What is a DST? Your Guide to the Most Popular Passive 1031 Exchange Investments

Legal Structure of a Delaware Statutory Trust

A DST is created by filing a Certificate of Trust with the Delaware Division of Corporations under the Delaware Statutory Trust Act of 1988. The trust holds legal title to one or more commercial properties. Investors own beneficial interests in the trust, not deed interests in the underlying properties.

For tax purposes, a 1031-compliant DST is classified as a grantor trust. This classification is critical. It means the trust is disregarded as a separate entity for federal income tax purposes. Each beneficial owner is treated as a direct owner of their proportionate share of the trust's real estate holdings.

You report your pro-rata share of the property's income, expenses, depreciation, and gain or loss on your personal tax return. The trust itself does not pay taxes. You receive a Schedule K-1 annually showing your allocated items.

Key Structural Elements

The trustee holds legal title and manages the property. Beneficial owners have no management authority. This complete passivity is not a design choice but an IRS requirement for 1031 qualification.

There is no statutory limit on the number of beneficial owners. Traditional Tenancy-in-Common (TIC) structures are limited to 35 co-owners to avoid partnership classification. DSTs have no such restriction because they are trusts, not co-ownership arrangements.

Debt is typically structured as non-recourse to individual investors. The loan is secured by the property only, not by personal guarantees. Your pro-rata share of the DST's debt counts toward your debt replacement requirement in a 1031 exchange, but you do not personally sign on the loan.

History and IRS Approval

The Delaware Statutory Trust Act was passed in 1988, creating the legal framework for DSTs. However, DSTs were not widely used for real estate until the IRS clarified their treatment for 1031 exchanges.

On August 16, 2004, the IRS issued Revenue Ruling 2004-86. This ruling established that beneficial interests in a DST holding real property can qualify as like-kind replacement property under Section 1031, provided the DST meets specific operational restrictions.

The ruling did not change the tax code. It clarified how existing code provisions apply to DST structures. The IRS concluded that a properly structured DST is a grantor trust, not a business entity or partnership. This classification is what allows DST interests to qualify as direct real estate ownership.

Revenue Ruling 2004-86 also established seven specific restrictions that DSTs must follow. These restrictions ensure that the DST operates as a passive investment trust rather than an active business enterprise. Violating any of these restrictions reclassifies the DST as a business entity, which would disqualify it for 1031 exchanges.

DSTs existed before 2004 and continue to exist for purposes other than 1031 exchanges. But the 2004 ruling is what made DSTs viable as a 1031 exchange solution for passive real estate investors.

The Seven Deadly Sins: IRS Restrictions on DSTs

To maintain qualification as a grantor trust eligible for 1031 exchanges, a DST trustee cannot take the following seven actions. These restrictions are commonly called the "Seven Deadly Sins" in the DST industry. For a deeper analysis, see our guide on navigating IRS restrictions on DSTs.

Additional Limitation: Capital Improvements

The trustee can make normal repairs and maintenance, but cannot make capital improvements unless required by law or the lease agreements in place at trust formation. Non-structural modifications and minor improvements not required by law or lease are permissible if relatively insignificant.

Consequences of Violation

If the trustee violates any of these restrictions, the DST is reclassified as a business entity, likely a partnership for tax purposes. This reclassification is retroactive to the date of trust formation.

For beneficial owners, this means:

• Loss of 1031 exchange treatment (immediate tax liability on deferred gains)
• Potential partnership audit procedures
• Increased complexity in tax reporting
• Possible penalties and interest

This is why sponsor reputation and operational compliance are critical due diligence factors. A violation affects all beneficial owners, not just the trustee.

Standard 1031 Exchange Rules Apply

DST interests qualify as like-kind real property, but all standard Section 1031 requirements still apply.

45-Day Identification Rule

You must identify potential replacement properties, including DST interests, within 45 calendar days after closing on your relinquished property. This deadline is absolute. The identification must be in writing, signed by you, and delivered to your qualified intermediary or another acceptable party before midnight on day 45. Learn more about mastering the 45-day identification period.

180-Day Closing Rule

You must acquire your replacement property within 180 days after closing on your relinquished property, or by the due date of your tax return for the year of sale (including extensions), whichever is earlier.

