1031 exchange DST properties let you sell an investment property, defer the federal tax bill, and reinvest the proceeds into a fractional interest in professionally managed real estate without ever screening a tenant or fixing a roof. Under Section 1031 of the Internal Revenue Code, reinvesting your full sale proceeds into like-kind real estate postpones federal capital gains tax, depreciation recapture, and the net investment income surtax — a combined bill that can claim 30% or more of what you cleared at closing. IRS Revenue Ruling 2004-86 treats a beneficial interest in a qualifying Delaware Statutory Trust as direct ownership of the underlying real estate for federal tax purposes, so buying into a DST satisfies the like-kind requirement.1Internal Revenue Service. Rev. Rul. 2004-86
What You Actually Own in a DST
A Delaware Statutory Trust is a legal entity formed under Delaware trust law that holds title to one or more investment properties. The typical inventory is apartment complexes, industrial warehouses, medical office buildings, or net-leased retail occupied by national tenants.2Delaware Code Online. Delaware Code 12 Chapter 38 – Treatment of Delaware Statutory Trusts You and other investors each own an undivided fractional beneficial interest in the trust and, through it, in the property.
Minimums generally start around $100,000 for exchange investors. A sponsor runs the trust: it selects and acquires the property, arranges the financing, oversees management, and handles every operational decision. You collect your share of the net rental income, typically distributed quarterly, and make no management decisions of your own. Most DSTs use a master tenant structure, where a single entity leases the whole property from the trust and subleases to the actual occupants. That layered arrangement keeps the passive investors insulated from operations and keeps the trust compliant with the IRS classification it depends on.
The Taxes You’re Deferring
Three federal taxes hit when you sell appreciated investment real estate outright, and a successful 1031 exchange defers all three.3Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Property Held for Productive Use or Investment
Long-term capital gains tax on your profit runs 0%, 15%, or 20% depending on taxable income; most investors selling meaningful investment real estate land in the 15% or 20% bracket.4Internal Revenue Service. Topic No. 409, Capital Gains and Losses Depreciation recapture is taxed at a flat 25%, and the IRS applies it to the depreciation you were entitled to claim during ownership whether or not you actually took the deductions.5Office of the Law Revision Counsel. 26 USC 1(h) – Maximum Capital Gains Rate On a property held 15 or 20 years, that accumulated recapture can be substantial. The 3.8% Net Investment Income Tax then applies to capital gains if your modified adjusted gross income exceeds $200,000 filing single or $250,000 filing jointly, thresholds that are not indexed for inflation.6Internal Revenue Service. Net Investment Income Tax
Stacked, the combined federal rate easily reaches 28.8% or higher before state taxes enter the picture. A DST exchange defers the whole bill for as long as you keep exchanging into qualifying replacement property.
Who Qualifies to Invest
DST offerings are private placements sold under Regulation D, so they’re restricted to accredited investors as defined by the SEC. The thresholds have not been adjusted for inflation and no change is scheduled for 2026.7U.S. Securities and Exchange Commission. Accredited Investors
- Net worth over $1 million individually or with a spouse, excluding your primary residence.
- Individual income over $200,000 in each of the two most recent years, with a reasonable expectation of the same in the current year.
- Joint income over $300,000 with a spouse or partner under the same two-year lookback.
- Entities with total assets over $5 million, provided they weren’t formed solely to buy into the offering.
Registered broker-dealers, investment advisors, and licensed financial professionals holding Series 7, 65, or 82 certifications qualify regardless of personal wealth. You’ll document accredited status through a purchaser questionnaire in the subscription process.
The 45-Day and 180-Day Deadlines
The 1031 timeline is unforgiving. Miss either deadline by a day and the exchange fails, making the entire sale fully taxable.
By midnight on day 45 after closing your sale, you must deliver a written, signed identification of the replacement properties to your qualified intermediary.8Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031 Sending it to your accountant or real estate agent does not count. For a DST, the identification typically names the trust and the property it holds.
Three rules govern how many replacements you can list. The three-property rule lets you identify up to three properties of any value, and it’s the option most DST investors use, often listing two or three different offerings in case one fills before closing. The 200% rule allows more than three, but only if the combined fair market value of everything identified stays within 200% of what you sold. The 95% exception saves you if you break both prior limits, but only if you actually acquire at least 95% of the total value identified — a bar most investors cannot clear in practice.
The second deadline is 180 calendar days after closing, or the due date of your tax return including extensions for the year of sale, whichever comes first. If you closed in November and don’t file an extension, your effective deadline shifts to April 15 instead of the full 180 days. Filing an extension is cheap protection.
Boot: The Trap of Partial Reinvestment
Anything you don’t reinvest becomes “boot” and is taxable.9Office of the Law Revision Counsel. 26 USC 1031(b) – Gain From Exchanges Not Solely in Kind
Cash boot is simple: sell for $800,000, invest $750,000 in a DST, and the $50,000 you kept is taxable. Mortgage boot is trickier and catches more people. If the debt on your relinquished property was $400,000 and the DST’s debt attributable to your interest is only $300,000, that $100,000 of debt relief is treated as money you received. You can offset mortgage boot with additional cash, but the debt has to balance, and exchanges go sideways when investors overlook that.
Boot doesn’t kill the whole exchange. You still defer tax on the portion you properly reinvested and only pay on the boot amount. But full deferral is the point of doing this, and boot from careless planning is the most avoidable mistake in the process.
