Delaware Statutory Trust Real Estate Guide

What Is a Delaware Statutory Trust and Why Do Real Estate Investors Use Them?

A Delaware Statutory Trust (DST) is a legal entity created under Delaware statutory law that holds title to one or more income-producing properties. Real estate investors use DSTs primarily as replacement properties in 1031 exchanges, allowing them to defer capital gains taxes while shifting from active property management to passive ownership.

The DST structure gained significant traction after the IRS issued Revenue Ruling 2004-86, which confirmed that a beneficial interest in a DST qualifies as direct ownership of real estate for 1031 exchange purposes. This ruling opened the door for investors to exchange out of actively managed properties and into professionally managed, institutional-grade real estate without triggering a taxable event.

DSTs typically hold large commercial assets such as multifamily apartment communities, net lease retail properties, medical office buildings, industrial distribution centers, and senior living facilities. A sponsor company acquires the property, structures it as a DST, and then sells fractional beneficial interests to individual investors. Each investor receives a proportional share of rental income and potential appreciation.

The minimum investment for most DST offerings ranges from $100,000 to $250,000, though some sponsors accept lower amounts for cash investments outside of a 1031 exchange. Only accredited investors may participate, meaning individuals must have a net worth exceeding $1 million (excluding their primary residence) or annual income above $200,000 ($300,000 for joint filers) for the past two years.

How Does the DST Structure Work Under IRS Revenue Ruling 2004-86?

Revenue Ruling 2004-86 established that DST interests qualify as "like-kind" property under IRC Section 1031, but only if the trust meets specific structural requirements. The ruling treats each DST investor as owning an undivided fractional interest in the underlying real property, not a security or partnership interest, for tax purposes.

Under this framework, the DST is structured as a passive investment vehicle. The trustee (typically the sponsor or an affiliate) manages all property operations, leasing, and financing decisions. Investors receive monthly or quarterly distributions generated by rental income, and they may benefit from depreciation deductions that pass through to their individual tax returns.

The legal structure requires a master tenant arrangement or direct ownership format. In the master tenant structure, the DST owns the property and leases it to a master tenant entity (usually a sponsor affiliate), which then subleases to actual tenants and manages day-to-day operations. This layer provides the operational flexibility that DSTs otherwise lack due to the seven prohibited activities.

For investors completing a 1031 exchange, DSTs solve several practical challenges. The 45-day identification period and 180-day closing deadline create pressure to find suitable replacement property. DSTs can close quickly because the property is already acquired and the offering is pre-structured. Investors simply purchase beneficial interests rather than negotiating purchase contracts, inspections, and financing.

What Are the Seven Prohibited Activities That Govern DST Operations?

The IRS restricts DSTs from engaging in seven specific activities to maintain their qualification as real property interests rather than business entities. These restrictions, outlined in Revenue Ruling 2004-86, are non-negotiable. Violating any single prohibition can disqualify the entire structure from 1031 exchange treatment.

1. No new capital contributions. Once the DST offering closes, neither the trustee nor the investors may contribute additional capital to the trust. This means there is no mechanism to fund unexpected capital expenditures or cover operating shortfalls after closing.

2. No renegotiation of existing loans. The DST cannot refinance, modify, or renegotiate the terms of its mortgage. If interest rates decline significantly, the trust cannot take advantage of lower rates through a refinance.

3. No new loans or additional borrowing. The trust cannot obtain new financing for any purpose, including property improvements, tenant build-outs, or cash shortfalls.

4. No reinvestment of sale proceeds. If the trust sells the property or any portion of it, the proceeds must be distributed to investors. The DST cannot use the funds to acquire replacement property.

5. No renegotiation of existing leases. The DST cannot renegotiate lease terms with current tenants. It may enter into new leases with new tenants under pre-established leasing guidelines, but existing lease modifications are prohibited.

6. No acceptance of new capital from investors. Similar to the first prohibition, no new investors may be admitted and existing investors cannot increase their positions after the offering closes.

7. No major alterations to the property. The DST cannot make significant modifications, improvements, or alterations to the property beyond normal maintenance and repairs. This limits the ability to reposition or substantially renovate the asset.

