Using DSTs in Estate Planning and How Step-Up in Basis Works for Heirs

At death each heir's basis in the DST interest resets to fair market value, and the deferred gain is gone

§1014(a)(1) gives property acquired from a decedent a basis equal to 'the fair market value of the property at the date of the decedent's death.' That applies to a DST interest since Rev. Rul. 2004-86 describes each investor as 'the owner of an aliquot portion of the trust' who is 'considered to own an undivided fractional interest' in the property, so what heirs inherit is a slice of real estate with a fresh basis, and Publication 559 adds that inherited property is automatically long-term.

Hypothetical: a $1,000,000 DST interest carries a $200,000 basis rolled through two prior exchanges, so $800,000 of gain, including $150,000 of prior depreciation taxable at up to 25%, is waiting. At death the heirs' basis becomes $1,000,000; if the trust sells for $1,000,000 a year later they recognize nothing, and their depreciation schedule starts over on the building portion of that new basis.

The trust's loan does not shrink the step-up. In Crane v. Commissioner the Supreme Court held that the basis of inherited mortgaged property is 'the value of the property, undiminished by mortgages thereon,' so a $1,000,000 property share carrying $400,000 of nonrecourse debt takes a $1,000,000 basis even though the estate's equity is $600,000.

How the interest is valued and reported on Form 706

The estate includes the interest at fair market value, which Reg. §20.2031-1(b) defines as the price 'between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell.' For a DST the usual evidence is the sponsor's or broker-dealer's estimated value, which FINRA Rule 2231 requires on customer statements for unlisted real estate programs, based on valuations performed at least annually with a third-party valuation expert, backed where the estate is large by an appraisal of the property share.

Debt changes the estate figure but not the basis. Reg. §20.2053-7 provides that when the estate is not liable on the loan, 'only the value of the equity of redemption (or the value of the property, less the mortgage or indebtedness) need be returned as part of the value of the gross estate,' which fits the nonrecourse loans DSTs carry.

The Form 706 instructions require a return 'within 9 months after the date of the decedent's death,' with an automatic six-month extension on Form 4768, but only for estates whose gross estate plus adjusted taxable gifts exceeds $15,000,000 in 2026 or that elect to pass unused exclusion to a surviving spouse. Whether a minority or marketability discount applies to a non-controlling DST interest is an appraisal and legal question, not something to assume in either direction.

Dividing DST positions among heirs is arithmetic, not a partition suit

A building passes by deed and has to be sold or co-owned to split; a DST interest passes by percentage. Delaware's statute makes the interest 'personal property notwithstanding the nature of the property of the statutory trust' (12 Del. C. §3805(c)) and 'freely transferable except to the extent otherwise provided in the governing instrument' (§3805(d)), so the trust agreement's transfer terms, usually a trustee consent for transfers at death, are what the executor follows.

Hypothetical: $900,000 spread across three DSTs can pass as one-third of each trust to each of three children, or one trust to each child if the values are close, with no deed, no financing and no buyout. Each child then receives distributions on a separate account and can make an independent choice when a trust sells (the process and paperwork for heirs and trusts and if you inherit a DST, can you exchange out of it).

The personal-property classification may also matter for probate, since out-of-state real estate typically requires a proceeding in its own state while intangible personal property is administered where the owner lived; ask your estate attorney whether that avoids an ancillary proceeding for property the trust holds elsewhere.

DSTs versus keeping the building until death: what you give up and what you keep

The step-up is identical either way, so the estate-planning case for a DST rests on the years before death: no management in your eighties, no forced sale by heirs who cannot agree, and no illiquid single asset to appraise and split. The costs are the DST's load, the absence of a secondary market, sponsor and master-tenant risk, and the chance that the trust sells before you die and hands you another 45-day decision (exchanging again after the trust's sale and holding for the step-up vs exchanging now).

How the interest is titled between spouses carries over from real estate rules. Under §2040(b) a qualified joint interest between spouses puts only half in the first estate, and Publication 559 confirms only that half is stepped up, while §1014(b)(6) steps up both halves of community property at the first death, a distinction worth settling before the DST subscription is signed in a community-property state.

Holding the interest through a revocable living trust keeps it a grantor trust, preserves the exchange treatment and the step-up, and keeps it out of probate; an irrevocable trust that removes the interest from your estate removes the step-up with it (trust-owned real estate and exchanges).

A §721 roll-up before death changes what heirs inherit: partnership units, not real estate

Some sponsors offer to contribute the DST's property into a REIT operating partnership under §721, after which you hold operating-partnership units, a partnership interest. The units still receive a §1014 step-up at death, and if the partnership has a §754 election in effect, §743(b) adjusts the partnership's inside basis 'upon the death of a partner' to match, so the built-in gain in the units is also reset (DST-to-721 roll-ups).

What heirs lose is the exchange. Partnership units are not real property, so they can never be traded into another 1031 property; heirs can typically redeem units for REIT shares or cash on the partnership's terms, with the stepped-up basis keeping that redemption largely free of gain (after a 721, no more 1031).

For a family that wants liquidity after death, that trade can suit them; for one that wants to keep real estate compounding through further exchanges, it removes the option permanently. Breakwater Exchange places clients into DSTs with vetted national sponsors, including trusts with and without a 721 option, and the choice belongs in your estate plan, so confirm it with your CPA or estate attorney before you subscribe.

• Record the adjusted basis you carry into each DST and keep the closing statements: the executor needs them only if the trust sells before death, but the heirs' CPA will ask.
• Keep the sponsor's annual estimated-value statements; they anchor the date-of-death valuation.
• Decide the ownership form now: individual, joint, community property or revocable trust each changes the step-up and the probate path.
• Tell your executor which trusts you hold and who the sponsor's transfer contact is; distributions continue to the estate until the transfer is processed.
• Note whether a trust carries a 721 option and record your intention, because heirs may be offered it after you are gone.