Executing the Exchange Step by Step
Engage a qualified intermediary before you list the property. It’s not optional: the intermediary must be named in the purchase contract and must hold the sale proceeds directly. If the money touches your account even briefly, the exchange is dead.10Internal Revenue Service. Miscellaneous Qualified Intermediary Information The intermediary cannot be anyone who has served as your agent within the previous two years, which rules out your accountant, attorney, or broker.
When your property closes, the proceeds go straight to the intermediary’s escrow, and your 45-day identification clock starts. During that window, you review offerings with a financial advisor or broker-dealer that specializes in 1031 DSTs. Each offering comes with a Private Placement Memorandum detailing the property, sponsor track record, projected income, debt structure, fees, and risk factors. Read the risk section carefully.
You then submit the written identification, complete a subscription agreement, the purchaser questionnaire proving accredited status, and the trust’s operating documents. You’ll provide tax ID, banking information for distributions, and your exact investment amount. The sponsor confirms availability and sends a funding request to your intermediary, which wires the money to the trust’s closing agent. After funding, you receive a certificate of beneficial interest and the tax reporting package for filing time.
What the Sponsor Can and Can’t Do
Revenue Ruling 2004-86 doesn’t just bless DSTs for 1031 exchanges; it imposes tight operational limits the trust must follow to keep that treatment. Practitioners call them the “seven deadly sins” because breaking any one could reclassify the trust as a business entity and disqualify it from 1031 treatment entirely.11Internal Revenue Service. Rev. Proc. 2020-34 – Section 3
Once the offering closes, no additional capital can be contributed, not even by existing investors. The trustee cannot refinance the property or take on new debt. Existing leases must stay as written, with renegotiation permitted only if a tenant becomes bankrupt or insolvent. All cash must be distributed to investors in proportion to their ownership, with only reasonable reserves retained. Any cash the trust does hold has to sit in short-term, low-risk instruments. Capital improvements are limited to routine maintenance, minor non-structural work, or changes required by law. And when the property eventually sells, proceeds must go to investors rather than fund another acquisition.1Internal Revenue Service. Rev. Rul. 2004-86
These restrictions are the trade-off for passive tax-deferred investing. You get professional management and income without landlord work; you give up any ability to influence how the property is run.
Risks and Costs the Sales Pitch Downplays
DSTs solve real problems, but the marketing tends to lead with the benefits.
Illiquidity is the dominant risk. There’s no established secondary market for DST interests. Assume you can’t exit until the sponsor sells the underlying property, which typically takes five to seven years. Private resales, when they happen at all, often come at steep discounts to the underlying property value.
Fees are heavy and front-loaded. Upfront costs — acquisition fees, offering expenses, selling commissions, and broker-dealer charges — commonly run 7% to 12% of the equity invested, and some offerings exceed 15%. A $500,000 investment might put only $440,000 of actual equity to work in real estate. Sponsors also collect ongoing asset management fees and often use affiliated companies for property management, creating layered charges that reduce net return. The total is in the PPM, but you have to look for it.
You have no control. That’s not negotiable; it’s baked into the IRS rules. If the single tenant in a net-leased DST goes bankrupt or the mortgage terms become unfavorable, the sponsor’s ability to react is severely limited by the same restrictions that preserve the tax treatment.
Sponsor risk is real. You’re handing complete authority over a long-term, illiquid investment to a third party, with no mechanism to remove them if performance disappoints. Investigate the sponsor’s history across previous offerings, not just the projections on the current one.
What Happens When the DST Sells
Most DSTs hold property for roughly five to seven years before the sponsor exits. At that point you face the same choice you had with your original property: pay the taxes or defer again.
Another 1031 Exchange
The most common path is rolling into another 1031, either into a new DST, a property you buy directly, or both. The same 45-day and 180-day deadlines apply, and you’ll need a qualified intermediary again. Some investors chain DST-to-DST exchanges over decades.
A 721 Exchange Into a REIT
Some sponsors structure offerings to permit a 721 exchange at the end of the hold. Under Section 721, contributing property to a partnership in exchange for a partnership interest is a tax-free transaction.12Office of the Law Revision Counsel. 26 USC 721 – Nonrecognition of Gain or Loss on Contribution The DST property is contributed to a REIT’s operating partnership, and you receive Operating Partnership units instead of cash. Deferred gain rides along in the OP units.
OP units generally convert one-to-one into REIT shares after a holding period, and the conversion typically triggers the deferred gain. Most investors hold OP units for the distributions rather than converting immediately. The appeal is eventual liquidity through publicly traded REIT shares; the cost is that the tax bill comes due at conversion. Investors focused on estate planning sometimes hold OP units until death to pass the stepped-up basis to heirs.
Step-Up in Basis at Death
This is the endgame that makes serial 1031 exchanges powerful for wealth transfer. When you die, heirs inherit at current fair market value rather than your original cost basis. An investor who bought for $200,000, exchanged up to holdings worth $2 million, and deferred taxes at every step can pass those assets to heirs whose basis resets to $2 million. The deferred federal tax bill dies with the original investor.
Reporting the Exchange on Form 8824
You report each 1031 exchange on IRS Form 8824, “Like-Kind Exchanges,” attached to your return for the year you sold the relinquished property.13Internal Revenue Service. Instructions for Form 8824 The form describes both properties, records the dates, and calculates any recognized gain from boot. Your DST sponsor provides the property information and figures you’ll need.
Any boot you received — cash kept or debt relief you didn’t offset — gets reported on the same form. Depreciation recapture on any recognized gain is reported separately on Form 4797. Keep closing statements, intermediary records, subscription documents, and the sponsor’s tax package together. The IRS can audit 1031 exchanges years after filing, and rebuilding records from scratch is painful.