Delaware Statutory Trust (DST) Taxes After a 1031 Exchange

Why didn't my Delaware statutory trust send a K-1?

A Delaware statutory trust that meets the terms of Revenue Ruling 2004-86 is a trust for federal tax purposes, not a partnership. Its owners are treated as owning their share of the property itself, so no partnership return and no Schedule K-1 exist (Rev. Rul. 2004-86).

In tax terms it is a grantor trust: the IRS looks through it and treats each owner as owning an undivided fractional share of the real estate. That is also why the exchange worked: a certificate of trust or beneficial interest is never real property for a 1031 exchange (Form 8824 instructions), but an interest in a qualifying Delaware statutory trust counts as an interest in the building it holds.

The trust keeps this treatment only while the trustee's powers stay narrow. The ruling says a trust becomes a business entity, usually a partnership, if the trustee can, for example, sell and buy new property, enter new leases, refinance the loan, or make more than minor non-structural changes to the building. If the sponsor's documents mention a change of structure, ask whether the trust still reports as a grantor trust.

The trustee reports under the grantor trust rules in 26 CFR 1.671-4. Depending on the method chosen, the trust may file a Form 1041 with an attached statement, or send Forms 1099 and a statement to each owner. Either way, the statement shows your share of each item of income and deduction, and you must include those items on your own return. If you hold the interest through your own revocable living trust, or a one-owner LLC that has not elected to be taxed as a corporation, you usually still report it on your own return, because both are ignored for income tax (26 USC 676; 26 CFR 301.7701-3).

What a case needs:

• Simple: one trust, no cash taken out, the same or more debt, and the old property fully documented.
• Needs judgment: several trusts, less debt than before, cash received, a cost segregation study, missed depreciation in past years, or a sale coming up.

Gather the closing statements for both sides of the exchange, the qualified intermediary's ledger, your Form 8824, the old property's depreciation schedule and suspended losses, and every trustee or sponsor statement and study.

How do I report each Delaware statutory trust on Schedule E?

Usually, you list each property the trust owns as its own line on Schedule E, Part I, with its address, and enter only your share of its rent and expenses. The instructions say to report only your part of a part-interest rental and to complete lines 1a, 1b and 2 for each property (Schedule E instructions).

• One trust, one building: one Schedule E line.
• One trust, several buildings: usually one line per building, because each has its own address, property type and often its own state.
• More than three properties: attach extra Schedules E, and put the combined totals on one of them.

Preparers differ on whether a trust with many buildings can be shown on one line. The facts that decide it are whether the trustee's statement breaks out each building, whether the buildings sit in different states, and whether you will need per-building figures when one building is sold.

Use the trustee's income and operating expenses, such as property tax, insurance, management fees and interest on the trust's loan. Do not copy any depreciation figure from the statement without checking it. Depreciation on your return comes from your own basis, which the next section explains.

The trustee's Forms 1099 and statement show the same items, so report each item once (26 CFR 1.671-4). You report your share of rent and expenses, not the cash the trust paid out to you. Interest the trust earns on its cash reserves is portfolio income, not rent (Publication 925).

How do I split my old basis and depreciation across several trusts?

Split your total basis among the trusts by each one's fair market value (26 CFR 1.1031(j)-1). Within each trust, the part that replaces the old property's remaining basis keeps the old depreciation schedule, and any extra basis from new debt or added cash starts a new one.

Your total basis in the new property is your old property's adjusted basis, plus any extra debt you took on or cash you added, minus any debt relief or cash you received, plus any gain you recognized. The part that equals your old property's remaining depreciable basis is "exchanged basis"; anything above it is "excess basis" (26 CFR 1.168(i)-6).

Several trusts. Each trust's share of exchanged and excess basis gets its own depreciation schedule. Trading one property for several trusts is one exchange on one Form 8824, but the instructions call it a multi-asset exchange (Form 8824 instructions). Trusts often carry different amounts of debt, so keep the basis split in writing with your return.

Different recovery periods. If the new building has a longer recovery period than the old one, such as an apartment building (27.5 years) exchanged into an office or retail building (39 years), the exchanged basis is depreciated over what remains of the longer period. If the new period is shorter, the exchanged basis keeps the old, longer period (26 CFR 1.168(i)-6(c)).

The election is hard to undo. The election to treat all basis as new is made on Form 4562 by the due date, including extensions, of the return for the exchange year. It cannot be made later through a change in accounting method, and it can be revoked only with IRS consent, which the regulation says is granted only in extraordinary circumstances (26 CFR 1.168(i)-6(j)). The election changes depreciation timing only; it does not change whether gain is recognized.

Can I use the sponsor's cost segregation study?

Usually only in part. A cost segregation study splits a building's cost into shorter-lived parts, such as fixtures, equipment and land improvements. How much of it you can use depends on which part of your basis you apply it to.