These restrictions have significant practical implications. Because the DST cannot refinance or contribute new capital, sponsors typically structure offerings with built-in reserves for anticipated capital needs during the projected hold period. Sophisticated sponsors model various scenarios and set aside adequate reserves at closing to address potential vacancies, repairs, and operating shortfalls.

What Returns Can Investors Expect from DST Investments?

DST investments typically target annual cash-on-cash returns ranging from 4% to 7%, with total returns (including projected appreciation at sale) targeting 8% to 12% over a hold period of five to ten years. These projections vary significantly based on property type, location, leverage ratio, and market conditions.

Cash distributions flow from net rental income after debt service, property management fees, asset management fees, and reserves. Most DSTs distribute income monthly or quarterly. The leverage ratio typically ranges from 50% to 65% loan-to-value, which amplifies both returns and risk compared to an all-cash investment.

An important tax benefit of DST ownership is depreciation. Investors receive their proportional share of the property's depreciation deductions, which can shelter a significant portion of cash distributions from current income tax. This "phantom loss" reduces taxable income even though the investor receives actual cash. Use our DSCR calculator to evaluate how debt service coverage ratios affect cash flow projections on leveraged real estate investments.

Fee structures vary by sponsor but commonly include acquisition fees (1% to 3% of property value), asset management fees (0.5% to 1% annually), property management fees (3% to 6% of gross revenue), and disposition fees (1% to 3% at sale). These fees reduce investor returns and should be carefully evaluated when comparing offerings. Higher fees do not necessarily indicate better management, so investors should focus on the sponsor's track record, the quality of the underlying real estate, and the net projected returns after all fees.

How Do DSTs Compare to TICs and Direct Property Ownership?

Investors considering passive real estate options frequently compare Delaware Statutory Trusts to Tenants-in-Common (TIC) structures and direct property ownership. Each approach has distinct advantages and limitations depending on the investor's goals, capital, risk tolerance, and desire for control.

DST vs. TIC structures. Before Revenue Ruling 2004-86, TIC arrangements were the primary vehicle for fractional 1031 exchange investments. TICs allow up to 35 co-owners to hold undivided interests in a property. Unlike DSTs, TIC investors have voting rights on major decisions and can refinance or modify the property. However, TICs require unanimous consent among co-owners for most actions, which creates decision-making gridlock. TICs also expose each investor to personal liability for the property's mortgage (often through recourse loans), while DST investors have no personal liability for trust-level debt.

DST vs. direct ownership. Direct ownership provides maximum control, flexibility, and the ability to force appreciation through value-add strategies. Investors can refinance, renovate, change property management, and make all operational decisions. The tradeoff is active involvement, concentrated risk in a single asset, and the operational burden of property management. DSTs offer diversification across institutional-grade properties and professional management but sacrifice all investor control.

For investors nearing retirement or seeking to transition from active management, DSTs provide a practical exit from landlord responsibilities while maintaining real estate exposure and tax deferral. For investors seeking higher returns through hands-on value creation, direct ownership or permanent loan financing for stabilized acquisitions may be more appropriate.

What Risks Should Investors Evaluate Before Investing in a DST?

DST investments carry specific risks that differ from traditional real estate ownership. Understanding these risks is essential for making informed allocation decisions.

Illiquidity. DST interests are not traded on public exchanges. There is no guaranteed secondary market, and investors should expect to hold their interests for the full projected hold period of five to ten years. Early exit options are extremely limited and typically involve selling at a significant discount.

No control over operations. Investors have no voting rights and cannot influence management decisions, property operations, leasing, or disposition timing. The sponsor and trustee make all decisions, and investors must trust the sponsor's judgment and alignment of interests.

Structural inflexibility. The seven prohibited activities prevent the DST from adapting to changing market conditions. If the property needs a major renovation to remain competitive, the DST cannot fund it. If interest rates drop substantially, the trust cannot refinance to capture savings. Review our commercial refinancing guide to understand how refinancing works for traditional commercial real estate.

