How a Delaware statutory trust 1031 exchange works
In a Delaware statutory trust 1031 exchange, you sell your relinquished property through a qualified intermediary and use the proceeds to buy beneficial interests in one or more DSTs, instead of buying a whole building. Each DST holds title to real estate that a sponsor bought and financed, and you own a percentage of it.
The exchange itself follows the same rules as any other 1031. You identify replacement property within 45 days, close within 180 days, keep your hands off the cash and reinvest enough value and equity to avoid taxable boot. What changes is the property you receive: a passive share of a professionally managed asset rather than a deed in your own name.
Owners use DSTs for three main reasons. They want to stop managing tenants, they need a replacement that can close quickly, or they want to split one sale across several properties and markets. Each reason comes with trade-offs covered further down.
Why a DST interest counts as real property: Rev. Rul. 2004-86
A DST interest qualifies because the IRS treats a properly limited DST as a grantor trust, so each owner is treated as owning an undivided fractional interest in the real estate itself. That is the holding of Revenue Ruling 2004-86, published in Internal Revenue Bulletin 2004-33.
The ruling turns on how little the trustee can do. In the facts the IRS approved, the trustee could only collect and distribute income. Because the trustee had no power to vary the investment, the trust was an investment trust under Treas. Reg. 301.7701-4(c), not a business entity. A business entity, such as an LLC that owns a building, would make your interest a partnership interest, and partnership interests are not real property for Section 1031.
Since 2018, Section 1031 has applied only to real property held for business or investment (Form 8824 instructions). DSTs fit that rule because the tax law looks through the trust to the building.
The trustee limits and what they mean for you
Rev. Rul. 2004-86 approved a trust whose trustee could not change the deal after it closed. Sponsors write those limits into every DST trust agreement, and each one shapes how the investment behaves.
| Limit in the ruling | What it means as an owner |
|---|---|
| No new contributions of money or assets | The trust cannot raise more equity if the property needs cash |
| No renegotiating the loan | The financing in place at purchase stays until sale |
| No new leases or lease changes, except on tenant bankruptcy | Many DSTs use a master lease to a sponsor affiliate |
| Only minor non-structural changes, unless law requires more | Major renovations are off the table |
| No buying new property or exchanging the property | Sale proceeds cannot be reinvested inside the trust |
| Cash held only in short-term government obligations or bank CDs | Reserves earn little and must be distributed |
1031 DST exchange timeline and deadlines
A 1031 DST exchange runs on the same clock as any deferred exchange under Treas. Reg. 1.1031(k)-1. Both periods start the day your relinquished property transfers and run at the same time, including weekends and holidays.
| Step | Deadline | Notes for DST buyers |
|---|---|---|
| Engage a qualified intermediary | Before the sale closes | Proceeds must go to the intermediary, not to you |
| Identify replacement property | Midnight of day 45 | Written, signed and delivered; name the specific DST offerings |
| Close on the replacement | Earlier of day 180 or your return due date with extensions | File an extension if your return is due before day 180 |
| Subscribe to the DST | Inside the 180 days | The intermediary wires funds to the sponsor under your subscription |
| Report the exchange | With your tax return | Form 8824, listing each DST interest received |
Using DSTs to meet the identification rules
DST interests are often named on an identification list because the property is already owned and financed, so the purchase can close within days of your subscription being accepted. That makes a DST a common backup when a direct purchase falls through near day 45 or day 180.
The identification rules in Treas. Reg. 1.1031(k)-1(c)(4) still apply. You can name up to 3 properties of any value, or any number whose combined value is no more than 200% of the property you sold, or more than that if you then acquire at least 95% of the value you identified. Each DST offering counts as a property. Offerings can sell out, so ask the sponsor or your broker how it reserves space before you rely on it.
Replacing debt and value with DST interests
To defer all of the gain, the replacement must be worth at least your net sale price and you must reinvest all of your net cash. Debt paid off at the sale has to be replaced with new debt or with added cash, or the net relief counts as boot under Treas. Reg. 1.1031(d)-2.
DSTs help here because most carry a loan, and you take on your share of it when you buy in. A DST at 50% loan-to-value gives you two dollars of property for each dollar of equity. A debt-free DST gives you one. Mixing the two lets you match the debt you had, but you have to do the math before you identify.
Worked example: a 16-unit building into two DSTs
An owner sells a 16-unit building for $3,000,000 with $90,000 of selling costs, so the net sale price is $2,910,000. The loan payoff is $1,200,000, leaving $1,710,000 of cash with the qualified intermediary. Adjusted basis is $1,100,000, of which $700,000 of depreciation has been taken. The gain is $1,810,000.
Sold outright by a top-bracket filer, the $700,000 of depreciation is taxed at up to 25% ($175,000), the remaining $1,110,000 at 20% ($222,000), and the 3.8% net investment income tax adds $68,780. That is about $465,780 of federal tax, before any state tax. The 20% rate applies above $545,500 of taxable income for single filers and $613,700 for joint filers in 2026 (Rev. Proc. 2025-32).
Plan A: the owner puts all $1,710,000 into two DSTs, each at 50% loan-to-value. The owner’s share is $3,420,000 of property and $1,710,000 of debt. Value is above $2,910,000, debt is above $1,200,000 and all the cash is reinvested, so the full $1,810,000 is deferred.
