If you’re a real estate investor, you’ve likely heard of the 1031 exchange—a tax-deferred strategy that allows you to sell investment property and reinvest the proceeds into another property without immediately paying capital gains taxes. What you may not know is how Delaware Statutory Trusts (DSTs) can add flexibility, diversification, and passive income potential to this strategy.
This powerful combination can help you grow wealth, simplify management, and open doors to institutional-grade investments. Let’s dive into how these tools work and why they might be the perfect fit for your real estate goals.
What Is a 1031 Exchange?
A 1031 exchange, named after Section 1031 of the IRS Code, allows investors to defer paying capital gains taxes when they sell one investment property and reinvest the proceeds into another of equal or greater value. The exchange must meet specific IRS rules, including strict timelines and the use of a qualified intermediary (QI).
The key requirement is that both the property you sell and the one you acquire must be “like-kind,” meaning they are held for business or investment purposes. But “like-kind” is broad—it can include everything from apartment buildings to vacant land, commercial properties, and even fractional ownership in DSTs.
What Are Delaware Statutory Trusts (DSTs)?
A DST is a legal entity that allows multiple investors to pool resources to acquire fractional ownership in high-value, income-producing real estate. These trusts own properties such as shopping centers, apartment complexes, industrial warehouses, or office buildings. Investors receive a share of the income generated without taking on the responsibilities of property management.
DSTs are a perfect match for 1031 exchanges because they qualify as like-kind property, making it easy for investors to transition their capital while enjoying hands-off ownership.
How DSTs Work in a 1031 Exchange
When using a DST as part of a 1031 exchange, you reinvest the proceeds from your property sale into one or more DSTs. Each DST holds a portfolio of professionally managed properties, and you own a fractional interest in the trust.
For example:
- You sell a $500,000 rental property and reinvest the proceeds into fractional ownership of a DST holding a $50 million portfolio of Class A apartment buildings.
- The DST generates monthly income from tenant rents, which you receive as passive income.
Benefits of Using DSTs in a 1031 Exchange
- Simplified Management
DSTs are managed by professional operators, eliminating the need for hands-on involvement. This makes them ideal for investors looking to retire or reduce property management responsibilities. - Diversification
With a DST, you can spread your investment across multiple properties, asset classes, or geographic regions, reducing risk. - Access to High-Value Properties
Individual investors may not have the capital to purchase high-value, institutional-grade properties like office towers or industrial complexes, but DSTs make it possible to own a fraction of these assets. - Ease of Meeting Deadlines
DST investments are typically pre-arranged and ready for immediate acquisition, which helps investors meet the 45-day identification and 180-day closing deadlines required in a 1031 exchange. - Partial Investment Option
If you have leftover funds after purchasing a primary replacement property, DSTs are an excellent way to invest the remainder and avoid taxable “boot.”
Considerations and Risks of DSTs
Like any investment, DSTs are not without risks:
- Lack of Control: Investors do not have decision-making authority regarding the management of DST properties.
- Illiquidity: Your fractional ownership is not easily sold or exchanged until the trust dissolves, typically after 5–10 years.
- Market Risk: Income may fluctuate based on market conditions or tenant performance.
For these reasons, DSTs are best suited for investors who prioritize passive income and long-term growth over short-term liquidity and control.
How to Incorporate DSTs into Your 1031 Exchange Strategy
Here are some scenarios where DSTs might make sense:
- Transitioning to Passive Investing
You’ve spent years managing your own properties and want to shift to a hands-off role while continuing to grow your wealth. A DST lets you stay invested in real estate without the daily headaches of property management. - Meeting Tight Deadlines
Struggling to identify a replacement property in your 1031 exchange? A pre-packaged DST investment can help you meet IRS deadlines while providing a high-quality asset. - Portfolio Diversification
You’ve sold a large property and want to reduce risk by investing in multiple asset types or locations. A DST can hold properties ranging from multi-family housing in Florida to office buildings in California. - Partial Exchanges
If your replacement property costs less than the one you sold, you can invest the remaining funds in a DST to defer taxes on the entire amount.
Real-Life Example of a 1031 Exchange Using DSTs
Scenario:
- You sell a $1 million retail property in a slowing market.
- With the proceeds, you reinvest $700,000 into a multi-family property in a growing suburb.
- To invest the remaining $300,000, you purchase fractional interests in two DSTs: one holding industrial warehouses and another focused on student housing.
The result? You’ve diversified your portfolio, deferred all capital gains taxes, and transitioned to investments requiring minimal involvement.
Final Thoughts
Combining a 1031 exchange with Delaware Statutory Trusts is a powerful strategy for building wealth in real estate. By deferring taxes, gaining access to professionally managed properties, and diversifying your portfolio, you can achieve long-term growth and financial freedom—all while reducing the hassles of active property management.