What happens to a DST in my IRA when I die?

The beneficiary form decides who gets the account, and the trust keeps going without you

An IRA is a contract with the custodian, so the beneficiary designation on file controls who receives it; a will does not reach it unless the estate is named or no form exists. The DST interest is simply one of the account's assets and moves with it. The trust described in Rev. Rul. 2004-86 does not terminate on the bankruptcy, death or incapacity of any owner, so the sponsor keeps paying distributions to the account.

A beneficiary who is not your spouse cannot treat the account as their own. Section 408(d)(3)(C) denies rollover treatment to an inherited account, and Publication 590-B says the beneficiary can neither contribute to it nor roll money in or out, but may make a trustee-to-trustee transfer as long as the receiving IRA is set up in the deceased owner's name for the beneficiary's benefit.

A surviving spouse has more room. Publication 590-B lets a spouse who is the sole beneficiary treat the IRA as their own, roll it into their own IRA, or remain a beneficiary. Treating it as their own puts the DST interest on the spouse's own required-distribution schedule.

The ten-year rule is the problem, because the trust sells only when the sponsor decides

Under Publication 590-B's 10-year rule, a designated beneficiary who is not taking life-expectancy payments must withdraw the entire balance by December 31 of the year containing the tenth anniversary of the owner's death. If you die before your required beginning date, no distribution is required in years one through nine.

If you die on or after that date, the beneficiary has two obligations. Reg. section 1.401(a)(9)-5(d)(1) keeps the requirement to take an annual distribution in force until the interest is fully distributed, and paragraph (e)(2) of the same regulation still requires the whole interest out by the end of the calendar year that includes the tenth anniversary.

Eligible designated beneficiaries, which Publication 590-B defines as a surviving spouse, a minor child, a disabled or chronically ill person, or anyone not more than ten years younger than you, may instead take life-expectancy payments. If you name your estate or no one and die before your required beginning date, the 5-year rule applies and the whole balance must be out by the end of the fifth year. A DST's exit is set by the sponsor's sale decision, which DST full cycle explained describes.

What the beneficiary can actually do with an interest that has no market

There are three moves: wait for the trust to sell and take the cash; take the interest out in kind, reporting its fair market value as income under section 408(d)(1) as the instructions for Form 1099-R require for property; or meet the annual amounts from other assets in the same account while waiting. Taking a DST interest out of an IRA in kind covers the mechanics and the sponsor's role.

Publication 590-B imposes a 25% excise tax on any amount not distributed as required, reduced to 10% if the shortfall is corrected within the correction window. Start the in-kind conversation with the custodian in year eight, not year ten.

If the trust is financed, the inherited account is still the taxpayer under section 514 and still files Form 990-T, as can I buy a DST in my IRA or 401k plan explains.

There is no step-up inside an IRA, which reverses the usual DST estate result

A DST interest held personally is real property for federal tax purposes under the holding of Rev. Rul. 2004-86, and property acquired in a 1031 gets a step-up at death explains the usual result. Inside an IRA none of that happens. Section 408(d)(1) includes every amount paid or distributed out of the account in gross income, so the beneficiary pays ordinary income tax on the full value whether the trust sells or the interest comes out in kind.

A Roth IRA changes the character but not the clock. Publication 590-B says the owner owes no lifetime required distribution, but after death the entire interest must be distributed by the end of the fifth or tenth calendar year after the year of death, as applicable. Distributions are tax-free to the beneficiary if the five-year period for qualified distributions has run, so a Roth leaves heirs the same illiquidity problem with a smaller tax bill.

The estate questions for a personally held zero cash flow trust are covered in what happens to a zero cash flow DST at my death.

Worked example and what to set up now

Hypothetical, rounded figures. You die at 78 with a $300,000 traditional IRA holding a $200,000 DST interest and $100,000 of cash; your adult daughter is the designated beneficiary. Because you died after your required beginning date, she takes an annual distribution each year, drawn from the cash, and must still empty the account by December 31 of the tenth year. If it has not sold by year ten, she takes the interest in kind and reports its custodian-valued amount, say $190,000, as income in one year.

Three steps reduce the damage. Name beneficiaries on the custodian's form. Keep enough liquid assets in the same account to cover the annual amounts for several years. Tell the beneficiary what the trust is and who the custodian is; a DST is a private placement whose distributions can fall or stop and whose property can sell for less than the account paid. Model the distribution years against the trust's likely hold with your CPA before you buy.