• Excess basis: this is new property, so the study's shorter recovery periods can apply to it. Excess basis in used property can also qualify for bonus depreciation (Publication 946; 26 CFR 1.168(k)-2(g)(5)). The current bonus rate is 100% for qualifying property acquired and placed in service after January 19, 2025. Excess basis from an exchange before January 20, 2025 got the rate for the year it was placed in service: 100% through 2022, then less each year (26 USC 168(k)(6)).
• Exchanged basis, no election: when a part's new recovery period is shorter, exchanged basis keeps the old building's longer period, so the study gives little or no speed-up here.
• Exchanged basis, with the election: all basis becomes new property, so the study's recovery periods can apply to all of it. For used property, bonus depreciation still reaches only the excess basis (26 CFR 1.168(k)-2(g)(5)).

Most trust buildings are used property, because the trust bought an existing building. Bonus depreciation also applies only to parts with a recovery period of 20 years or less, never to the building shell.

Two points are unsettled. First, the bonus depreciation regulation for exchanges still states dates that end before January 1, 2027, because it was written before the law that restored the full rate; Publication 946 also warns that 26 CFR 1.168(i)-6 does not reflect the limit of exchanges to real property. Second, preparers disagree on how to apply a study written for the trust's purchase price to an owner's own carried-over basis. The deciding facts are the study's method, whether your basis split is documented, and whether the election was made on time.

Does cash or less debt make part of the exchange taxable?

Yes. Cash, other property, and net debt relief you receive are taxed up to the amount of your gain (26 USC 1031(b)). Debt the other side takes over, or that is paid off at closing, counts as money you received (26 CFR 1.1031(d)-2).

Form 8824 line 15 adds up:

• cash paid to you;
• the fair market value of other property you received; and
• net liabilities taken over by the other side: the debt you were relieved of, minus debt you took on, cash you paid and other property you gave up.

Exchange expenses reduce that sum, but not below zero (Form 8824 instructions). Cash you add can offset debt relief, but debt you take on cannot offset cash you receive.

Personal property inside the trust. Furniture, equipment and similar items that come with the building are not real property. The rule that lets incidental personal property up to 15% of the replacement property's value ride along only protects the qualified intermediary safe harbor (Form 8824 instructions). It does not make that property like-kind. If you transferred and received more than one group of like-kind properties, or cash or other (not like-kind) property, the instructions say to skip lines 12 through 18 and attach your own statement showing how you figured the realized and recognized gain.

If a missed item of cash, other property or debt relief, or a wrong depreciation figure, causes an underpayment through negligence or a substantial understatement of tax, the accuracy-related penalty of 20% of that underpayment may apply (26 USC 6662).

My return shows no depreciation for the trust: how is it fixed?

Amend the one return that left it out, or, if two or more returns in a row did, usually file Form 3115 and catch up in one year (Publication 946). Either way, your basis drops each year by the depreciation you could have claimed, whether you claimed it or not, so missed depreciation still raises the gain when the trust sells.

Publication 946 explains both routes and the exceptions. The election to treat all basis as new cannot be made late through Form 3115 (26 CFR 1.168(i)-6(j)).

Ask the sponsor for the closing statements, the purchase price split between land and building, any cost study, and every year's operating statement. Ask your old preparer for the old property's depreciation schedule.

Do I file nonresident state returns where the properties are?

You may need to, if the state taxes personal income and your share passes its filing threshold. As a grantor trust owner, you have rental income from each property's state directly, and no partnership return or composite filing covers you. Each state sets its own rules, so check each state every year.

California is one example. Its residency guide says a Nevada resident who sells a rental in California owes California tax on the gain (FTB Publication 1031). If you exchanged property in California for property outside California, including a trust interest in buildings outside California, Form FTB 3840 is due for the exchange year and each year after, generally until the deferred California gain is recognized (FTB 3840 instructions). When a trust sells California buildings and you take cash, escrow generally withholds 3 1/3% of your share of the price, unless you elect a figure based on your gain, on a Form 593 in your own name, because the trust is ignored; you claim it on your California return (FTB Form 593 instructions). Other states have their own rules.

For how nonresident returns work in general, see State returns for fund investors.

Is the income passive, and do my old suspended losses carry over?

Rental income from a Delaware statutory trust is usually passive. A rental is passive even if you materially participate, unless you are a real estate professional who also materially participates in that rental (Publication 925). A trust owner has no say in operations, so meeting that test is rare, and the rule that lets owners who actively manage a rental deduct some rental loss against other income usually does not apply either.

Suspended losses from the property you gave up are freed in full only when you dispose of your entire interest in a fully taxable transaction to an unrelated person (26 USC 469(g); Form 8582 instructions). A like-kind exchange defers gain, so it is not fully taxable, and the losses usually stay suspended. Neither Publication 925 nor the Form 8582 instructions says how those losses attach to the new property. Keep a record that ties them to the trusts you received. For what suspended losses can offset, see Suspended passive losses from fund investments.

Our trust is selling: exchange again, do a 721 exchange for partnership units, or pay the tax?

