Can my practice lease the building from a DST I own?

A DST's tenant is chosen before you arrive, and the trustee cannot add your practice afterwards

The ruling that makes a trust interest exchangeable describes a fixed arrangement. In Rev. Rul. 2004-86, A buys Blackacre, signs a 10-year net lease with tenant Z, then forms the trust and contributes the building; the trust assumes the lease and the loan as they stand. Two days later, investors B and C exchange their properties for A's interests through a qualified intermediary.

The trust agreement then ties the trustee's hands. The trustee "may not renegotiate the lease with Z or enter into leases with tenants other than Z, except in the case of Z's bankruptcy or insolvency," and may not "accept additional contributions of assets (including money)." A trustee with those powers would make the trust a business entity, classified as a partnership if it has two or more owners.

So the only trust that could have your practice as its tenant is one formed around a lease your practice signed before the trust existed; an existing offering cannot make room for you. The ruling does not discuss master leases, which DST master leases covers.

The ruling's facts keep the tenant unrelated to the investors, and it is silent on a tenant you own

One sentence in the facts matters: "Z is not related to B, C, or DST's trustee within the meaning of section 267(b) or section 707(b)." Nowhere does the ruling consider a tenant controlled by an investor, and it leaves A, who formed the trust, out of that sentence, so it says nothing either way about a tenant related to the person who set the trust up. A trust whose tenant is your professional corporation is outside the facts the IRS described, and the ruling is not authority for it.

Reasoning from the ruling's logic, the concern would be control. The trust is a trust because the leasing arrangements "are fixed for the entire life of DST" and the trustee cannot vary the investment; a tenant owned by a beneficiary can press for new terms from the other side of the table. Whether the IRS would treat that as a power to vary the investment has not been decided.

Section 267(b)(6) adds a second issue. It treats "a fiduciary of a trust and a beneficiary of such trust" as related persons, and section 1031(f)(3) uses the section 267(b) list for exchanges. The trustee that would be your landlord is your related person the day you buy in; who counts as a related party sets out the full list.

Selling your own building to a trust you will hold is a related-party sale with ordinary income

Some owners ask the question the other way round: can a sponsor's trust buy my building, lease it back to my practice, and let me exchange into it? Section 1239(b)(2) answers the sale side. It lists "a taxpayer and any trust in which such taxpayer (or his spouse) is a beneficiary" as related persons, and gain recognized on property that is depreciable in the buyer's hands "shall be treated as ordinary income."

The exchange side is no cleaner. An exchange with a related person falls under section 1031(f)(1), which removes the deferral if either side disposes of the property within two years of the last transfer, and section 1031(f)(4) denies deferral to any transaction "structured to avoid the purposes" of that rule.

There is also a more basic problem. The ruling treats each investor as owning "an undivided fractional interest in Blackacre," so a share bought back in the building you just sold is a share of the property you gave up. In the ruling the contributor sells all its interests and does no exchange; it never addresses a contributor who keeps or reacquires one. The two-year rule covers what a disposition inside the window costs.

The self-rental rule follows the rent into the trust

Suppose such a trust could be built. Reg. section 1.469-2(f)(6) treats net rental income from property "rented for use in a trade or business activity" in which you materially participate as "not from a passive activity," and the ruling treats each investor as owning a share of the trust's assets, so your share of the rent would be nonpassive.

That defeats one reason owners ask: rent from a building your own practice uses is not passive income for passive losses to offset. Physicians selling a medical office building works through that ordering.

The order that works: an unrelated buyer, a lease back, then trusts with unrelated tenants

Sell the building to an unrelated investor or to the group buying your practice, sign a lease back to the practice at market rent and well under thirty years, and send the proceeds to a qualified intermediary. Sale-leaseback then 1031 covers the tests that keep the sale a sale.

Then exchange into trusts whose tenants have nothing to do with you. A traditional DST or a medical office DST holds real estate with no leasing for you to manage, while your practice keeps its lease with the investor who bought the building. Trust interests cannot be sold on demand, the sponsor decides when the property is sold, and the property can lose value, so principal is at risk.

Hypothetical, round numbers: a dentist's LLC sells a $2,000,000 building with a $600,000 basis to an unrelated investor, the practice signs a 12-year lease, and the LLC exchanges all $2,000,000 into two trusts with unrelated tenants, deferring the $1,400,000 gain. Had the LLC sold to a trust it then bought into, recognized gain would be ordinary income under section 1239. Ask your CPA to test the entity chart before any letter of intent.