In Part 1 we covered the basics of a 1031 exchange. This part answers the question that started it: a friend is selling a rental, the clock is running, and a sponsor is offering an interest in a Delaware Statutory Trust (DST) as a ready-made replacement. Does that work, and what should you check?
First, the deadlines
The window is not six months. You must identify replacement property in writing within 45 days after the sale, and receive it within 180 days, or by the due date of that year’s return (with extensions) if earlier (IRC §1031(a)(3)). The deadlines are not extended for weekends or holidays. A DST is popular precisely because it can be identified and closed quickly.
What is a DST?
A trust formed under Delaware law that holds title to one or more income-producing properties — apartments, medical offices, distribution warehouses, net-leased retail. Investors buy beneficial interests, often with minimums around $100,000. A sponsor arranges the property and the financing; a trustee or manager runs it.
Why can a DST interest be “like-kind” to my rental?
A 1031 exchange must be real property for real property. An interest in a business entity, such as a partnership, does not qualify. In Rev. Rul. 2004-86, the IRS ruled that a properly structured DST is a grantor trust for tax purposes, so each investor is treated as owning an undivided interest in the real estate itself. That makes the DST interest eligible replacement property.
What makes a DST “properly structured”?
The ruling depends on the trustee having very limited powers — enough to hold and maintain the property, not to run a business. In practice that means the trustee cannot:
- accept new capital from investors after the offering closes;
- renegotiate the mortgage or borrow new money, except where a tenant defaults or similar distress;
- reinvest proceeds from selling the property;
- make improvements beyond normal repairs, maintenance and changes required by law;
- hold cash other than in short-term debt obligations;
- keep cash instead of distributing it, beyond necessary reserves;
- enter into new leases or renegotiate existing ones, except in a tenant bankruptcy or insolvency.
Most sponsors include a “springing LLC” provision: if a problem arises that needs these powers, the DST converts into an LLC. That protects the property but ends the structure investors relied on for future exchanges, so ask how and when it has been used.
Do I still need a qualified intermediary?
Yes. A DST does not replace the exchange mechanics. Your sale proceeds must go to a qualified intermediary, never to you, or you risk being treated as having received the cash (Treas. Reg. §1.1031(k)-1(g)). The intermediary then wires the funds to the DST sponsor at closing. Escrow alone is not enough unless it meets the regulation’s qualified escrow rules.
How does debt work?
To defer all the gain, the replacement property must be at least equal in value and debt to what you sold; debt relief you do not replace is treated as cash received (Treas. Reg. §1.1031(b)-1(c)). DSTs usually carry non-recourse loans at a set ratio, which can help you replace debt without signing personally. Check whether the loan’s maturity and prepayment terms fit your plans.
What should I check before investing?
- The offering memorandum, the tax opinion and the trust agreement.
- The property: tenant credit, lease length and rent increases, location, and condition reports.
- Fees: sponsor load, acquisition and asset-management fees, and disposition fees. These can take a noticeable share of your investment.
- The exit: DSTs are illiquid, usually held five to ten years, and you do not control when the property is sold.
- The sponsor’s track record, including past springing-LLC conversions.
- Who is selling it to you. DST interests are securities, normally sold through a broker-dealer, so check registration and the compensation they receive.
Are DSTs a good idea?
They solve a timing problem and suit investors who want passive income without managing a building. The trade-offs are fees, illiquidity and loss of control. If you have time to find and run a property yourself, a direct purchase usually costs less. Either way, decide before day 45.
State tax notes
California follows §1031 but tracks gain deferred on California property exchanged for out-of-state property. You may have to file an annual Form 3840 so the state can tax that gain when the replacement property is eventually sold.
Can I get out of a DST early?
Usually not easily. DST interests are illiquid. There is no public market, and most offering documents restrict transfers. The sponsor typically decides when the property is sold, often five to ten years out. If you might need the money sooner, a DST may not fit.
What happens when the DST sells the property?
You receive your share of the sale proceeds, and the deferred gain becomes taxable unless you do another exchange. Some sponsors offer a path into a new DST or a REIT through an UPREIT transaction under §721; that second step defers gain again but changes what you own and how you can exit. Read how the sponsor plans to end the investment before you go in.
What fees should I expect?
DSTs often carry upfront costs (selling commissions, offering and organizational costs, and financing fees) that can total a meaningful percentage of the equity raised, plus ongoing asset management fees and a share of profits on sale. Ask for a clear table of every fee and compare it with what you would pay to own a replacement property directly.
Is a DST right for someone who lives overseas?
It can be. A nonresident investor still files U.S. returns for U.S. rental income, and a sale may be subject to FIRPTA withholding at the DST level or on distribution. U.S. estate tax applies to U.S.-situs property owned at death, and whether a DST interest is treated as U.S.-situs property should be analyzed before investing. Coordinate with a tax adviser in both countries.
What questions should I ask the sponsor?
Ask how long the sponsor has been doing DSTs and how its earlier programs performed through a full cycle, including sale. Ask who the master tenant is, how the loan is structured and when it matures, what reserves are set aside for repairs and vacancies, and what happens if the property needs more money, since a DST generally cannot raise new capital from investors. Ask for the private placement memorandum and read the risk factors, not just the summary. An independent review by your own adviser before you sign is worth the cost.
Sources: IRC §1031; Treas. Reg. §§1.1031(b)-1, 1.1031(k)-1; Rev. Rul. 2004-86; California Rev. & Tax. Code §18032 and FTB Form 3840. As of November 2026.
