DSTs vs 1031 for Deferring Capital Gains

[Lee Singleton]

Hello everyone, 

This is my first post on Bigger Pockets. My focus is working with Accredited Investors to help defer capital gains. I get asked often about the difference between DSTs and 1031s, so I wrote up this quick comparison. The main point I always stress with investors is, do you want to actively manage an asset, or are you ready to invest more passively? Active management vs. passive investment is one of the main differences between a DST and a 1031.

Understanding the Differences Between DSTs and 1031 Exchanges

Investing in real estate often involves exploring various strategies and tools to maximize returns and minimize tax liabilities. Delaware Statutory Trusts (DSTs) and 1031 Exchanges are two commonly discussed options in this realm. While both can be utilized for tax-deferred real estate investments, they operate differently and cater to different investor needs and circumstances.

DSTs:

Delaware Statutory Trusts (DSTs) are a form of ownership structure that allows multiple investors to pool their resources and invest in large commercial properties. In a DST, investors purchase beneficial interests rather than direct ownership of the underlying real estate asset. This structure provides several benefits:

1. Passive Investment: DSTs offer investors a passive investment opportunity, as professional asset managers handle property management and operations. This can be appealing to investors seeking passive income without the responsibilities of active property management.

2. Diversification: By pooling funds with other investors, DSTs enable investors to access a diversified portfolio of institutional-grade properties across various asset classes and geographic locations. This diversification can help mitigate risks associated with individual property investments.

3. Tax Deferral: One of the primary advantages of investing in a DST is the potential for tax deferral. Through a 1031 Exchange, investors can roll over proceeds from the sale of a property into a DST without triggering immediate capital gains taxes. This allows investors to defer taxes on their gains and potentially enhance their overall returns.

1031 Exchanges:

A 1031 Exchange, named after Section 1031 of the Internal Revenue Code, allows real estate investors to defer capital gains taxes on the sale of investment properties by reinvesting the proceeds into a like-kind property. Unlike DSTs, which involve pooled investments in professionally managed properties, 1031 Exchanges allow investors to maintain direct ownership of their replacement properties. Here are some key aspects of 1031 Exchanges:

1. Direct Ownership: In a 1031 Exchange, investors retain direct ownership of their investment properties, giving them control over property management and decision-making. This can be advantageous for investors who prefer hands-on involvement in managing their real estate assets. 

2. Flexibility: 1031 Exchanges offer investors flexibility in selecting replacement properties, allowing them to tailor their investment strategy to their specific goals and preferences. Investors can choose properties that align with their risk tolerance, investment objectives, and desired geographic locations.

3. Tax Deferral: Like DSTs, the primary benefit of a 1031 Exchange is the ability to defer capital gains taxes on the sale of investment properties. By reinvesting proceeds into like-kind properties, investors can defer taxes and potentially increase their purchasing power for acquiring higher-value properties.

Key Differences:

While both DSTs and 1031 Exchanges offer tax-deferred investment opportunities in real estate, they differ in several key aspects:

1. Ownership Structure: DSTs involve pooled investments with beneficial interests, while 1031 Exchanges entail direct ownership of replacement properties.

2. Management Involvement: DST investments are passive, with professional asset managers handling property management, whereas 1031 Exchange investors retain control over property management decisions.

3. Diversification vs. Control: DSTs offer diversification through pooled investments, whereas 1031 Exchanges provide investors with direct control over their replacement properties.

In summary, both DSTs and 1031 Exchanges can be valuable tools for tax-deferred real estate investments. Each caters to different investor preferences and objectives. Understanding the nuances of each option is crucial for investors to make informed decisions that align with their financial goals and risk tolerance.

I hope this clarifies the distinctions between Delaware Statutory Trusts (DSTs) and 1031 Exchanges. Please let me know if you have any questions or need to discuss any current situation you might be thinking about with a 1031 or DST. 

[Dave Foster]

@Lee Singleton DSTs have a shelf life. The sponsor will always have a 2-6 year disposition plan. Whether they sell to another investor or some group like a pension fund. When the DST is sold a 1031 exchange is almost always used to sell the old DST and buy the new dst.

So, you want to think of it a little differently.  DSTs and 1031 exchange are not two different real estate products.  Brick and mortar real estate are DSTs are two different real estate products.  And both have their place as you explained very well.

1031 exchanges are simply the tool that let's you sell either a DST or brick and mortar and purchase new DSTs or Bricks and mortar. The greatest thing about the 1031 is that it allows you to actually shift from bricks and mortar to DSTS in times when you want less management head aches. Or like now when the ROI on bricks and mortar is so low because of interest rates. And when interest rates drop - you can use the 1031 to move back into bricks and mortar from DSTs.