The tax treatment of a Delaware Statutory Trust, or DST, depends on how the trust is structured, but a properly structured DST used in a 1031 exchange is generally treated as an interest in real estate rather than a share of stock or a partnership interest. Under IRS Revenue Ruling 2004-86, the Delaware Statutory Trust described in the ruling is classified as a trust for federal tax purposes, and an investor may exchange real property for an interest in that DST without immediate recognition of gain or loss if the other Section 1031 requirements are met.
For investors, that usually means the DST itself is designed to preserve tax deferral when purchased as replacement property in a 1031 exchange. Instead of paying capital gains tax at the time of the exchange, taxes are generally deferred until the investor later sells a taxable interest without completing another qualifying exchange. If cash is received, debt is not fully replaced, or other 1031 rules are not satisfied, some taxable gain may still be recognized. The IRS also notes more broadly that Section 1031 generally allows gain deferral when investment or business real property is exchanged for like-kind real property.
Investors should also understand that tax deferral does not mean tax elimination. A DST investor may still receive taxable income from property operations, and future depreciation-related tax consequences or gain recognition can apply depending on the investment’s performance, debt structure, holding period, and exit strategy. Because Delaware statutory trust tax treatment can vary based on the facts of the transaction, investors should review their specific situation with a qualified tax advisor before making a decision.