Equal or Greater Value

To defer all capital gains, your replacement property must have a fair market value equal to or greater than your relinquished property. If you purchase property of lesser value, you recognize gain to the extent of the difference (called "boot"). Learn how to avoid boot in your 1031 exchange.

Equal or Greater Debt

To defer all capital gains, your replacement property must have debt equal to or greater than the debt on your relinquished property. If you reduce debt, you recognize gain equal to the debt reduction.

This is where DST structures provide a specific advantage. Your pro-rata share of non-recourse DST debt counts toward your debt replacement requirement, even though you do not personally guarantee the loan.

Qualified Intermediary Requirement

You cannot have actual or constructive receipt of exchange funds. A qualified intermediary must hold the proceeds from your relinquished property sale and use those proceeds to acquire your replacement property.

Investment or Business Use

Both your relinquished property and replacement property must be held for investment or productive use in a trade or business. Personal residences, vacation homes used primarily for personal enjoyment, and property held primarily for sale do not qualify.

Benefits of DST Investments

Complete Passivity

The defining benefit of DST ownership is the absence of any management responsibility. You have no landlord duties. You do not make decisions about property operations, leasing, repairs, or capital expenditures. The trustee handles all aspects of property management.

For investors exiting decades of active property management, this passivity is often the primary motivation for choosing a DST over direct property ownership.

Access to Institutional Properties

DSTs typically hold properties valued between $50 million and $200 million or more. These are assets that individual investors rarely have the capital or expertise to acquire and manage directly.

Properties in DST offerings are generally:

• Class A or B quality in their respective categories
• Located in primary or strong secondary markets
• Leased to creditworthy tenants with established operating histories
• Professionally managed by institutional property management firms

You gain access to this asset quality through fractional ownership.

Diversification Across Multiple Properties

Minimum investment requirements for DSTs typically range from $25,000 to $100,000 per property. This allows you to spread your 1031 exchange proceeds across multiple DST investments rather than concentrating all capital in a single property.

You can diversify by:

• Property type (multifamily, industrial, net-lease retail, medical office)
• Geographic location (different states and metropolitan areas)
• Tenant credit quality and industry
• Lease structure (triple-net, modified gross, full-service)
• Sponsor and property management team

Diversification does not eliminate risk, but it reduces concentration in any single property or market.

Simplified 1031 Exchange Execution

DST properties are already acquired, stabilized, and available for immediate purchase. You are not negotiating with sellers, arranging inspections, or coordinating closings with third-party lenders.

When you identify a DST, the sponsor reserves your allocation. You are not competing with other buyers who might offer more favorable terms. The property is available when your funds are ready to deploy.

DST closings typically occur in three to five days once your qualified intermediary has funds ready to transfer. This rapid closing capability is particularly valuable late in your 180-day exchange period or when direct property purchases fall through.

Non-Recourse Debt Without Personal Underwriting

Most DST offerings include non-recourse debt at the trust level. Your pro-rata share of this debt satisfies your 1031 exchange debt replacement requirement without requiring you to:

• Qualify for a loan personally
• Provide financial statements or tax returns to lenders
• Sign personal guarantees
• Meet lender net worth or liquidity requirements

For investors who have difficulty qualifying for commercial real estate loans due to age, income structure, or other factors, this is a significant practical benefit.

Estate Planning Considerations

At your death, your heirs receive a stepped-up basis in inherited DST interests. This eliminates the deferred capital gains tax permanently. The built-in gain that you deferred through 1031 exchanges throughout your life disappears at death for your heirs.

DST interests are also easier to divide among multiple heirs than direct property ownership. You can specify in your estate plan that each heir receives a specific percentage of your DST holdings without the complications of co-ownership in physical real estate.

Risks and Limitations of DST Investments

Understanding DST investment risks is essential for making informed decisions.

Complete Illiquidity

DST interests are private placements with no established secondary market. You should assume you cannot sell your interest until the sponsor sells the underlying property, which typically occurs five to ten years after the DST formation.

There is no exchange where you can list and sell your interest. Some sponsors may facilitate transfers between accredited investors, but these are exceptions and cannot be relied upon for exit planning.

If you need access to your capital for any reason during the hold period, you likely will not be able to liquidate your DST investment.

Zero Management Control

You have no voting rights on property operations. You cannot:

• Influence leasing decisions or tenant selection
• Direct property improvements or capital expenditures
• Approve or reject financing decisions (within the limits of the Seven Deadly Sins)
• Control the timing or terms of property sale

The trustee and sponsor make all decisions. If you disagree with their management, asset strategy, or disposition plans, you have no ability to intervene or override their decisions.