Sponsor risk. The success of a DST investment depends heavily on the sponsor's ability to manage the property, maintain occupancy, and execute a profitable exit. Sponsor bankruptcy, mismanagement, or fraud can devastate investor returns. Due diligence on the sponsor's track record, financial strength, and litigation history is critical.

Market and property risk. Like all real estate, DST properties are subject to vacancy, rental rate declines, natural disasters, environmental issues, and broader economic downturns. Leverage amplifies these risks. A property with 60% LTV could lose significant equity value in a downturn even if cash flow remains positive.

Financing risk. Because DSTs cannot refinance, the existing loan terms dictate the financial structure for the entire hold period. If the loan matures before the property is sold, the sponsor may need to convert the DST to another structure (often a limited partnership called a "springing LLC"), which can have tax implications for investors.

What Due Diligence Should You Perform Before Selecting a DST Sponsor?

Selecting the right sponsor is arguably the most important decision in DST investing. The sponsor controls every aspect of the investment, from property acquisition to asset management to disposition strategy.

Start by reviewing the sponsor's full track record. Request a complete history of prior DST offerings, including actual returns versus projected returns, hold periods, occupancy rates, and disposition outcomes. A sponsor with ten or more completed full-cycle DST investments provides a much more reliable track record than a newer entrant with only active offerings.

Verify the sponsor's financial stability. Review audited financial statements and confirm the sponsor has sufficient capital to support its portfolio through potential downturns. Ask about the sponsor's co-investment in each offering, as sponsors who invest their own capital alongside investors demonstrate stronger alignment.

Examine the property's fundamentals independently. Review the appraisal, environmental reports, property condition assessment, rent roll, lease terms, and local market data. Compare the acquisition price to recent comparable sales. Evaluate the submarket's vacancy trends, population growth, employment drivers, and new construction pipeline.

Review all offering documents carefully, including the Private Placement Memorandum (PPM), trust agreement, and subscription agreement. Pay particular attention to fee disclosures, conflict of interest provisions, and the sponsor's exit strategy. Consider engaging a securities attorney and tax advisor who specialize in DST investments to review the documentation before committing capital. Schedule a consultation with Clearhouse Lending to discuss how DSTs and other investment structures align with your portfolio goals.

For investors considering conduit loans or CMBS financing within DST structures, understanding loan terms, defeasance requirements, and prepayment provisions is essential to evaluating the overall investment profile.

What Is the Step-by-Step Process for Investing in a DST Through a 1031 Exchange?

Completing a 1031 exchange into a DST requires careful coordination of timelines, intermediaries, and documentation. Here is the process from start to finish.

Step 1: Sell the relinquished property. The investor closes on the sale of their existing investment property. A Qualified Intermediary (QI) must hold the sale proceeds to maintain 1031 exchange eligibility. The investor cannot take constructive receipt of the funds at any point.

Step 2: Identify replacement properties within 45 days. The investor must formally identify potential replacement properties (including DST interests) in writing to the QI within 45 calendar days of closing the sale. Most investors use the three-property rule (identify up to three properties regardless of value) or the 200% rule (identify any number of properties whose combined value does not exceed 200% of the relinquished property's sale price).

Step 3: Conduct due diligence on DST offerings. Review the PPM, property financials, sponsor track record, and fee structure for each identified DST. Consult with your tax advisor and financial advisor to confirm the investment aligns with your objectives.

Step 4: Subscribe and fund within 180 days. Complete the subscription documents and direct the QI to transfer exchange funds to the DST. The investor must close on the replacement property within 180 calendar days of selling the relinquished property (or by the tax return due date, including extensions, if earlier).

Step 5: Receive distributions and tax documents. After closing, the investor begins receiving monthly or quarterly income distributions. The DST provides annual K-1 tax documents reporting the investor's share of income, deductions, and depreciation.

Ready to explore your 1031 exchange options? Contact our team to discuss how DST investments can fit into your overall commercial real estate strategy.

What Tax Benefits Do DST Investors Receive Beyond 1031 Exchange Deferral?

Beyond the primary benefit of capital gains tax deferral through a 1031 exchange, DST investors access several additional tax advantages that improve after-tax returns.