A trust sale is a sale of your share of the building, so each path is open to you, but only if you choose before the sale closes. To exchange again, your share of the sale cash must go to a qualified intermediary, never to you; cash paid to you or available to you before you get the new property can make the gain taxable (26 CFR 1.1031(k)-1(f)). Each path has a different tax result.

Debt in a partnership exchange. A drop in your share of debt is treated as a cash distribution to you (26 USC 752(b)). Gain results to the extent cash, including that deemed cash, exceeds your basis in the units (26 USC 731(a)). The same rule applies when the units are later redeemed for cash, so the deferral usually ends at redemption. Cash or debt relief from the partnership around the time you contribute can also be treated as a partly taxable sale under the disguised sale rule (26 USC 707(a)(2)(B)). Ask for the partnership's debt allocation before you choose. For the final partnership return and a later sale, see Your final fund tax form.

Paying the tax. Your share of the sale is reported like any sale of rental real estate. The part of the gain from past depreciation, including depreciation you could have claimed but did not, is unrecaptured section 1250 gain, taxed at up to 25%. The rest of the long-term gain is taxed at up to 20%. Net investment income tax of 3.8% may also apply.

What should I keep each year for the next exchange, sale or inheritance?

Keep one file for each trust, for as long as you own any property that came from the exchange chain:

• Form 8824 and any statement you attached, for every exchange in the chain;
• the basis split across trusts, showing exchanged and excess basis for each;
• depreciation schedules, any 1.168(i)-6(i) election, and any Form 3115;
• each year's trustee statements and any cost study;
• suspended passive losses carried from the old property;
• state returns and any state exchange forms, such as California's Form FTB 3840.

If you die owning the interest, your heirs' basis and the treatment of suspended losses follow separate rules; see Inheriting a fund interest.

A CPA firm can report each trust, split basis and depreciation across several trusts, fix missed years, and file the property states; see hedge fund and real estate investor tax services, or individual tax returns for a simpler return.

Example

All figures are in US dollars and illustrative. For simplicity, land is ignored; in a real return, land has basis but is never depreciated.

Four trusts, more debt

An owner exchanges a rental worth $1,000,000, with an adjusted basis of $400,000 and a $300,000 mortgage, into four trusts worth $1,100,000 in total that carry $400,000 of debt. The owner's equity of $700,000 goes in, and no cash comes out.

• Realized gain: $1,000,000 − $400,000 = $600,000. Assuming the trusts hold no furniture or other personal property, nothing is taxed, because the new debt ($400,000) is more than the debt relieved ($300,000).
• Basis in the trusts: $400,000 + $100,000 net new debt = $500,000.
• Exchanged basis: $400,000, which continues the old schedule. Excess basis: $100,000, which is new property.
• Split by value: four equal trusts of $275,000 each get $125,000 of basis each, made up of $100,000 exchanged and $25,000 excess.

If one trust's study puts 20% of its value in five-, seven- and 15-year parts, about $5,000 of that trust's excess basis could qualify for bonus depreciation. Without the election, its exchanged basis gets no speed-up.

Same exchange, less debt

The owner instead buys four trusts worth $900,000 in total that carry only $200,000 of debt, and adds no cash. The owner is relieved of $100,000 more debt than they take on.

• Form 8824 line 15: $300,000 debt relieved − $200,000 debt taken on = $100,000.
• Recognized gain: the smaller of $100,000 and $600,000, so $100,000 is taxed now.
• Basis: $400,000 − $100,000 debt relief + $100,000 gain = $400,000.
• Exchanged basis: $400,000. Excess basis: none, so no part of the new basis can get bonus depreciation.

The trust sells

Continuing the first example, the old rental cost $600,000, so $200,000 of depreciation was taken before the exchange. Five years later, one trust sells and the owner takes cash rather than exchanging again.

• Owner's share of the price: $300,000.
• That trust's basis: $125,000 − $30,000 of depreciation since the exchange = $95,000.
• Gain: $300,000 − $95,000 = $205,000.
• Unrecaptured section 1250 gain: the trust's quarter of the old depreciation ($50,000) + $30,000 = $80,000. The other $125,000 is long-term capital gain.

Suspended losses tied to that trust are freed only if the owner disposed of the entire interest in a fully taxable sale.

Different for you?

• Choosing between an exchange and an opportunity zone fund: see 1031 exchange or opportunity zone fund.
• You live in Canada and exchanged a US rental: see Exchanging a US rental property.
• You own the rental directly, not through a trust: see Rental property taxes.
• Your suspended losses and what they can offset: see Suspended passive losses from fund investments.
• You may qualify as a real estate professional: see Real estate professional status for fund investors.
• Your units or fund interest reach a final sale: see Your final fund tax form.
• Your heirs and the basis at death: see Inheriting a fund interest.
• You hold many trusts and partnership interests: see Choosing a CPA for many fund investments.
• Several trusts, missed depreciation, less debt, cash out, or a sale coming up: these need professional judgment; see hedge fund and real estate investor tax services.