Sponsor Dependency

Your returns depend entirely on the sponsor's judgment, expertise, and integrity. A competent sponsor with strong asset management and capital markets capabilities can generate solid risk-adjusted returns. An incompetent or conflicted sponsor can produce losses even in good properties.

Factors you cannot control but which affect your returns:

• The sponsor's initial property selection and pricing
• The quality of ongoing property management
• Leasing strategies and tenant retention efforts
• Timing and execution of property sale
• Sponsor's financial stability and reputation in the market

Due diligence on sponsor track record and operational capabilities is as important as property-level underwriting. Review our 20 questions to ask a real estate sponsor.

Structural Inflexibility

The Seven Deadly Sins restrictions eliminate management flexibility in challenging situations.

If the property experiences financial stress, the sponsor cannot:

• Raise additional capital from beneficial owners
• Refinance to a lower interest rate or better terms
• Make major capital improvements to reposition the asset
• Modify leases to retain tenants facing financial difficulty
• Sell the property and reinvest proceeds in better opportunities

These restrictions are necessary to maintain 1031 eligibility. But they limit the sponsor's ability to respond to adverse market conditions or capitalize on opportunities.

Real Estate Market Exposure

DST investments are real estate. They are subject to:

• Tenant default and vacancy risk
• Economic downturns in the property's market
• Changes in supply and demand for the property type
• Interest rate movements affecting property values
• Competition from new construction or renovated properties
• Changes in neighborhood quality or tenant demand

Institutional quality and professional management reduce these risks but do not eliminate them. Significant losses are possible.

Fee Structures

DST sponsors charge fees that reduce your net returns. Common fee types include:

Acquisition Fees: Typically 1% to 3% of property purchase price, paid at DST formation.

Asset Management Fees: Ongoing fees, typically 0.5% to 1.5% of property value annually, paid from property cash flow.

Disposition Fees: Typically, 1% to 2% of sale price, paid when the property is sold.

Debt Placement Fees: Fees paid to arrange financing, often 1% of loan amount.

In addition to sponsor fees, the property incurs normal operating expenses including property management fees, maintenance, insurance, taxes, and debt service.

You should underwrite DST investments on a net basis after all fees and expenses. Total fees are often higher than the cost of owning direct real estate but reflects the value of passive ownership and professional management. For a detailed breakdown, see our DST fees and debt analysis.

Tax Code Change Risk

Section 1031 has existed since 1921 and has survived numerous tax reform efforts. However, it is frequently proposed for elimination or modification.

If Congress eliminates or restricts Section 1031, it would likely affect your ability to exchange out of a DST investment tax-free when the property is sold. This does not create additional tax liability beyond what would apply to any real estate investor, but it would eliminate the ability to continue deferring gains indefinitely.

Who Should Consider DST Investments?

Investors Exiting Active Management

If you have spent years or decades managing rental properties and no longer want the responsibilities of direct ownership, DSTs provide a path to exchange into passive ownership while deferring capital gains taxes.

Common scenarios include:

• Retirement or semi-retirement from active real estate investing
• Relocation to a different state or region where you cannot manage property effectively
• Health issues that make active property management difficult
• Family situations where heirs do not want to inherit management responsibilities

Investors Facing 1031 Exchange Time Pressure

The 45-day identification deadline and 180-day closing deadline create significant time pressure. If you are struggling to find suitable direct replacement properties, DSTs provide immediately available alternatives.

DSTs are particularly valuable when:

• Your 45-day deadline is approaching and you have not identified three properties
• A direct property purchase falls through late in your exchange period
• Market conditions make suitable properties scarce or overpriced
• You need to close quickly to meet your 180-day deadline

Learn more about 1031 backup strategies to protect your exchange.

Investors Seeking Diversification

If you are selling a single large property and want to diversify across multiple assets, geographies, or property types, DSTs allow this diversification at lower minimum investment levels than direct property purchases would permit.

Investors Unable to Qualify for Financing

If you cannot qualify for commercial real estate loans due to:

• Age (many lenders cap loan terms at borrower age 75 or 80)
• Income structure (self-employment, retirement income, investment income)
• Debt-to-income ratios
• Recent credit events

DSTs provide access to leveraged real estate without personal loan qualification.

