The Pros and Cons of Investing in a DST vs. a REIT

Delaware Statutory Trusts and Real Estate Investment Trusts both provide ways to invest in real estate without becoming a traditional landlord, but they are very different investment structures. The most important differences involve 1031 exchange eligibility, ownership, liquidity, control, diversification, fees, and tax treatment.

For a property owner completing a 1031 exchange, that distinction can determine which option is even available. Shares of an ordinary REIT generally are not qualifying replacement real property under Section 1031. An interest in a properly structured DST, however, may qualify when the requirements described in IRS Revenue Ruling 2004-86 and the other Section 1031 rules are satisfied.

DST vs REIT at a Glance

What is a Delaware Statutory Trust?

A Delaware Statutory Trust is a legal trust structure that can hold real estate for multiple beneficial owners. In a typical real estate DST offering, investors purchase beneficial interests while the trust owns the underlying property or properties.

The investor is generally passive. The sponsor, trustee, and property management team handle the operational decisions rather than individual DST investors. This structure can appeal to owners who want to move away from tenant management, maintenance, leasing, and other responsibilities associated with direct ownership.

You can learn more about the structure and available considerations in our guide to Delaware Statutory Trust investments.

A DST should not be described as giving an investor greater property-level control than a REIT. In fact, limited investor control is one of the defining trade-offs of the structure. Investors should review the sponsor, financing, tenants, fees, reserves, projected hold period, exit assumptions, and the specific risks of a Delaware Statutory Trust before investing.

What is a REIT?

A Real Estate Investment Trust is a company or trust that owns, operates, or finances income-producing real estate or real estate-related assets. REITs may invest in apartments, industrial properties, healthcare facilities, self-storage, offices, retail properties, mortgages, or other real estate sectors.

Not every REIT is publicly traded. Publicly traded REITs are listed on securities exchanges and can generally be bought or sold relatively easily. Non-traded REITs are registered with the SEC but are not exchange-listed, while private REITs generally rely on exemptions from SEC registration. Liquidity, disclosure requirements, fees, valuation, and investor eligibility can therefore vary substantially among REIT structures.

Our REIT and 1031 exchange guide explains these structures in greater detail.

Can You Use a REIT in a 1031 Exchange?

Generally, an investor cannot sell qualifying real property and complete a Section 1031 exchange by simply purchasing ordinary REIT shares. Section 1031 applies to qualifying real property held for investment or productive use in a trade or business. IRS guidance excludes ordinary stock and securities from qualifying replacement real property.

The treatment of qualifying DST interests is different. IRS Revenue Ruling 2004-86 describes a specific DST structure in which the beneficial owners are treated as owning interests in the underlying real estate for federal tax purposes. That is why properly structured DST interests may be used as replacement property in a 1031 exchange when the other exchange requirements are satisfied.

The IRS Form 8824 instructions provide additional guidance on property that does and does not qualify for Section 1031 treatment.

Whether an investment may qualify for Section 1031 treatment and whether that investment is appropriate for a particular investor are two different questions.

Advantages and Disadvantages of DST Investments

Potential Advantages of a DST

• Potential 1031 eligibility: A qualifying DST may provide replacement property for an investor who wants to continue tax deferral.
• Passive ownership: Investors generally do not handle tenants, leasing, repairs, or daily property operations.
• Access to specific real estate: Investors can review the actual property, tenants, financing, location, and offering assumptions before investing.
• Allocation flexibility: Depending on available offerings and exchange requirements, investors may be able to allocate exchange proceeds among more than one DST.
• Real estate tax characteristics: Tax reporting may reflect income, expenses, and depreciation associated with the underlying real estate, subject to the investor’s individual circumstances.

Potential Disadvantages of a DST

• Limited liquidity: There is no public exchange where DST interests can normally be sold on demand.
• Very limited control: Investors generally cannot direct leasing, refinancing, property improvements, or the timing of a sale.
• Sponsor dependence: Investment results can depend heavily on the sponsor’s underwriting, financing, asset management, and disposition decisions.
• Concentration risk: Some offerings involve one property or a limited number of properties or tenants.
• Offering costs and fees: Investors should carefully evaluate all acquisition, financing, management, selling, and disposition costs disclosed in the offering documents.

