DSTs - Tax Treatment and Benefits

DST – Tax Treatment and Benefits

Delaware Statutory Trusts (DSTs) are mainly used by investors as a real estate investment. Specifically, because the Internal Revenue Service (IRS) has recognized DSTs as real property, DSTs are eligible for 1031 like-kind exchanges. Investors will use 1031 like-kind exchanges in order to defer the taxes that would be owed on the capital gains received from the sale of real property. Instead of paying any capital gain taxes, investors can roll the capital gain into and invest in a DST.

Below are some things to note about the tax treatment and benefits that investors need to know about before investing into a DST.

How does a DST allow for a 1031 like-kind exchange?
A 1031 like-kind exchange is named after Section 1031 of the Internal Revenue Code and when completed properly, it allows investors to defer the payment of capital gain taxes on the sale of investment properties. Investors are able to defer the payment of any capital gain taxes if they properly roll the proceeds from the sale into a like-kind property of equal or greater value.

Recently, the IRS has approved the use of DSTs for 1031 like-kind exchanges. As a result, investors looking to get out of managing investment properties can now sell and roll the proceeds from their investment properties into a DST. Using a DST for a 1031 like-kind exchange provides the same benefits as any other like-kind properties of equal or lesser value. Therefore, investors looking for a passive investment into real estate management can now defer paying any capital gains on the sale of their investment properties.

Income from DSTs flows through to the individual investors.
One of the major benefits of investing into a DST is the fact that the income generated from the management of the property or properties flows through the DST and directly to the individual owners. In other words, DSTs are like pass-through entities for tax purposes. Because the income generated flows directly to each beneficial owner, investors avoid paying double taxes like C-Corporations.

The ability for DSTs to avoid double-taxes is attractive to investors because this allows more of the money generated from the property or properties to end up going to each beneficial owner. More money ends up going to the beneficial owners because the DST does not have to pay any sales or business taxes on the revenues prior to distributing the money to the beneficial owners. Any investor would like to receive the greatest return possible, so the fact that DSTs are like pass-through entities is definitely an important and attractive feature.

Individual owners can claim their pro rata share of deductions from the DST.
When investing in a DST, beneficial owners will receive monthly statements showing their pro rata share of income as well as expenses. At the end of the year, the DST’s total expenses will be distributed to each beneficial owner on a pro rata basis. Each beneficial owner will then be able to claim their pro rata share of expenses incurred by the DST on their personal tax return. This will allow beneficial owners to reduce their taxable income and therefore reduce the amount of taxes owed to the IRS. By reducing the amount of taxes owed to the IRS, investors will be able to maximize their return from the DST and may also be able to shelter some of their other income.

In addition to the expenses incurred by the DST in operating and managing the property or properties, a DST may also incur losses for the year. If that happens, then beneficial owners will be able to claim their pro rata share of the DST’s losses for a given year. This allows beneficial owners another way to reduce their taxes owed and shelter their income from the DST and other sources of income.

Investors may be able to deduct depreciation from the investment property sold.
Another tax feature that might be attractive to investors is the ability to roll over the basis of the investment property sold for the 1031 like-kind exchange. This allows investors to know exactly what their basis is when they cash out of a given DST and need to calculate any capital gain or loss.

If the investor, prior to selling their investment property, fully depreciated the property, then that property’s basis will roll over into the DST. If, on the other hand, the investor did not yet fully depreciate the investment property, then the investor will still be able to take the depreciation deductions from the investment into the DST. This will allow the investor to further reduce their tax liability and shelter their income from the DST and other sources.

Another possibility for being able to take depreciation deductions from the DST is if the DST was greater than the value of the investment property sold in order to complete the 1031 like-kind exchange. In that case, an investor will also be able to take the depreciation deduction and reduce their tax liability and shelter the income from the DST and any other sources.

Because DSTs are considered real estate properties, investors will need to file state taxes in the states where the property or properties are located.
Another tax aspect of DSTs that investors need to be aware of is that investors will need to file taxes in every state where the DST holds property in. This is because DSTs are considered real estate properties and therefore, the investors of a DST will need to file in each state where the property or properties are located. The only exception to this requirement is if the property or properties held by the DST are in a state that does not have a state income tax requirement like Florida and Texas. This is important for investors to note so that they can fully comply with all the tax filing requirements and avoid any fees or penalties for failing to file all the necessary tax returns.
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