Estate Planning-Focused Investors

If your primary goal is to preserve capital for heirs while minimizing tax liability, DSTs combined with the stepped-up basis at death can be effective.

You defer capital gains taxes throughout your life through 1031 exchanges into DSTs. At death, your heirs receive a stepped-up basis, eliminating the deferred gains permanently. They can sell the DST interests or continue holding for income without recognizing the gains you deferred.

Who Should Not Invest in DSTs

Investors Who Need Liquidity

If there is any possibility you will need access to your invested capital before the DST's anticipated five to ten year hold period, do not invest in DSTs. There is no reliable exit mechanism.

Investors Who Want Control

If you want to make decisions about property management, leasing, capital improvements, financing, or sale timing, DSTs are not appropriate. You have zero management authority.

Investors Seeking Maximum Returns

DSTs provide professional management and passive ownership, but these benefits come at a cost. Fees reduce net returns compared to direct property ownership. If maximizing absolute returns is your primary objective, direct property ownership will likely produce better results albeit with active management responsibilities on your end.

Investors Who Are Not Accredited

DST interests are securities offered under private placement exemptions. They are only available to accredited investors who meet SEC qualification standards:

• Net worth exceeding $1 million (excluding primary residence), or
• Annual income exceeding $200,000 ($300,000 joint) in each of the prior two years with reasonable expectation of the same in the current year

If you do not meet these standards, you cannot legally invest in DST offerings.

What types of Properties Are Available in DSTs?

DSTs hold income-producing commercial real estate across most major property categories.

Multifamily Properties

Apartment communities are a common DST asset class, typically Class A or B properties in growing metropolitan areas. Properties generally have 200 to 500 units with professional property management.

Multifamily DSTs appeal to investors seeking:

• Consistent cash flow from diversified rent rolls
• Demographic-driven demand (population growth, household formation)
• Relatively low tenant concentration risk (no single tenant represents more than 0.2% to 0.5% of revenue)

Net-Lease Retail

Single-tenant retail properties with long-term triple-net (NNN) leases are common in DST offerings. Typical tenants include:

• Drugstores (Walgreens, CVS)
• Dollar stores (Dollar General, Dollar Tree, Family Dollar)
• Grocery stores and supermarkets
• Quick-service restaurants
• Auto parts retailers

NNN leases require the tenant to pay property taxes, insurance, and maintenance costs in addition to base rent. This structure provides predictable net income to the property owner. Learn more about triple net lease risks.

Industrial and Logistics

Distribution centers, warehouses, and light industrial properties have become popular DST investments. Properties are typically:

• 100,000 to 500,000+ square feet
• Located near major transportation corridors
• Leased to e-commerce, logistics, or manufacturing tenants

Medical Office Buildings

Medical office properties leased to healthcare providers, physician groups, or healthcare systems are common in DST offerings. Properties are often:

• Located near hospitals or in established medical districts
• Purpose-built for healthcare use with specialized infrastructure
• Leased to investment-grade healthcare systems or physician groups with strong financial backing

Self-Storage

Self-storage facilities with multiple buildings and hundreds of individual units are occasionally offered as DSTs. These properties typically have:

• 50,000 to 150,000 square feet of rentable space
• Professional third-party management
• Diversified income from hundreds of small tenants

Learn more about self-storage DST investments.

Hospitality

Select-service and extended-stay hotels appear in DST offerings less frequently than other property types. Properties are typically:

• Branded under major flags (Marriott, Hilton, Hyatt)
• 100 to 200 rooms
• Located in strong demand markets or near major employment centers

Hospitality DSTs like hotels tend to be more cyclical and operationally intensive than other property types. However, they offer potential for higher cash flow in strong economic conditions.

Comparing 1031 Exchange Structures: DST vs. TIC

Before DSTs became prevalent after 2004, Tenancy-in-Common (TIC) structures were the primary vehicle for fractional ownership in 1031 exchanges. TICs still exist but are far less common than DSTs. Here are a few key differences:

In practice, most investors conducting 1031 exchanges choose DSTs over TICs due to the passivity, simplified execution, and lower minimum investment requirements. TICs remain a niche option for sophisticated investors who want more control and are willing to accept the coordination challenges and are willing to be personally underwritten for the financing.

How Do I Invest in a DST?

