1031 Exchange Guide for Financial Advisors: Where DSTs Fit a Client's Plan

The DST answers a tax problem and a management problem; it does not answer a liquidity problem

Rev. Rul. 2004-86 is why the product exists. It holds that an owner of a properly limited Delaware statutory trust is treated as owning an undivided fractional interest in the trust's real estate, so a client can exchange a rental into it under section 1031. The same ruling sets the limits: the trustee may not exchange the property, buy other assets, accept additional contributions, renegotiate the loan or the lease, or make more than minor non-structural changes.

Those limits are what make the interest passive, and they also mean the trust cannot raise capital in a downturn or restructure its debt. The exit is the sponsor's sale of the property, at a time the sponsor chooses. For a client who may need the capital back on a known date, that is a planning constraint you should name up front; DST illiquidity and exits covers what the documents allow.

Accreditation is the entry test; suitability and best interest decide whether a particular trust fits

Most DST offerings rely on Rule 506 of Regulation D. Under Rule 501(a), an individual is accredited with net worth over $1,000,000, alone or with a spouse or spousal equivalent, not counting the primary residence, or with income over $200,000 individually or $300,000 jointly in each of the two most recent years and a reasonable expectation of the same this year. In a Rule 506(c) offering the issuer must take reasonable steps to verify that status; DST accredited investor rules covers the documents.

The broker-dealer recommending the trust must have a reasonable basis to believe it is suitable based on the client's investment profile, which FINRA Rule 2111 lists as age, other investments, financial situation and needs, tax status, objectives, experience, time horizon, liquidity needs and risk tolerance. For retail customers, Regulation Best Interest adds that the recommendation must be in the client's best interest without placing the firm's interest ahead of it.

You add the facts a placement firm rarely sees: the rest of the balance sheet, future cash needs and the estate documents. Share them, and ask for the rationale in writing. How much net worth to put into DSTs frames the concentration question.

Plan income from the offering documents, with the risks beside the numbers

DST distributions come from rent after debt service, reserves and fees, and they are not guaranteed. Because the trustee cannot accept new contributions, a vacancy or a capital need is funded from reserves or from reduced distributions, not from a capital call. A zero-cash-flow trust, which the client's cash out DST page describes as sending all operating income to debt service, pays no current distributions at all.

Taxable income and cash received are different numbers. The client reports a share of rent, interest, expenses and depreciation from the trustee's grantor statement, so a high-depreciation year can show less taxable income than the cash paid, and a zero-cash-flow trust can show taxable income with no cash. Build the plan from the projections and risk factors in the private placement memorandum, and treat any stated distribution rate as a target the sponsor can change; DST distribution timing and reliability lists what moves it.

Hypothetical: a client needs $100,000 of cash from a $1,500,000 exchange for a home project. Taking it at closing makes $100,000 taxable boot; keeping the full amount in the exchange and drawing from other portfolio assets defers all of the gain. Run your own numbers with your CPA.

The estate plan is often the deciding factor, because the deferred gain disappears at death

Under section 1014, property acquired from a decedent takes a basis equal to fair market value at the date of death. Every dollar of gain deferred through a chain of exchanges, including the depreciation that would have been taxed at up to 25%, is erased for the heirs. A DST interest qualifies just as a building would, because the owner is treated as holding real estate.

The practical advantage is division. Delaware law gives each beneficial owner an undivided interest 'in the proportion (expressed as a percentage)' of the whole, so an interest can be split among heirs by percentage instead of by deed. Contributing DST interests to an operating partnership in a section 721 roll-up still allows a step-up, but the heirs then hold partnership units that cannot go into another 1031. Whether the client still needs to defer at all, given the 2026 estate exemption, is covered in the 2026 estate exemption and 1031.

An RIA keeps advising; the DST itself is placed through a broker-dealer

Selling a DST interest is broker-dealer activity, and FINRA Rule 2040 bars member firms from paying transaction-based compensation to anyone who would have to register as a broker-dealer to receive it and is not registered. An RIA that is not dually registered therefore does not share in a selling commission. Ask how the offering's fees and loads are disclosed and compare them across sponsors; advisor fees and conflicts for DSTs covers the questions.

In a typical engagement the advisor stays on the planning side, we introduce the client to sponsors and their offerings, reserve equity in one or more trusts, and coordinate identification with the client's qualified intermediary.