Elias Lavi, CPA is co-owner and founder. LaviCPA does not select a DST for you and does not hold exchange funds. A sponsor's brochure is a sales document. This page is the tax comparison. For the exchange rules, see the 1031 exchange CPA page. For a scoped plan before you list, see the 1031 Exchange Tax Plan.
Side by side
Both columns assume a deferred exchange of real property held for investment, with a qualified intermediary holding the proceeds. A DST interest qualifies as like-kind real property only when the trust is the investment trust described in Rev. Rul. 2004-86. A rental you buy qualifies when you hold it for investment or for use in a business, under IRC §1031. Real property in the United States is not like-kind to real property outside the United States. Neither column states a fee, a rate, or a minimum. Those amounts live in the offering documents or on the closing statement.
| Question | DST that meets Rev. Rul. 2004-86 | Another rental you buy |
|---|---|---|
| Control | The trustee collects and distributes income. You do not set rents, pick tenants, or decide when the building sells. | You control leasing, capital projects, financing, and the sale, subject to the loan and the law. |
| Fees and loads | The private placement memorandum lists selling commissions, dealer-manager fees, and organization and offering expenses. Those costs come out of what you invest, so less of the check buys the real estate. The amounts are in that document. They are not stated here. | You pay the purchase closing costs on the settlement statement, such as title, escrow, and any transfer tax that applies. There is no securities offering load unless a sponsor is in the deal. The amounts are on that statement. |
| Liquidity | Illiquid. You generally hold until the trustee sells the property. In the ruling, sale of the property ends the trust. You cannot list your fractional interest the way you list a building. | You can list the property. What you clear depends on the market, the loan, and any exchange deadline that is still running. |
| Financing and nonrecourse debt | The ruling's example used a nonrecourse loan that was in place before the trust began and that the trust assumed. The trustee may not renegotiate or refinance it. Your share of the debt is in the offering. Read that share against the debt you are giving up. | You choose the loan. It can be recourse or nonrecourse, and you can refinance later. You still have to replace the debt you gave up, or add cash. |
| Management | The sponsor or its manager runs the property. You do not. | You run it, or you hire a manager under a contract you can change. That fee is in the management agreement. |
| Estate and step-up | If the interest is included in your estate, IRC §1014 generally sets the basis to fair market value at the date of death. A fractional interest can be divided among heirs. Estate inclusion and the statutory exceptions still have to be reviewed. | The same §1014 adjustment can apply if you own the property and it is in your estate. The paperwork is a deed or an entity interest, not a securities certificate. The tax rule is the same. |
| Minimums | The offering sets a minimum investment. The figure is in the memorandum. This page does not repeat one, because it changes by offering. | There is no sponsor minimum. You need enough cash from the exchange, plus replacement debt or added cash, to buy the property the seller will actually sell. |
| Refinance or add capital | You generally cannot. The trust described in the ruling may not take additional contributions of money or other assets. A power to renegotiate or refinance the acquisition debt makes the trust a business entity under the ruling, not like-kind real property. | You can refinance, raise a new loan, or put more cash in, subject to the lender. That is the landlord's ordinary fix when a loan matures or the building needs cash. |
Why the DST cannot refinance or take more capital
Rev. Rul. 2004-86 answers two questions. The Delaware statutory trust in the ruling is an investment trust, classified as a trust. A taxpayer may exchange real property for an interest in that trust without recognizing gain or loss under §1031, if the rest of §1031 is met. The IRS text is in the Internal Revenue Bulletin for 2004-33 and in the ruling PDF.
The trust agreement in the ruling limits the trustee to collecting and distributing income. The trustee may not accept additional contributions of assets, including money. The trustee may not renegotiate the debt used to buy the property. The ruling then says that if the trustee has the power to renegotiate or refinance that debt, or to dispose of the property and buy a new one, or to do more than minor non-structural work that the law does not require, the trust is a business entity. With two or more owners, that entity is generally a partnership, unless it is a corporation. A partnership interest is not like-kind real property.
