Delaware Statutory Trust Tax Treatment
Carl E. Sera, CMT
October 27, 2020
When considering a Delaware Statutory Trust property for a 1031 exchange, it is important that you have solid idea on the potential tax treatment of DST properties. The IRS under Revenue Ruling 2004-86 blessed the Delaware Statutory Trust (DST) as “Like Kind” exchange property for the purposes of a 1031 exchange.
This article gives a brief overview of the various Delaware Statutory Trust Tax Treatment that you must understand before purchasing a DST property. If you're thinking about purchasing, schedule a free consultation call with us.
Delaware Statutory Trust Tax Return – Year End Accounting and Reporting
For majority of real estate investors looking to sell their rental property and do a 1031 exchange is the tax treatment it offers. You are simply hoping to defer capital gains tax. But how is your Delaware Statutory Trust transactions tax return treated?
When you sell your rental property and enter into a DST property, you are sure to receive a potential monthly rental income. When you receive these monthly incomes from your rental property, they are reported on your schedule E section on your tax return. The Delaware Statutory Trust Tax Reporting for a DST is exactly the same.
The rental income you receive monthly from the DST sponsor all gets reported to the IRS at the end of the year. You will receive a 1099 of your income and your CPA will report this income on your tax return on schedule E. Remember that your Delaware Statutory Trust Tax treatment will be taxed as ordinary income.
Depreciation Delaware Statutory Trust Tax Treatment
Just like in a typical 1031 exchange, the depreciation on your annual tax return is carried over in a Delaware Statutory Trust exchange. So, if you have fully depreciated your relinquished property, then the basis is transferred to the new DST property you purchased.
However, if you still have leftover basis in your relinquished property, or you purchased a higher value in the new DST properties than you had in the old property you sold, then you are able to take advantage of depreciation deductions.
Delaware Statutory Trust State Tax Treatment
Owning a property outside your state of residence, then you will need to file your state income tax with that state. This also applies to DST properties except the state in which the state doesn’t have income tax filing requirement like Texas and Florida.
Purchasing Equal or of Greater Value – DST Property Taxation Regarding 1031 Exchange Rules
One of the rules of the 1031 exchange requires that taxpayers doing such an exchange purchase a replacement property that is equal or of greater value than their relinquished or old property. Therefore, if you have paid off your old property mortgage in full, it is sometimes advisable that you purchase DST property/properties that are all-cash or debt free.
By purchasing DST properties that are all-cash or debt free, you are avoiding the risk that comes with using loans in a real estate investment. For instance, if you have $1 million of equity from a building you sold free and clear purchases a DST that has a 50% loan to value, and you are now purchasing $2 million of that DST ($1 million of equity down plus the $1 million of debt due to the property being a 50% LTV equals a total purchase price of $2 million).
When the DST property sells, that investor will have to purchase equal or greater value per the IRS 1031 exchange rules and the investor will have to continue to take on debt to have a fully tax deferred exchange BUT the investor is now able to start depreciating property all over again and receiving tax-advantaged income.
And if you're already familiar with DSTs and you may want to learn more about Delaware Statutory Trust Commissions and Fees.
This website is neither an offer to sell nor a solicitation of an offer to buy any security which can be made only by a prospectus, or offering memorandum, which has been filed or registered with appropriate state and federal regulatory agencies, and sold only by broker dealers and registered investment advisors authorized to do so.