Key Takeaways:
- Delaware Statutory Trusts (DSTs) are eligible for 1031 exchanges, offering an alternative when searching for like-kind property. 1031 exchange investors can roll proceeds into multiple investments at the exact amounts needed to satisfy the like-kind replacement requirement.
- The fractional ownership of DSTs gives solo investors access to commercial-grade real estate assets similar to those owned by institutional investors, insurance companies, pension funds, and real estate investment trusts (REITs).
- Investors receive passive income without the responsibilities of managing tenants, handling maintenance, or searching for financing.
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A Delaware Statutory Trust (DST) is a relatively new but compelling alternative for real estate owners who are ready to step back from hands-on management but still want to stay invested in income-producing property.
Whether you're eyeing a 1031 exchange or exploring options to simplify your portfolio, DSTs offer a structure that blends the tax benefits of real estate ownership with the ease of a professionally managed investment.
DSTs have become more popular recently because they resemble the structure of a real estate partnership or LLC. However, instead of managing properties directly, investors receive regular income distributions while a third-party sponsor — usually a professional real estate company — oversees the operations, financing, and maintenance of the property or portfolio.
In this article, we break down how DSTs compare to traditional real estate investments and why they are gaining traction among investors who want flexibility and long-term strategy.
What Is a DST?
A DST is a legal entity created under Delaware trust law. These special business trusts were created in 1988 with the passing of the Delaware Business Trust Act, which was renamed the Delaware Statutory Trust Act (DST) in 2002.
DST investors don't actually own physical real estate; they own shares of the trust that was formed to be the legal owner of the underlying properties held within the trust. Each investor is treated as an owner of the trust — commonly referred to as a "grantor trust" — and the income and expenses are reported directly on their individual income tax returns.
These special business trusts create a legally secure and clearly defined entity that establishes legal separation between the trust and its beneficiaries. However, since the Internal Revenue Service (IRS) treats each investor's beneficial interests as direct property ownership, DSTs are eligible for 1031 exchanges both upfront and upon exit.
DSTs are typically formed by real estate companies called "sponsors", who identify and acquire the assets that are placed under trust using their own capital. DST sponsors engage a registered broker-dealer to open an offering period, and individual investors purchase fractional shares of the DST. Although they provide equity capital, DST beneficiaries are passive investors.
DST sponsors control the day-to-day operations of the assets held under trust. Sponsors are also responsible for distributing monthly cash flow distributions, quarterly reporting, tax reporting, and performance reviews of the assets under their management.
Sponsors vary greatly in management experience, and a thorough vetting process should be undertaken before investing in a DST.
Types of Properties Held in a Delaware Statutory Trust
A DST can hold nearly all types of commercial real estate properties across the U.S., including:
- Student housing
- Senior housing
- Medical offices
- Self-storage facilities
- Distribution centers
- Corporate headquarters
- Multifamily housing
These assets are often unattainable for individual investors due to the hefty purchase price (usually anywhere from $30 million to $100 million), but they're accessible through the DST's fractional ownership model.
How DSTs Work in a 1031 Exchange
One powerful feature of a DST is its compatibility with Internal Revenue Code Section 1031, which allows investors to defer capital gains taxes when exchanging one real estate asset for another. Traditionally, this has locked investors into actively managing replacement properties — but DSTs offer an alternative path forward.
DST interests are sold as securities, so investors must work with a registered broker-dealer or registered investment advisor to invest in a DST.
Two critical requirements in a delayed exchange are (1) that the replacement property must be properly identified within the identification period, and (2) acquired before the end of the exchange period. Failure to identify a replacement property within the 45-day period will disqualify the 1031 exchange.
DSTs are also a potential backup replacement property when an investor can't identify a replacement property for a 1031 exchange within the allowable timeline (45 days), because most DST sponsors have already identified the underlying properties.
Case Study: From Active Owner to Passive Investor
One of our clients, a long-time real estate owner, personally managed an apartment building he owned for decades. He was nearing retirement age, and the burdens of maintenance and tenant management were becoming increasingly difficult. However, he wanted to preserve his real estate portfolio as an income stream during his lifetime and as an asset to leave for his children.
Rather than selling the property and paying capital gains taxes on the profits, the client took advantage of a 1031 exchange to trade the apartment building for a DST portfolio of properties. As a result, he continued to receive monthly income without the need to actively manage the real estate and had a potentially appreciating asset to pass down to his heirs. The DST structure also made it easier to divide assets among beneficiaries compared to physical property.
Considerations and Risks
As with all real estate investments, DSTs involve risk. Market fluctuations can affect property values, and fractional ownership means you don't have direct control over operations or decision-making. Plus, investing in properties located across multiple states may introduce new state-level income tax filing requirements.
While it's crucial to be aware of these factors, many investors find the benefits outweigh the limitations — particularly when they want to simplify portfolio management, diversify their investments, and continue to invest in real estate.
Whether you want to reduce active involvement in your real estate holdings or are looking for replacement property for a 1031 exchange, a DST could be an option.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