Sponsors write those limits into the trust so the interest can be replacement property. The limit is the product. Once you are in, a cash need or a loan that has to be rewritten is not yours to solve.
Debt you have to replace
Relief of a liability is treated as money or other property received. A liability you take on with the replacement offsets it. That is Treas. Reg. §1.1031(b)-1, with the basis examples in Treas. Reg. §1.1031(d)-2. If the debt allocated to your DST interest is less than the debt you gave up, the gap is generally taxable boot unless you add cash. The same match applies to a rental: a smaller mortgage, not filled in with cash, is boot. The dollars are on your closing statement and, for a DST, in the offering. Our boot guide walks through cash and debt. The 1031 exchange calculator estimates dates, realized gain, and boot. It does not hold funds, and it is not a qualified intermediary.
The California piece DST sellers skip
California fixes the source of gain when you sell or exchange property located in California. The Franchise Tax Board says that source is preserved no matter when you later recognize the gain. You recognize it when the replacement is sold or disposed of in a later taxable transaction. Leaving California does not take that gain off California's books. The annual filing is required regardless of whether you are still a resident.
The form is FTB 3840, California Like-Kind Exchanges. For taxable years beginning on or after January 1, 2014, you file it when you exchange California real property for like-kind property outside California and any of the California-source realized gain is not recognized. You file it for the year of the exchange and each later year until that deferred gain is recognized on a California return. If you have no other California filing, you still sign and file the form as an information return. If you file neither the form nor a return, the FTB may estimate the income and assess tax, plus penalties and interest. The instructions cite Revenue and Taxation Code sections 18032 and 24953. The short version is on the FTB page Reporting like-kind exchanges. What goes on the form, next to federal Form 8824, is in our Form 8824 and FTB 3840 guide.
The trigger is the location of the property, not the label on the replacement. An out-of-state rental you buy yourself turns it on. So does a DST interest in a building outside California, because Rev. Rul. 2004-86 treats that interest as an interest in the real property. A rental that stays in California does not trip the out-of-state 3840 rule. California conformity for the exchange itself is on the 1031 exchange CPA page.
The other state can add a return of its own. Because a qualifying DST interest is an interest in real property, the state where the building sits may require a nonresident return on income from that property. If the offering holds property in more than one state, each of those states writes its own rule. The property list is in the memorandum. The form and any filing threshold are in that state's instructions. This page does not state another state's rate or threshold. A rental in one other state raises that question for one state, plus Form 3840 when the property you sold was in California and the rental is not.
One drawback of each
The DST drawback is the lock. You cannot refinance the property or put more capital in. A loan maturity, a vacancy, or a repair the reserves do not cover stays inside the limits that made the interest like-kind property under Rev. Rul. 2004-86. You wait for the trustee to sell.
The rental drawback is the clock, and the work that stays with you. You must identify the replacement in writing within 45 days. You must receive it by the earlier of 180 days after the sale or the due date of your return for that year, including extensions. That is IRC §1031(a)(3). You also keep the management. Miss the window and the sale is taxable. The IRS explains the real-property limits on its like-kind exchange page.
Some investors identify a DST as a backup inside the 45 days, next to a rental they hope to buy. The written identification still has to describe the property unambiguously, including the percentage of a DST interest. The three-property, 200 percent, and 95 percent rules are on the 1031 exchange CPA page. Who holds the funds, who models the tax, and who handles the contracts is a different question: CPA vs QI vs attorney.
Related pages
- 1031 exchange CPA in Los Angeles, including identification rules, boot, and California conformity
- 1031 Exchange Tax Plan, a one-time remote plan. Fee quoted on the consult. Not a QI engagement
- 1031 exchange calculator for the 45-day and 180-day dates, realized gain, and boot
- CPA vs qualified intermediary vs attorney
- Form 8824 and FTB 3840
- Taxable boot in a 1031 exchange