Plan B: the owner puts $855,000 into a DST at 50% loan-to-value and $855,000 into a debt-free DST. The share is $2,565,000 of property and $855,000 of debt. Debt relief is $1,200,000 minus $855,000, or $345,000, and that is boot. Taxed as depreciation recapture at up to 25% plus the 3.8% surtax, it costs about $99,360. Same cash, different debt, very different result.
DST interests are securities: who can buy them
DST interests are securities, so they are sold through private placements, usually under Regulation D Rule 506, and almost always only to accredited investors. They are commonly sold through registered broker-dealers, who review whether the investment is suitable for you.
For an individual, accredited means a net worth over $1 million excluding your primary residence, alone or with a spouse or partner, or income over $200,000 ($300,000 with a spouse or partner) in each of the last two years with the same expected this year. Holders of Series 7, 65 or 82 licenses in good standing also qualify (SEC).
Rule 506(b) and Rule 506(c) differ. A 506(b) offering cannot be advertised publicly and may admit up to 35 non-accredited but financially sophisticated buyers in any 90-day period, who must receive extra disclosure. A 506(c) offering may be advertised, but every buyer must be accredited and the issuer must take reasonable steps to verify it, such as reviewing tax returns or getting a letter from a CPA, attorney or registered adviser. In both, the issuer files Form D with the SEC within 15 days after the first sale.
Most syndications are sold the same way, to accredited investors under one of these two rules. Any offering is made only through official offering documents to eligible investors.
What to check in any 1031 DST investment
The private placement memorandum is where the real terms live, and the items below are the ones that most often decide whether a DST works for an exchanger.
- Load: selling commissions, offering costs and sponsor fees paid out of your equity at the start, which lower the value working for you.
- Ongoing fees: asset management, property management and master lease terms, and which ones go to sponsor affiliates.
- The loan: rate, fixed or floating, maturity date and whether it matures before the sponsor expects to sell. The trustee cannot refinance.
- Reserves: how much cash is set aside for repairs and vacancy, since the trust cannot raise more money later.
- The exit: who decides when to sell, whether the sponsor plans a 721 roll-up into a REIT, and what happens if the market is weak.
- Conversion language: many trust agreements let the trustee convert the DST into an LLC if the property is in trouble. That can protect the asset but generally ends 1031 treatment for later exchanges.
- The sponsor: how it handled past properties that struggled, not only the ones that sold well.
Risks of a DST in a 1031 exchange
The main risk is that you trade control for convenience. You cannot sell the building, refinance it, replace the manager or decide when to exit. If rents fall or the loan comes due at a bad time, the rules that protect the tax treatment also stop the trustee from fixing the problem with new capital.
DST interests are illiquid. There is usually no market to sell them before the property is sold, and transfers may need sponsor approval. Distributions depend on property income and can drop or stop. You can lose money, and a failed property can leave you with a taxable event and less cash to pay it with.
Read the risk factors in the memorandum in full, and compare the after-fee picture against a direct purchase, another exchange path or paying the tax.
721 exchange vs. 1031 exchange
A 1031 exchange swaps real estate for other real estate, while a 721 exchange contributes real estate to a partnership, usually a REIT operating partnership, for partnership units. Both defer gain, but only the 1031 leaves you owning real property you can exchange again.
The two meet in DSTs. Some DSTs are sponsored by REITs that hold an option to buy the trust’s property later in a Section 721 transaction, paying DST owners in operating partnership units. Once you hold units, a later 1031 is generally off the table. Our 721 exchange guide covers the UPREIT structure in more depth.
| Feature | 1031 exchange (including into a DST) | 721 exchange |
|---|---|---|
| What you receive | Real property, or a DST interest treated as real property | Operating partnership units |
| Code section | IRC 1031 | IRC 721 |
| Deadlines | 45 days to identify, 180 days to close | No identification window |
| Further 1031 exchanges | Available | Generally not available |
| Path to cash | Sell the property, a taxable event | Convert units to shares or cash, a taxable event |
| Who controls the asset | You, or the DST sponsor | The REIT |
When the DST property sells
When the sponsor sells the property, each owner receives a share of the net proceeds and has the same choices as any seller. You can take the cash and pay tax on the deferred gain, or do a new 1031 exchange into another DST or a building you own directly, starting a fresh 45-day and 180-day clock.
Because each owner is treated as owning part of the real estate, each owner makes this choice separately. Arrange a qualified intermediary before the sale closes if you plan to exchange again, so the proceeds never reach your account.
DST, syndication or another building
A DST is one of three common homes for exchange money, and the right one depends on the source of the cash and how much control you want. Buying another building directly keeps control and full 1031 flexibility but keeps you a landlord. A DST keeps the deferral and drops the management. A typical LLC syndication interest is not real property, so exchange proceeds used to buy one would generally be taxed, though syndications can suit cash that is not tied to an exchange. Our comparison of DSTs and syndications goes through the trade-offs side by side.
Skyline Capital Investments buys apartment buildings with five or more units and sponsors syndications for investors in our network. If you are selling a building to fund an exchange, we can talk through timing on the sale. If you want to learn about passive multifamily ownership with money outside an exchange, you can join our investor network. You can estimate the deferred tax first with the 1031 exchange calculator.