Depreciation pass-through. Each DST investor receives their proportional share of the property's depreciation deductions. For a $10 million multifamily property with a 27.5-year depreciable life and a 75% depreciable basis, annual depreciation totals approximately $272,727. An investor with a 5% interest would receive roughly $13,636 in annual depreciation deductions, sheltering a meaningful portion of cash distributions from ordinary income tax.

Step-up in basis at death. If a DST investor passes away while holding their interest, the beneficiaries receive a stepped-up cost basis equal to the fair market value at the date of death. This eliminates all deferred capital gains taxes from prior 1031 exchanges, potentially saving heirs hundreds of thousands of dollars. This makes DSTs a powerful estate planning tool when combined with sequential 1031 exchanges.

Potential for cost segregation. Some DST sponsors commission cost segregation studies that accelerate depreciation by reclassifying building components into shorter recovery periods (5, 7, or 15 years instead of 27.5 or 39 years). This front-loads depreciation deductions, increasing tax benefits in the early years of ownership.

State tax considerations. DST investors owe state income tax in the state where the property is located, regardless of where the investor resides. Investors in high-tax states may benefit from holding DST interests in properties located in no-income-tax states such as Texas, Florida, or Nevada. Our commercial mortgage calculator can help you model how different financing structures affect your overall investment returns.

What Questions Do Investors Frequently Ask About Delaware Statutory Trusts?

What is the minimum investment for a DST? Most DST offerings require a minimum investment of $100,000 to $250,000. Some sponsors accept lower minimums of $50,000 to $75,000 for non-1031 exchange cash investments. The minimum varies by sponsor and offering.

Can non-accredited investors participate in DSTs? No. DST offerings are private placements under SEC Regulation D, which restricts participation to accredited investors. You must meet the income or net worth thresholds defined by the SEC. There are no exceptions to this requirement.

How long is the typical DST hold period? Most DST offerings project a hold period of five to ten years. The actual hold period depends on market conditions, property performance, and the sponsor's disposition strategy. Investors should be prepared to hold for the full projected term since early exit options are extremely limited.

What happens when a DST property is sold? When the sponsor sells the underlying property, investors receive their proportional share of net sale proceeds. Investors can then complete another 1031 exchange into a new DST or other qualifying real estate to continue deferring capital gains taxes. If they choose not to exchange, the deferred gains become taxable.

Are DST distributions guaranteed? No. DST distributions depend on the property's actual rental income and operating performance. Distributions can be reduced or suspended if the property experiences vacancy, unexpected expenses, or other financial challenges. Past distributions do not guarantee future payments.

Can I invest in multiple DSTs simultaneously? Yes. Many investors diversify across multiple DST offerings to spread risk across different property types, geographic markets, and sponsors. During a 1031 exchange, you can split your exchange proceeds among several identified DST properties, subject to the identification rules.

What is a "springing LLC" in DST investing? A springing LLC is a contingency structure written into many DST agreements. If the trust encounters a situation where it must take an action prohibited by the seven restrictions (such as refinancing a maturing loan), the DST converts or "springs" into a limited liability company. This preserves the investment but may have different tax implications than the original DST structure.

How do I evaluate if a DST is a good investment? Focus on four areas: the sponsor's completed track record (not just current offerings), the quality and location of the underlying property, the reasonableness of financial projections and fee structure, and how the investment fits within your overall portfolio allocation. Independent advice from a qualified tax advisor and securities attorney is strongly recommended.

Where Can You Find Authoritative Sources on DST Investing?

1. Internal Revenue Service. "Revenue Ruling 2004-86: Treatment of Delaware Statutory Trusts." IRS.gov, 2004.
2. Securities and Exchange Commission. "Regulation D Offerings." SEC.gov, 2024.
3. National Association of Real Estate Investment Trusts (Nareit). "1031 Exchange and DST Investment Structures." Nareit.com, 2024.
4. Delaware Division of Corporations. "Delaware Statutory Trust Act, Title 12, Chapter 38." State of Delaware, 2023.

Contact Clearhouse Lending to discuss how DST investments and 1031 exchanges fit into your commercial real estate strategy.