FAQ: 1031 DST Properties

FAQ: 1031 DST Ownership & Structure

What exactly is a Delaware Statutory Trust in the context of a 1031 exchange?

A DST is a separate legal entity created as a trust under Delaware law that holds the title to a piece of real estate. Unlike a typical real estate partnership (LLC), which the IRS classifies as a security, a DST is structured to be a "grantor trust" under Rev. Rul. 2004-86. This allows the IRS to see through the trust to the individual investors, treating them as direct owners of the real property for tax purposes. This is the foundational requirement that allows DST interests to be considered "like-kind" to other real estate.

Why has the DST become more popular than the Tenant in Common (TIC) model?

The DST model solved a major financing bottleneck that plagued TICs after the 2008 financial crisis. In a TIC, up to 35 co-owners are on the deed and must each sign off on major decisions, including financing. Lenders found this chaotic and risky. In a DST, the lender only deals with one borrower (the trust) and one decision-maker (the trustee/sponsor), which makes institutional-grade financing much easier to secure.

Does an investor in a DST receive a property deed?

No. Investors in a DST hold a "beneficial interest" in the trust, which is documented by a certificate of ownership. Although they do not hold a deed directly, the IRS treats this beneficial interest as the equivalent of owning a fractional share of the real property itself for the purpose of a tax-deferred exchange.

What are the "Seven Deadly Sins" of DST management?

These are seven specific prohibitions established by Revenue Ruling 2004-86 that ensure the trust remains a passive entity. They include: no new capital contributions after the offering closes, no new debt or refinancing, no reinvestment of proceeds, no major structural improvements, no renegotiation of leases (unless in bankruptcy), no speculative cash investments, and a requirement to distribute all net cash flow.

What happens if a DST property requires an emergency repair that exceeds its reserves?

Because of the "No New Capital" rule, a DST cannot simply ask investors for more money. Most sponsors maintain a healthy "reserve fund" at the outset to cover anticipated repairs. In extreme cases where the property is in jeopardy, the DST may be "converted" into an LLC (often called a "Springing LLC"), which allows for more active management but permanently disqualifies the asset for further 1031 exchanges by the current owners.

Is the DST model available to everyone?

No. DST offerings are typically regulated under SEC Regulation D, Rule 506(b) or 506(c), which restricts participation to "accredited investors." These are individuals with a net worth over $1 million (excluding their primary residence) or an annual income exceeding $$200,000 (or $300,000 with a spouse).

What is the typical minimum investment for a DST?

Minimums vary by sponsor and offering but generally range from $25,000 to $100,000. Some institutional-grade DSTs may have higher minimums, particularly if they are focused on high-net-worth wealth preservation.

Can a DST own more than one property?

Yes. While many DST offerings center on a single institutional asset like a large apartment building, some are "portfolio DSTs" that hold multiple properties, such as a collection of 10-15 single-tenant retail buildings (e.g., Dollar General or CVS locations).

How do DST investors receive their income?

Income is typically distributed monthly or quarterly via ACH direct deposit. The income is "pro-rata," meaning if you own 5% of the trust, you receive 5% of the net rental income after expenses and debt service.

What is a "Master Lease" in the DST structure?

To satisfy IRS requirements, many DSTs employ a Master Lease structure where the trust leases the entire property to a "Master Tenant" (usually an affiliate of the sponsor). The Master Tenant then manages the individual sub-leases with the actual residents or commercial tenants.

How long does a DST investment typically last?

The "hold period" is generally projected to be between 5 and 10 years. The goal is for the sponsor to sell the property when market conditions are optimal to realize capital appreciation for the investors.

What is meant by a DST going "full-cycle"?

A DST has gone "full-cycle" when the underlying property is sold, the trust is dissolved, and the investors receive their final payout of equity and appreciation. At this point, the investor can either pay their taxes or perform another 1031 exchange into a new DST or other property.

Are DSTs liquid?

No. DSTs are illiquid, long-term investments. While some firms are developing secondary markets, there is no guarantee that an investor can sell their interest before the sponsor sells the property. Investors should assume their capital is committed for the duration of the hold period.

What are the fees associated with a DST?

Fees can be substantial and include sponsor acquisition fees, organizational and offering costs, property management fees, and disposition fees upon sale. These are disclosed in the Private Placement Memorandum (PPM).

How does a DST investor report their income to the IRS?

Instead of a K-1, DST investors receive a "Grantor Trust Letter" (or a substitute 1099). This document details their pro-rata share of the income and expenses, which the investor then reports on Schedule E of their 1040.

Can I use a DST for a "Partial" 1031 exchange?

Yes. If you sell a property for $1 million but only want to reinvest $800,000, you can place the $800,000 into a DST and take the $200,000 as "boot," which will be taxable.

What is "Mortgage Boot," and how do DSTs help avoid it?

If you sell a property that had a $500,000 mortgage and buy a replacement property with only a $400,000 mortgage, the $100,000 reduction in debt is considered "boot" and is taxable. DSTs often come with pre-packaged debt that allows investors to easily "match or up" their debt to avoid this tax.

What is a "Debt-Free" DST?

Some DST offerings are purchased with all cash and carry no mortgage. These are popular for investors who own their relinquished property "free and clear" and want to eliminate the risk of lender foreclosure.

Can I refinance a DST?

No. The "No New Debt" rule prohibits the trustee from refinancing the property. This means the interest rate and loan terms are fixed for the life of the trust.

What is the role of a "Sponsor" in a DST?

The sponsor is the professional real estate company that identifies the asset, performs due diligence, secures financing, packages the DST, and manages the property on behalf of the trust.

How do I evaluate a DST sponsor?

Investors should look at the sponsor’s track record: how many properties have they taken full-cycle? Have they ever missed a distribution? What is their experience in that specific asset class (e.g., multifamily vs. industrial)?.

Can I 1031 exchange from a DST into a single-family home?

Yes. When the DST sells (goes full-cycle), you can take your proceeds and perform a 1031 exchange into any like-kind property, including a single-family rental that you manage yourself.

What is a "Springing LLC"?

This is a provision in the DST trust agreement that allows the trust to convert into a standard LLC if the property faces an emergency (like a major tenant default) that requires active management prohibited by the DST rules.

Do DSTs offer diversification?

Yes. Because the minimum investments are relatively low, an investor with $1 million in exchange proceeds can diversify across 10 different DST properties in different states and sectors.

Are DSTs a good hedge against inflation?

Many DSTs involve multifamily properties where leases can be adjusted annually, or commercial properties with built-in rent escalations, which can provide a potential hedge against inflation.