DSTs and 1031 Exchanges for Foreign Investors: FIRPTA and Other Tax Issues

Section 1031 has no citizenship test, but the exchange has to stay inside the United States

Nothing in § 1031 limits nonrecognition to U.S. persons; the statute looks at the property, not the owner's passport. The one geographic rule is § 1031(h): real property in the United States and real property outside it are not like-kind, so a Florida rental cannot be exchanged into a Lisbon flat, while a foreign owner exchanging Florida for a DST holding Texas industrial is fine.

The DST side works because Rev. Rul. 2004-86 treats each beneficial owner as owning an undivided interest in the trust's real estate. Accreditation is also citizenship-blind; the income and net-worth tests in the accredited investor rules apply the same way, though the subscription package will ask for a Form W-8BEN or W-8ECI instead of a W-9.

Not every sponsor accepts non-U.S. subscribers, because the trust becomes a withholding agent for you. Ask that question before you spend a day of your 45-day identification window on an offering that will decline you.

FIRPTA takes 15% of the gross price at closing, and a deferred exchange cannot use the nonrecognition notice

Under § 1445(a) the buyer of U.S. real property from a foreign person must withhold 15% of the amount realized, meaning the full sale price including debt paid off, not the gain, and remit it on Forms 8288 and 8288-A within 20 days of the transfer. A buyer who fails to withhold is liable for the tax, which is why closing agents insist on it.

A seller in a nonrecognition transaction can normally hand the buyer a notice under Treas. Reg. § 1.1445-2(d)(2) and avoid withholding. Paragraph (d)(2)(iv) removes that option for 'non-simultaneous like-kind exchanges under section 1031 where the transferee cannot determine that the exchange has been completed' by the time the withholding is due, and for simultaneous exchanges with any boot; every delayed exchange through a qualified intermediary is non-simultaneous, so the notice is off the table.

The regulation's own words: in these cases 'the transferee is excused from withholding only upon the timely application for and receipt of a withholding certificate'.

Form 8288-B must be on file by closing day, and the IRS has about 90 days to answer while your 180 days run

Form 8288-B is the application for a withholding certificate, and the first ground it lists is 'a claim that the transferor is entitled to nonrecognition treatment'. If it is submitted on or before the transfer date, Treas. Reg. § 1.1445-1(c)(2) lets the buyer hold the 15% instead of sending it to the IRS until 20 days after the IRS mails its decision, and the seller must tell the buyer in writing, by the day of transfer, that the application is in.

The IRS says it will 'normally act on an application within 90 days' of receiving everything it needs, and it needs U.S. taxpayer identification numbers for every party. A nonresident without an ITIN files Form W-7 with the 8288-B attached, which is the step most often left too late; start it when the listing goes up, not at contract.

Hypothetical: a nonresident sells a $2,000,000 rental on day 0 and the buyer holds $300,000. DSTs are identified by day 45 and could close by day 90, but the certificate arrives on day 110, so the exchanger either adds $300,000 of outside cash to the intermediary and reinvests the full $2,000,000, or reinvests $1,700,000 and recognizes gain up to the $300,000 shortfall as boot, recovering the withheld tax on Form 1040-NR; qualified intermediary IPX1031 describes the same cash-replacement fix.

• Day −60 or earlier: apply for the ITIN (Form W-7) and engage cross-border tax counsel
• By closing day: file Form 8288-B, notify the buyer in writing, and confirm it will hold rather than remit the 15%
• Days 1–45: identify replacement DSTs, choosing sponsors that accept non-U.S. investors
• By day 180: close, adding outside cash equal to the withheld amount if the certificate has not arrived
• Following year: file Form 1040-NR to recover any withholding not returned early

Inside the trust, rent is taxed at 30% of gross unless you make the § 871(d) election

Rent paid to a nonresident is 'fixed or determinable annual or periodical' income, and § 1441(a) requires the payer, here the DST trustee or its agent, to withhold 30% of the gross amount unless the income is effectively connected with a U.S. trade or business. A passive DST interest is not, so without an election the trust withholds 30% of your share of rent with no deduction for depreciation, interest or fees.

Section 871(d) lets you elect to treat all U.S. real property income as effectively connected. You then file Form 1040-NR, deduct your share of the trust's expenses and depreciation, and pay graduated rates on the net; you make the election known to the trust on Form W-8ECI, and it stays in force for every later year unless the IRS consents to revoke it.

A nonresident with no U.S. wages files Form 1040-NR by June 15 rather than April 15, but the DST's grantor statement may not arrive until mid-April either way. The state where the property sits will usually want a nonresident return too; see state tax and multi-state filing issues for DST investors and the state pages under 1031 rules by state.

When the DST sells, the trustee withholds 21% of your share of the gain, and the certificate problem returns

Because a DST is a grantor trust, Treas. Reg. § 1.1445-5(c)(1)(iv) requires the trustee to withhold 'the rate specified in section 1445(e)(1) multiplied by the amount of the gain' allocable to the portion of the trust owned by a foreign person. Section 1445(e)(1) uses the highest rate under § 11(b), which is 21%.

That is 21% of gain rather than 15% of gross, often the smaller number, but § 897(a)(1) still taxes the gain itself as effectively connected income, so a 1040-NR follows either way. If you want to exchange out of the DST into the next replacement property, you are back to a certificate application timed against the sponsor's closing date, which you do not control.

What happens when a DST sells and how to 1031 out of it covers the mechanics; for a foreign owner, add the 8288-B lead time to every step.

A DST interest is a U.S.-situs asset for estate tax, and only $60,000 of it is sheltered

Section 2101 taxes a nonresident noncitizen's U.S.-situated property at death, and § 2102(b)(1) allows a unified credit of just $13,000, which the IRS translates into a $60,000 filing threshold: above that, Form 706-NA is due within nine months of death. U.S. real property is squarely U.S.-situs, and a grantor trust interest in it is looked through the same way.

The United States has estate or gift tax treaties with 15 countries, and the IRS notes they 'often provide more favorable tax treatment' by limiting which assets count as U.S.-situated or by prorating the credit under § 2102(b)(3). Whether your country is on that list changes the answer more than anything inside the DST.

For a domestic investor, DSTs in estate planning is about the step-up in basis; for a nonresident it is about whether to hold the interest personally at all, which counsel in both countries should answer before the exchange.

When cross-border counsel is essential, and what to ask the sponsor first

You need a U.S. tax adviser who has filed Forms 8288-B and 1040-NR with a § 871(d) election before, and a home-country adviser who can say whether your country taxes the same gain, credits U.S. tax, or treats the 1031 deferral as a taxable disposal, since deferral under U.S. law does not bind another treasury. Confirm every point on this page with your CPA or attorney, because treaty terms and the figures above change.

Breakwater Exchange is licensed in all 50 states within a regulated broker-dealer framework and works with vetted national DST sponsors; ask which of them accept non-U.S. subscribers before your identification clock starts.

• Does the trust accept non-U.S. persons, and on which W-8 form?
• Who is the withholding agent for rent, and will it honor a § 871(d) election on Form W-8ECI?
• On sale, will the trustee cooperate with a withholding certificate, and how much notice of closing will you get?
• Which states will require a nonresident return for this trust's properties?