Delaware Statutory Trusts as 1031 Replacement Property
A Delaware statutory trust (DST) holds title to investment real estate, and an exchanger buys a beneficial interest in the trust instead of buying a property outright. Under IRS Revenue Ruling 2004-86, a properly structured DST interest is treated as an undivided fractional interest in the trust’s real property, so it can serve as replacement property in a 1031 exchange. DST interests are also securities, usually sold as private placements to accredited investors, and they trade control and liquidity for a passive role.
Diamond Real Estate Group is a real estate brokerage, not a broker-dealer or investment adviser. We don’t sell, recommend or rank DST offerings. This page explains the structure in plain terms so you can compare it fairly with buying property directly, and so you know which questions belong with your CPA, a securities attorney or a registered financial professional. For the exchange rules themselves, start with our 1031 exchange guide.
What Revenue Ruling 2004-86 says
The IRS published Revenue Ruling 2004-86 in Internal Revenue Bulletin 2004-33 on August 16, 2004. In its facts, an owner placed a net-leased rental property, subject to a nonrecourse loan, into a Delaware statutory trust. The trust’s interests were “of a single class, representing undivided beneficial interests in the assets” of the trust, and two other taxpayers exchanged their own real property, through a qualified intermediary, for those interests.
The ruling reached two conclusions. First, the DST was an investment trust classified as a trust for federal tax purposes, because the trustee had no power to vary the investment. Second, the investors were treated as grantors who each owned an undivided fractional interest in the property, so the exchange counted as one for real property rather than for an interest in a trust or other entity. Section 1031 now applies only to real property, so an interest treated as a stake in a business entity would not qualify; that is why the classification matters.
The trustee restrictions, and why they matter
The ruling’s result depends on a trustee whose job is limited to collecting and distributing income. Sponsors and advisers often summarize the limits as the “seven deadly sins.” In the ruling’s own terms, the trustee:
- May not accept additional contributions of assets, including money, after the offering closes.
- May not renegotiate the loan or obtain new financing.
- May not renegotiate the lease or lease to anyone else, except on the tenant’s bankruptcy or insolvency.
- May not exchange the property for other property.
- May make only minor non-structural modifications unless the law requires more.
- Must hold cash only in short-term government obligations or bank certificates of deposit that mature before the next distribution.
- Must distribute all available cash, less reserves, to the beneficial owners quarterly.
The ruling warns that a trustee with broader powers, such as the power to refinance, renegotiate or make more than minor changes, would turn the DST into a business entity, and the tax result would change. For an investor, that means the trust can’t respond to a market downturn the way an owner can: no new capital call, no refinance, no major re-tenanting or redevelopment. Ask the sponsor what the offering documents say happens if the tenant leaves or the loan matures before the property is sold.
DST interests are securities
A DST interest is sold as an investment, through offering documents, by a sponsor. Most such offerings are private placements that rely on Regulation D. The SEC’s investor bulletin on Regulation D says most private placements use Rule 506, and that only accredited investors may buy in a generally solicited offering under Rule 506(c). It also says private placement memoranda “typically are not reviewed by any regulator.”
Who counts as an accredited investor
The SEC’s April 2021 investor bulletin gives the tests for individuals:
| Test | Threshold |
|---|---|
| Income | Over $200,000 a year, or $300,000 with a spouse or spousal equivalent, in each of the prior two years, with a reasonable expectation of the same this year |
| Net worth | Over $1 million, alone or with a spouse or spousal equivalent, not counting the primary residence |
| Professional credentials | A Series 7, 65 or 82 license held in good standing |
Because these are securities, the person selling them should be registered. Before relying on anyone’s advice, check the representative’s and firm’s registration with FINRA and with the California Department of Financial Protection and Innovation, which reviews broker-dealer and investment adviser licensing under the state Corporations Code. Issuers must file a Form D within 15 days of the first sale, and you can find it on the SEC’s EDGAR database, though the SEC notes a Form D does not mean the offering was approved or registered.
Fees, illiquidity and other risks
Regulators have flagged the same risks for years. In Notice to Members 05-18 (March 2005), FINRA’s predecessor NASD addressed tenant-in-common interests offered for 1031 exchanges, a structure that preceded the DST’s widespread use. Its points carry over by analogy:
- Illiquidity. NASD called TIC interests “illiquid securities” with no known secondary market, and said resales may happen only at a significant discount. The SEC’s Regulation D bulletin says investors should not expect to resell restricted securities easily and should be prepared to hold them indefinitely.
- Fees. NASD warned that as fees in an exchange offering rise, the money saved by deferring tax is offset. Read the offering’s sources-and-uses table for sponsor, selling and financing costs.
- Concentration. Concentrating an investor’s assets in a single asset class “is not suitable for many investors,” the notice said.
- Tax opinion. NASD said firms should obtain a clean legal opinion that the interests “should” or “will” qualify under section 1031.
- Who gets paid. The notice said it understood SEC staff would treat a real estate agent’s receipt of a referral fee from a broker-dealer as unregistered broker-dealer activity. Whoever suggests an offering, ask how they are compensated.
Other risks are structural: you can’t choose when the property sells, distributions often depend on one tenant or a small group, and a lender’s terms can control the outcome if things go wrong.
