What Happens When a DST Sells

Most explanations of a Delaware Statutory Trust stop at the point you invest. They cover what it is, why it qualifies for a 1031 exchange and how quickly it can close, and then they stop.

That leaves the question people actually hesitate over unanswered: what happens in year seven, when the sponsor sells the building?

It is the right question to ask, and the honest answer has a good part and an uncomfortable part. This article covers both. It is educational only and is not tax, legal or investment advice. Every offering differs and only its own offering document governs it.

The uncomfortable part first

You do not decide when it sells.

The trustee makes that call, on their timetable, based on their read of the market. You cannot force a sale, block one, refinance, or negotiate the price. If they sell in year five when you wanted ten, that is what happens. If they hold to year twelve when you wanted out at seven, that is also what happens.

These restrictions are not a design flaw. They are the reason the structure qualifies for 1031 treatment at all. A DST that allowed investors to make operating decisions would start to look like a partnership, and a partnership interest is not like kind to real property. The passivity is the point, and the loss of control is what you pay for it.

There is no public market for a DST interest either. A limited secondary market exists but it is thin, informal and typically prices at a meaningful discount. In practice you should treat the money as committed until the sponsor sells.

Which means the target hold period is not a detail. It is the single most important number in the offering after the load. If you might need that capital in four years, a seven to ten year hold is the wrong home for it, regardless of how good the property is.

What actually happens at the exit

When the sponsor does sell, the process is mechanical.

• ›The trust sells the property and pays off the debt at the trust level.
• ›Costs of sale and any disposition fee come out.
• ›What remains is distributed to beneficial owners in proportion to their interests.

You then have a decision to make, and it is a genuine fork with real consequences. The sale is a taxable event unless you do something about it, and the gain that arrives is not just the gain on the DST. It is the original deferred gain from the property you sold years ago, plus whatever the DST gained, plus depreciation recapture that has continued accruing the whole time you held it.

This is the thing almost nobody explains up front. A DST exit is not a small tax event. It is the whole deferred chain arriving at once.

Your three options at that point

Exchange again into another DST or property. A DST sale can itself be the relinquished side of a new 1031 exchange, so the gain keeps deferring. But the clock starts the moment the trust sells, which means you have 45 days to identify and 180 to close, exactly as before. This is the part that catches people: the sponsor decides when your next 45 day window opens. You may get warning, or you may get very little.

Take the cash and pay the tax. Entirely legitimate, and sometimes the right answer. But you are paying capital gains on the accumulated chain, depreciation recapture at up to 25 percent, possibly the net investment income tax, and state tax. Owners who have deferred through two or three exchanges are often surprised at the size of that bill.

Consider a 721 exchange, where the offering allows it. Some DSTs are structured with a path into a Real Estate Investment Trust operating partnership, converting your interest into REIT units. That defers the gain, gives you a more liquid holding and spreads you across a larger portfolio. It also ends your ability to do further 1031 exchanges with that capital, because REIT shares are not like kind to real property. It is a one way door, and whether it is available depends entirely on how the offering was structured at the outset.

The planning point most people miss

Because the sponsor controls the timing, the work has to be done in advance rather than when the sale is announced.

Anyone holding a DST should know, well before an exit is likely:

• ›The stated target hold period, and how long has elapsed.
• ›What your intention is at exit. Exchange again, take the cash, or convert to REIT units. Decide in principle now, not in a hurry later.
• ›Whether the offering has a 721 path, because that is fixed at the start and cannot be added afterwards.
• ›Roughly what the tax would be if you took the cash, which you can only know by adding up the full deferred chain rather than looking at the DST in isolation.

An owner who has thought about this has 45 comfortable days. An owner who has not is making a significant decision under time pressure with the clock already running.

Does this make DSTs a bad idea?

No, but it makes them a specific idea rather than a general one.

They suit someone who genuinely wants no involvement, who can commit the capital for the stated period, and who values closing in days over controlling the outcome. That describes a lot of people selling investment property in their sixties and seventies, which is why the structure exists.

They suit someone who might need liquidity, or who wants a say in when the asset trades, considerably less. If either of those is you, that is worth establishing before you invest rather than discovering in year six.

The short version

You do not control when a DST sells. When it does, the proceeds come back and the entire deferred gain becomes taxable unless you exchange again, and the 45 day clock starts on the sponsor's timetable rather than yours.

The three exits are another exchange, cash and tax, or a 721 conversion into REIT units where the offering allows it. Which are open to you is largely determined by decisions made at the point you invest, which is precisely why the hold period and the structure deserve more attention than the headline distribution rate.

Want to see the current options with hold periods and structures laid out? Download the vetted property list and a licensed specialist will walk you through what each one commits you to and how it exits. Free, and no obligation.

About this article. 1031Property is an independent information and referral service. We are not a broker dealer, a Qualified Intermediary, a tax adviser or a law firm, and we do not sell securities or property. Nothing here is tax, legal or investment advice. Delaware Statutory Trust interests are securities offered to accredited investors only through a licensed broker dealer and definitive offering documents, and investing involves risk including the loss of principal. Read every offering document in full and confirm your position with your own CPA and adviser.