Engage a trusted expert to review any DST investment before committing capital.

Advisors to Consult:

• CPA or tax advisor: Verify the tax treatment and suitability for your specific situation
• Attorney: Review the legal structure and your rights as a beneficial owner
• Financial advisor or broker: Assess whether the investment fits your overall asset allocation and risk tolerance
• Qualified Intermediary: Confirm the DST qualifies for your 1031 exchange and the documentation is properly completed

Do not rely solely on the sponsor's projections to make your decision.

DST Investments and the Current Market Environment

DST offerings reflect current commercial real estate market conditions and capital markets environment.

Interest Rate Environment

Most DST properties carry fixed-rate debt locked in at the time of property acquisition. In rising rate environments, sponsors may offer DSTs with lower leverage to maintain acceptable debt service coverage ratios. In falling rate environments, higher leverage may be available.

Your projected returns are directly affected by the interest rate on the DST's debt. A property with a 6% cap rate and a 5.5% interest rate on 60% leverage could potentially produce significantly lower cash-on-cash returns than the same property with 4% interest rate debt.

Review the debt terms carefully and understand how the interest rate affects projected cash flow.

Property Type Availability

DST sponsor activity concentrates in property types and markets where debt and equity capital is readily available and institutional buyers are active.

Multifamily, industrial, and net-lease retail DSTs are generally more common than office or hospitality offerings because lenders and investors currently favor these property types.

Sponsor Competition and Property Pricing

When capital is abundant and competition among DST sponsors is high, sponsors may pay higher prices for properties to maintain deal flow. This can result in lower projected returns for beneficial owners.

When capital is scarce and competition is low, sponsors may be able to acquire properties at more attractive pricing, potentially leading to higher returns.

Understanding the current market environment helps you assess whether projected returns are realistic and sustainable. See our market outlook for more analysis.

A Combined Strategy: DSTs and Direct Property

Many sophisticated investors use a combination approach in their 1031 exchanges, allocating a portion of proceeds to direct property and a portion to DST investments.

A typical allocation might be:

• 60% to 70% in direct property (for control and potentially higher returns)
• 30% to 40% in DST investments (for guaranteed execution and risk mitigation)

This approach provides several advantages:

Flexibility to Pursue Preferred Properties

You can spend time finding and negotiating for a direct property that meets your specific criteria without the pressure of needing to deploy all proceeds within tight deadlines.

Guaranteed Exchange Completion

If the direct property purchase falls through or takes longer than expected, the DST allocation protects your exchange. You have already identified the DST as replacement property and can close within days if needed.

Debt Replacement Management

DSTs with debt can help satisfy your debt replacement requirement, allowing you to purchase direct property with less or no debt.

Implementation in Identification

Under the three-property rule, you might identify:

• Direct property #1 (primary target)
• Direct property #2 (strong backup)
• DST investment #3 (guaranteed safety net)

You pursue the direct properties while maintaining the DST as a fallback. If both direct properties close, you acquire them and do not close on the DST. If one or both fall through, you have the DST as guaranteed replacement property.

This strategy is particularly common among investors exchanging properties valued at $1 million or more, where minimum investment requirements for both direct property and DST investments are easily met.

Final Considerations

DST investments are a specialized solution for accredited investors who want to defer capital gains taxes through 1031 exchanges while exiting active property management.

The benefits are clear: complete passivity, access to institutional quality properties, simplified exchange execution, and elimination of personal loan requirements.

The limitations are equally clear: illiquidity, no management control, sponsor dependency, and structural inflexibility.

DSTs are neither better nor worse than direct property ownership. They are different and serve different investor objectives. The decision to invest in DSTs should be based on your specific circumstances, including:

• Your willingness to remain in active property management
• Your need for control over investment decisions
• Your tolerance for illiquidity
• Your ability to qualify for commercial real estate loans
• Your estate planning objectives

If passive ownership, simplified execution, and guaranteed exchange completion align with your priorities, DSTs deserve serious consideration. If control, flexibility, and maximum returns are more important, direct property ownership remains the better choice.

There is no requirement to choose one approach exclusively. A combined strategy using both DSTs and direct property can provide the benefits of both structures while mitigating the limitations of each.

Whatever approach you choose, conduct thorough due diligence, engage qualified professional advisors, and understand exactly what you are purchasing before committing capital.

DST Frequently Asked Questions

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