Delaware Statutory Trust Tax Treatment, Taxation, and Tax Returns: DST 1031 Exchange Market Insights and Thoughts

A woman and a man researching Delaware statutory trust tax reporting on their computer

By: Dwight Kay

When considering a Delaware Statutory Trust property for a 1031 exchange, investors and their CPAs must also consider the tax treatment of DST properties – How is a Delaware Statutory Trust taxed? This article gives a brief overview of the various Delaware Statutory Trust tax treatment and DST taxation topics that investors should understand and go over with their CPA and tax attorney prior to making any investment decisions.

DSTs are considered to be separate legal entities. The IRS under Revenue Ruling 2004-86 blessed the Delaware Statutory Trust (DST) as “Like Kind” exchange property for the purposes of a 1031 exchange. https://www.irs.gov/irb/2004-33_IRB#RR-2004-86

If you’re looking for DST exchanges to enjoy capital gains tax deferment, remember that fractional ownership in a DST comes with some tax implications. Be sure to consult an experienced and knowledgeable expert to not only choose the right DST investment option that meets your objectives but also to understand its taxation rules and regulations.

Delaware Statutory Trust Tax Return – Year End Accounting and Reporting
Investors opt for a DST exchange property to defer capital gains tax. But what about the Delaware Statutory Trust’s distributions to investors? How is a Delaware Statutory Trust taxed in terms of the income it generates? Investors would do well to remember that, similar to all other rental properties, the distributions from their Delaware Statutory Trust will be taxed as ordinary income. But how is this done?

When an investor purchases an interest in a DST 1031 exchange property, they will receive a year-end operating statement that shows their pro-rata portion of the properties rental income and expenses. They will also receive a Form 1099 which they will then provide to their CPA who will plug the numbers into Schedule E on the investor’s tax return, just like all other rental and commercial property the investor owns.

However, it’s important to note that the rental income generated from your DST property automatically gets reported to the IRS at the end of each accounting year. If you would like to see an example of the year end reporting provided by various DST sponsors please email us at info@kpi1031.com or call Kay Properties directly at 1-(855) 899-4597.

Depreciation Deductions and DST Taxation

With a 1031 exchange, an investor’s basis from the property he or she recently sold will carry forward with them into the new DST properties that they purchase. If the investor fully depreciated the property they sold already, that basis carries forward into the new DST properties. If they still had basis in the property they sold, or if they purchased a greater value in the DST properties than they had in the property they sold, then they now are able to take advantage of depreciation deductions to help shelter the income from the DST properties.

Delaware Statutory Trust State Tax Treatment

How is a Delaware Statutory Trust taxed when it is based out of the state of primary residence? When owning property out of state, you typically will need to file state income tax returns in that state. The same goes for DST properties unless the property is in a state with no income tax filing requirements, such as Texas or Florida. Typically CPAs will charge clients a few hundred-dollar fee for filing out of state on behalf of a DST investor.

That said, it’d be worthwhile to mention that most states consider the income received from DSTs to be taxable. However, the taxation rules may vary from state to state. So be sure to do your research when filing tax returns or seek advice from an experienced consultant.

Future 1031 Exchanges – Tax Treatment of Delaware Statutory Trust Properties in Future 1031 Exchanges

When an investor purchases a DST property and that DST property eventually sells, the investor is now free to purchase any other type of like kind real estate. Many of our investors end up 1031 exchanging back into more DST properties when it is time to reinvest.

Purchasing Equal of Greater Value – DST Property Taxation Regarding 1031 Exchange Rules
One of the 1031 exchange rules require investors to purchase property of equal or greater value. Therefore, it is recommended that investors who have paid off their properties in full invest in DST properties that are all-cash/debt-free. This is recommended for two reasons; first using leverage/loans in any real estate purchase or investment greatly increases the risk of loss. Second, if an investor that has $1 million of equity from a building he sold free and clear purchases a DST that has a 50% loan to value, then that investor is now purchasing $2 million of that DST ($1 million of equity down plus the $1 million of debt due to the property being a 50% LTV equals a total purchase price of $2 million).  When the DST property sells, that investor will have to purchase equal or greater value per the IRS 1031 exchange rules and the investor now is stuck with having to continue to take on debt to have a fully tax deferred exchange. That investor no longer has the luxury of staying debt free like he was before he exchanged into the DST property in the first place. Many clients that are at or near retirement have already paid off their properties in full and taking on more debt is not wise, especially considering the 1031 exchange rules.

At Kay Properties, we have been involved in billions of dollars of DST 1031 exchange properties and have worked with hundreds of investors, DST sponsor companies, CPAs, and Delaware Statutory Trust attorneys throughout the country. It is important to note that Kay Properties is unable to provide you with any tax or legal advice so please do speak with your CPA and attorney prior to making any investment decisions.

If you or your CPA have any questions regarding how a Delaware Statutory Trust is taxed, including the details of DST properties taxation, tax treatment or how they work with your tax return feel free to email us at info@kpi1031.com, register on our website at www.kpi1031.com or call us at 1-(855) 899-4597