What is the Delaware Statutory Trust 1031 Strategy?

Section 1031 of the Internal Revenue Code, or just "1031 exchange," is the most important law in real estate investing. It's hard to imagine scaling your wealth through real estate investing without the ability to exchange without paying capital gains.

Without section 1031, selling your investment or business property (i.e., non-primary residence) would result in a hefty taxation on your capital gains and some depreciations you've made. That would significantly reduce most investment returns, arguably to the point of wasting money on the whole endeavor. Now there are exceptions to almost everything, so there are situations of lower taxation on capital gains AND some where you have a reason to just pay the taxes.

But in the end, the IRS has provided 1031 exchanges as a tool to defer those taxes completely, albeit with some important restrictions. An important detail is that you have to exchange all of the proceeds from the sale into a replacement property of equal or greater value (or you get the boot, literally).

The "Normal" 1031 Exchange Strategy

The "normal" situation is that a rental property investor wants to sell their property because they've built a decent amount of equity in it. Then, using the 1031 exchange, they'll replace the relinquished property with an equal or greater value property. They won't pay taxes on the transfer, so usually have built up more equity than their original down payment, so they'll try to get a higher value property in order to cash flow more. Then the investor will repeat these upward exchanges repeatedly, which is basically "swap 'til you drop" in Latin.

This investment strategy doesn't only apply to rental properties; you can 1031 exchange into a variety of real estate assets. But as there are "different strokes for different folks," there are different investment objectives, levels of experience, timelines, risk tolerances, and starting capitals. Therefore, individual investors should always assess what works for them with a financial professional or the due diligence of one.

That being said, one of the 1031 exchange options that some investors will match well with is the DST. In 1031 terms, it's simply another choice of replacement property. Learn more about what a DST is and how it can work in your 1031 exchange strategy.

How DSTs Work in 1031 Exchanges

A Delaware Statutory Trust (DST) qualifies as a like-kind property for 1031 exchange purposes, making it an excellent replacement property option. This qualification was established by IRS Revenue Ruling 2004-86. When you sell your investment property and use a 1031 exchange, you can reinvest the proceeds into a DST, deferring all capital gains taxes while gaining access to professionally managed real estate.

DSTs are particularly valuable as a backup option during the 45-day identification period. If your primary replacement property falls through, a DST can serve as a reliable fallback to ensure your exchange remains valid and you don't lose your tax deferral benefits.

Benefits of the DST 1031 Strategy

• Tax Deferral: Defer all capital gains taxes by exchanging into a DST
• Passive Investment: No active property management required
• Professional Management: Experienced teams handle all property operations
• Diversification: Access to institutional-grade properties across different markets
• Predictable Income: Regular monthly distributions from rental income
• Flexibility: Can blend multiple DSTs to match your exact exchange requirements

For a comprehensive look at the advantages and disadvantages, see our guide on DST pros and cons.

Considerations for DST 1031 Exchanges

While DSTs offer many benefits, it's important to understand the limitations. DSTs are illiquid investments with typical holding periods of 5-10 years. You'll also give up direct control over property management decisions. Additionally, DSTs require accredited investor status and typically have minimum investment requirements starting around $100,000.

Before committing to a DST 1031 exchange, it's crucial to understand the potential problems with DSTs and work with experienced professionals who can guide you through the process.

Getting Started with a DST 1031 Exchange

If you're considering a DST 1031 exchange, start by:

1. Understanding the basics of 1031 exchanges and the strict timelines involved
2. Learning about how DSTs work as investment vehicles
3. Reviewing the pros and cons to ensure DSTs align with your goals
4. Consulting with a qualified intermediary and financial advisor

The DST 1031 strategy can be an excellent way to defer taxes while transitioning to passive real estate investment. With proper guidance and due diligence, it can help you build wealth tax-efficiently over the long term.