What is a Section 1031 exchange?
Under Section 1031 of the Internal Revenue Code, you can defer paying tax on the gain from the sale of business or investment real estate if you reinvest the gross sales proceeds into similar real estate property(ies) as part of a qualifying like-kind exchange. In general, you must identify replacement property(ies) within 45 days from the date of sale, and close on the purchase of the replacement property(ies) within 180 days.
What is a DST?
A Delaware Statutory Trust (DST) is a trust formed under the Delaware statutory trust law that allows passive, fractional ownership in real estate while qualifying as a “like kind” real estate replacement property under Section 1031. Properties held in a DST can be located anywhere in the U.S. and investors in a DST do not incur a tax liability in Delaware (unless the DST’s property happens to be in Delaware).
What are the benefits of investing in a DST?
- Access to institutional grade investment properties – Most DST programs have a relatively low minimum investment, which allows investment in larger institutional grade properties that many investors could not otherwise access on their own. DST investments include many asset classes such as: multifamily apartments, hotels, single tenant triple-net office, retail and industrial properties, student housing, medical office buildings, and multi-tenant office, retail and industrial facilities.
- Diversification – With low minimum investment requirements, investors can allocate proceeds from selling a single property across multiple DSTs and asset classes to achieve diversification within their real estate portfolio.
- Passive investment – DST programs are managed by experienced sponsors and property managers, which alleviates investors from the burdens of property management and operations involved in traditional real estate ownership. Thus, investors enjoy a 1031-exchange benefit through a truly passive real estate investment with the comfort of knowing that the DST properties are professionally managed.
- Nonrecourse debt – When investing in a DST to achieve a 1031 like-kind exchange objective, an investor needs to invest the net equity from the sale of their property. They will also be allocated a portion of the DST debt supporting the DST asset which is allocated pro rata and nonrecourse to each investor. However, investors may need to invest in more than one DST in order to replicate the debt-to-equity ratio of the property they sold.
- Income and appreciation – The vast majority of DST properties are investment grade properties with stable operating cash flow, which often generate immediate cash flow to investors.
- Tax advantages – Investing in DSTs offer the same tax advantages as investing in traditional real estate, including, without limitation, depreciation pass-through and interest deductions.
- Back-up plan – Investors often struggle to find a single replacement property that meets all of the Section 1031 exchange requirements within the 45-day identification period. DSTs can also serve as a back-up in the event you cannot identify and close on a replacement property within the required time periods.
Who should consider a DST investment?
Accredited investors who seek to achieve any of the following investment objectives:
- Passive real estate investment
- Investment in professionally managed institutional grade assets
- Portfolio diversification
- Stable cash flow
- Tax-sheltered cash flow
- Section 1031 exchange tax deferral
Download our interactive 1031 Like-kind Exchange Estimator Tool to estimate the potential tax savings of using a like-kind exchange when selling and buying investment real estate.
For more information on this topic or to learn how Baker Tilly specialists can help, contact our team.
This article was originally published on April 12, 2021 and updated on June 21, 2023.