Advantages and Disadvantages of REIT Investments

Potential Advantages of a REIT

• Liquidity for publicly traded REITs: Exchange-listed shares can generally be bought and sold during market hours.
• Accessibility: Public REIT shares can normally be purchased without the higher investment amounts often associated with private real estate offerings.
• Portfolio exposure: Many REITs own multiple properties, although the actual level of diversification varies by REIT.
• Professional management: Investors do not personally manage the underlying real estate.
• Public disclosure: Exchange-listed and SEC-registered REITs generally provide regular financial and operating information to investors.

Potential Disadvantages of a REIT

• No direct 1031 replacement property treatment: Ordinary REIT shares generally cannot be purchased as replacement real property in a Section 1031 exchange.
• Market volatility: Public REIT share prices can move with equity markets, interest rates, investor sentiment, property-sector conditions, and company-specific developments.
• No property-level control: Shareholders do not decide which individual properties the REIT buys, sells, finances, or manages.
• Dividend uncertainty: REIT distributions are not guaranteed even though REIT qualification includes distribution requirements based on taxable income.
• Structure-specific risk: Non-traded and private REITs can have very different liquidity, fee, valuation, and disclosure characteristics than publicly traded REITs.

DST vs REIT Tax Differences

For investors selling appreciated investment real estate, the most significant difference is usually Section 1031 eligibility. A qualifying DST may allow an investor to continue a properly structured exchange, while purchasing ordinary REIT shares generally does not.

DST investors may also receive tax benefits and obligations associated with their share of the underlying real estate. Depreciation can affect taxable income and basis, and a later taxable disposition may create capital gain and depreciation-related tax consequences. The amount and character of those consequences depend on the property, investor basis, prior deductions, and individual tax circumstances.

REIT investors receive shareholder tax reporting rather than direct property-level tax treatment. REIT distributions can consist of different tax components, and treatment depends on the specific REIT and the investor’s circumstances.

These issues should be reviewed with a qualified tax professional rather than selecting an investment solely because one structure appears more tax efficient.

A Hypothetical DST vs REIT Example

Assume an investor sells a rental property for $1.2 million and wants to defer eligible gain through a 1031 exchange. The investor is also tired of managing tenants and would prefer passive real estate exposure.

Buying $1.2 million of ordinary REIT shares would not by itself provide qualifying replacement real property for the 1031 exchange. If an available DST is properly structured to qualify and otherwise satisfies the investor’s exchange requirements, a DST interest could potentially serve as replacement property.

If the same investor did not need Section 1031 treatment and instead placed a high priority on daily liquidity, a publicly traded REIT might deserve consideration. The investment decision changes because the investor’s tax objective changes.

This example is hypothetical and does not establish whether either investment would be suitable for a particular investor.

What About a 721 UPREIT?

Investors sometimes hear that a DST can eventually provide a path into a REIT. This normally refers to a separate Section 721 UPREIT transaction rather than a direct 1031 exchange into REIT shares.

Some real estate may be contributed to an operating partnership in exchange for operating partnership units under Section 721. Certain DST programs may contemplate a later UPREIT transaction, but availability, timing, structure, liquidity, tax treatment, and future exchange options must be evaluated carefully.

See our complete explanation of the 721 UPREIT strategy before treating that approach as equivalent to a normal 1031 exchange.

How to Decide Between a DST and a REIT

The first question is not which investment has the highest projected return. It is what the investment needs to accomplish.

If Section 1031 tax deferral is essential, begin by determining which replacement properties may qualify. If liquidity is more important and tax-deferred replacement property is not required, a publicly traded REIT may provide greater flexibility. If an investor wants to evaluate specific underlying real estate while remaining passive, a DST may deserve consideration, but its illiquidity and lack of control must be acceptable.

Before purchasing a DST, review the offering documents carefully and perform DST due diligence on the sponsor, property, tenants, financing, fees, reserves, projections, conflicts, and exit assumptions.

The Better Choice Depends on the Investor’s Objective

DSTs and REITs should not be treated as interchangeable passive real estate investments. A DST can potentially satisfy a specific 1031 exchange need while providing passive exposure to identifiable real estate, but investors generally sacrifice liquidity and control. Publicly traded REITs can offer easier access, market liquidity, and broader portfolio exposure, but ordinary REIT shares generally cannot serve as Section 1031 replacement property.

Neither structure guarantees income, appreciation, diversification benefits, or protection from loss. The appropriate comparison should account for tax objectives, liquidity needs, investment horizon, property exposure, fees, sponsor or management quality, and overall portfolio strategy.