Selling Investment Property With a Delaware Statutory Trusts (DST)

Reader wants to know whether a 1031 exchange or Delaware Statutory Trust is preferred when selling investment property

Q: I read your recent response to a person who inquired about selling rental properties they own. While your response was factual you made no mention of the very viable solution of selling the properties and through a 1031 exchange reinvesting the gain in other like kind properties. This could also include Delaware Statutory Trusts (DST) investments where there’s minimal active management and which could be transferred tax free in an estate.

A: We don’t disagree with you that our reader could have tried to defer the payment of taxes on the sale of their investment properties. But, this particular reader stated that he had no intention of buying a replacement investment property. The reader appeared to have decided to cash out now that they were retired and on a pension.

Selling investment property can be difficult

We’ve written extensively about 1031 exchanges. Section 1031 of the Internal Revenue Code provides that an owner of investment property can sell that property and defer the payment of taxes if they follow the requirements of Section 1031.

In its essence, you can sell an investment property and deposit all of the funds from the sale of that property into a tax deferred exchange account. Then, you designate a replacement real estate investment property within 45 days of the closing of the sale. You must close on the replacement property that has a higher purchase price (and no more debt) than the property sold. Finally, you must close on the purchase no later than 180 days following the closing of the sale of the investment property.

Do All Partners Have to Do a 1031 Exchange?

Of course, there are a bunch of other rules and requirements. But you get the basic idea. Using a 1031 exchange allows an investor to sell investment real estate and avoid paying taxes as long as you buy a replacement property that costs at least as much. Rinse and repeat, and your heirs will eventually inherit the property at the stepped up basis.

However, you make a good point relating to Delaware Statutory Trusts (DST). A DST is a mechanism where you buy into an investment trust. You need to follow all the sale and purchase rules relating to Section 1031. But instead of owning your own property, you own a percentage of an investment trust in real estate.

Delaware Statutory Trusts allow you to be an owner without direct management responsibilities

You own your percentage equity in the trust but you don’t manage or control it. The investment trust deals with all of the issues relating to the property. You are simply an investor in the property with a bunch of other investors. The manager of the trust gets paid from the investment income. You become an investor who no longer has to worry about the day-to-day issues relating to the property.

A DST is one of several ways to transition from actively owning investment property to taking a more passive stance. When you’re an active investor, you can hire your own manager for the investment property. Or, you take care of all matters related to the property. With a DST, someone else makes all the decisions relating to the property. You simply bank the profits or take the losses from the ownership for tax purposes.

1031 Exchange Process, Timelines and Examples

Lastly, as you are likely a small owner of the trust, you may be at the mercy of the manager of the investment. Be aware that you could potentially lose money if the investment is poorly run because you don’t have the ability to control the sale of your ownership interest. Unless there’s a waiting list of people who want to buy into the DST, you’ll need to find someone willing to buy your exact interest.

Before you buy in, ask how difficult it is to sell this interest, should your heirs want to down the line. While you may get a pitch from the company that you can always sell your investment, you should look to past sales to confirm that owners have had no problem selling their shares.

1031 Exchange: Deadlines, Type Of Property Impact Eligibility

Sometimes, there will be an investment company that facilitates the sale of shares in real estate trusts. But, as always, timing is everything. Can and will they sell your share when you want to sell? It’s difficult to know and there are no guarantees. As always, be savvy about the investment and make sure you fully understand the risks involved.