DST interest vs. owning replacement property directly
| Question | DST interest | Direct ownership |
|---|---|---|
| Who makes decisions | Sponsor and trustee; investors have no management role | You, or a manager you hire and can replace |
| Financing | Loan arranged by the sponsor before the offering; no refinancing | You choose the loan and can refinance |
| Improvements and leasing | Minor non-structural changes only; lease can’t be renegotiated | Your choice, subject to local rules |
| Liquidity | Restricted securities; resale may be hard or discounted | You decide when to list and sell |
| Next exchange | Depends on when the sponsor sells; consult your CPA on exchanging again | You control timing |
| Work required | Passive | Active, or paid management |
| Regulation | Securities law: offering documents, accredited-investor limits | Real estate law: disclosures, inspections, title |
For exchangers who want income without landlord duties, direct options include a single-tenant net-leased building; see our guide to buying NNN leased property. Owners selling a group of rentals can read our page on portfolio disposition, and those leaving multifamily can compare options in our multifamily investing section.
How a DST fits into the exchange timeline
A DST interest is identified and acquired like any other replacement property. You still need a qualified intermediary to hold the sale proceeds, the 45-day identification and 180-day closing deadlines still apply, and the rules in our guide to 1031 identification rules govern how many properties you can name. Our 1031 deadline calculator finds both dates from your closing.
Because the ruling treats each investor as owning a share of the property, the trust’s mortgage generally comes with the interest. How that share counts toward replacing the debt on your relinquished property is a question for your CPA; our page on boot and partial exchanges explains why replacing value and debt matters.
California’s annual filing for out-of-state DSTs
Many DST properties are outside California. The Franchise Tax Board’s 2025 instructions for Form FTB 3840 say anyone who exchanges California real property for like-kind property outside the state must file the form for the year of the exchange and each later year, generally until the California-source deferred gain is recognized, regardless of residence. The instructions even tell filers what to enter when the property received is a Delaware statutory trust.
If you don’t file and don’t file a return, the FTB says it may estimate income and assess tax, penalties and interest. Our guide to the California clawback and Form FTB 3840 covers the details.
Questions to ask before investing in a DST
- What exactly does the trust own? Property type, location, tenant, lease term and rent escalations.
- What does the loan look like? Amount, rate, maturity date compared with the expected hold, and what happens at maturity.
- What are the total costs? Every fee in the sources-and-uses table, including those paid to the seller of the interest.
- What is the exit plan? Expected hold period and who decides when to sell.
- What does the tax opinion say? Whether counsel says the interests “will” or “should” qualify as real property for section 1031.
- Who is selling it to you? Check registration and disciplinary history, and ask how the seller is paid.
This is general information, not tax, legal or investment advice; talk to a CPA about how a DST fits your exchange, and to a securities attorney or registered financial professional before you invest in any offering.
Questions people ask
Can a DST be used for a 1031 exchange?
Yes, if it is structured to meet Revenue Ruling 2004-86. The IRS treats an interest in such a trust as an undivided fractional interest in the trust’s real property, so it can be like-kind replacement property if the other section 1031 rules are met.
What are the “seven deadly sins” of a DST?
It’s an industry nickname for the trustee limits in Rev. Rul. 2004-86: no new contributions, no refinancing or loan renegotiation, no lease renegotiation, no exchanging the property for other property, only minor non-structural changes, cash held only in short-term instruments, and distributions of available cash.
Do I have to be an accredited investor to buy a DST?
Most DSTs are private placements under Regulation D, and generally solicited Rule 506(c) offerings may be sold only to accredited investors. The individual tests are $200,000 income ($300,000 joint), $1 million net worth excluding your home, or certain securities licenses.
Can I sell my DST interest early?
Often not easily. DST interests are restricted securities, and the SEC says investors should be prepared to hold such securities indefinitely. Any resale may be at a discount.
Do I need to file Form FTB 3840 for an out-of-state DST?
Yes, if you exchanged California real property into it. The FTB requires the form for the exchange year and each later year until the California-source deferred gain is recognized.
Can Diamond Real Estate Group sell me a DST interest?
No. Diamond is a real estate brokerage and does not sell securities. We help clients sell relinquished property and buy direct replacement property, and we work alongside your intermediary and tax advisers.
If you’re planning an exchange and want to compare direct replacement property in the Bay Area or the North Bay, talk with Diamond Real Estate Group early in your 45-day window. Our investor services page outlines how we help.
Sources & notes
- Internal Revenue Service: Internal Revenue Bulletin 2004-33, Revenue Ruling 2004-86 (August 16, 2004)
- SEC Office of Investor Education and Advocacy: Accredited investors, updated investor bulletin (April 14, 2021)
- SEC Office of Investor Education and Advocacy: Private placements under Regulation D, updated investor bulletin (September 24, 2014)
- FINRA (NASD): Notice to Members 05-18, Section 1031 exchanges and tenants-in-common offerings (March 2005)
- California Department of Financial Protection and Innovation: Broker-dealers and investment advisers
- California Franchise Tax Board: 2025 instructions for Form FTB 3840
Last reviewed October 2026 by Matthew Martinez.
