|---|
| Ownership | You own and manage the property | Fractional beneficial interest; sponsor manages |
| Management | Active: tenants, repairs, leasing | Passive |
| Minimum investment | Full property price | Often $25,000 to $100,000 per offering |
| Diversification | Typically one property | Can spread proceeds across multiple DSTs and sectors |
| Financing | You qualify for and sign the loan | Non-recourse debt arranged by sponsor, if any |
| Control | Full control of decisions and timing of sale | No control; sponsor decides hold and sale |
| Liquidity | Sell when you choose (subject to market) | Illiquid; typical hold of 5 to 10 years |
| Eligibility | Any qualifying exchanger | Generally accredited investors only |
Where a DST may fit
- You want to stop being a landlord but keep your gain deferred
- You need a reliable backup identification within the 45-day window
- You want to diversify one property's equity across several properties or sectors
- You're planning your estate and want an asset that is simpler for heirs to divide
Where it may not
- You may need access to the money within the next several years
- You are not an accredited investor
- Your gain is small relative to the upfront costs of the offering
- You want control over when and how the property is sold
Our due diligence focus
Not all DSTs are alike. When we evaluate offerings with you, we look at sponsor track record and full-cycle results, tenant credit and lease terms, debt levels and maturity dates, total fees and loads, projected exit strategy, and whether a 721 UPREIT path is involved and appropriate for you.
Frequently asked questions
What is a 1031 exchange?
A 1031 exchange, named for Section 1031 of the Internal Revenue Code, allows an investor to defer capital gains tax on the sale of real property held for investment or business use by reinvesting the proceeds into like-kind real property. Taxes are deferred, not eliminated, unless the property is ultimately held until death, when heirs may receive a step-up in basis under current law.
What are the 1031 exchange deadlines?
You must identify potential replacement property in writing within 45 days of closing on the property you sell, and complete the purchase within 180 days of that closing (or by your tax return due date, including extensions, if earlier). Both deadlines run concurrently and are generally not extended except for federally declared disasters.
What is a Delaware Statutory Trust (DST)?
A DST is a legal entity that holds title to one or more institutional-quality properties, such as net-leased retail, medical office, industrial, or multifamily real estate. Investors purchase fractional beneficial interests, and the IRS has ruled (Rev. Rul. 2004-86) that a properly structured DST interest can qualify as replacement property in a 1031 exchange. A sponsor handles acquisition, management, and eventual sale.
Who can invest in a DST?
Most DST offerings are private placements available only to accredited investors, which generally means a net worth over $1 million excluding your primary residence, or income over $200,000 ($300,000 jointly) in each of the past two years with the expectation of the same this year. Certain professional licenses can also qualify.
Can I use a DST as a backup identification?
Yes. Because DST interests are typically pre-packaged and available to close quickly, many exchangers list one or more DSTs among their 45-day identifications as a backup in case a direct property purchase falls through.
What are the main risks of DSTs?
DSTs are illiquid, with no public market and typical hold periods of five to ten years. Distributions are not guaranteed, property values can decline, investors have no control over management decisions, and upfront and ongoing fees can be significant. When the DST sells its property, you will need to complete another exchange or recognize the deferred gain.
What is a 721 exchange or UPREIT?
Some DSTs are structured so the property may later be contributed to a REIT's operating partnership in exchange for OP units under Section 721. This can provide diversification and potential future liquidity, but it is generally a one-way door: OP units cannot be exchanged back into real estate through a 1031, and converting units to REIT shares or selling them is typically a taxable event.
How do you work with my CPA and qualified intermediary?
We coordinate with your tax professional and qualified intermediary on timing and documentation while focusing our role on evaluating replacement investments, sponsor due diligence, and how the result fits your income needs, liquidity, estate plan, and overall portfolio.
Planning to sell investment property in Northwest Indiana?
Start the conversation before you list. We'll review your situation, coordinate with your CPA, and help you compare your options. Serving Valparaiso, Chesterton, Crown Point, Munster, and the Greater Chicagoland area.
Important information
Delaware Statutory Trust (DST) and other private placement offerings are generally available only to accredited investors (as defined by SEC Regulation D) and are offered only by private placement memorandum, which should be read in full before investing. These investments are speculative and illiquid, typically have no secondary market, and may require holding periods of five to ten years or longer. Risks include loss of some or all principal, reduced or suspended distributions, tenant vacancies, leverage, concentration in a single property or sector, limited investor control, sponsor risk, and fees and expenses that can reduce returns. Distributions are not guaranteed and may include a return of capital. An exchange may not qualify for tax deferral if IRS requirements are not met, and a future sale or contribution of DST property to a REIT operating partnership (721 exchange) may result in a taxable event and eliminate future 1031 exchange eligibility.
This page is for general educational purposes only and is not a recommendation, an offer to sell, or a solicitation of an offer to buy any security. Patten Financial Group does not provide tax or legal advice; please consult your CPA, tax attorney, and a qualified intermediary regarding your specific situation. Patten Financial Group does not act as a qualified intermediary. All investing involves risk, including the possible loss of principal. Tax laws are subject to change.