DST vs Real Estate Crowdfunding: Why Only One Works as 1031 Replacement

The line is drawn by the regulations: entity interests are not real property, however much real estate sits inside

Section 1031(a)(1) defers gain only when real property is exchanged for real property of like kind. Reg. section 1.1031(a)-3(a)(5) then lists intangibles that are not real property regardless of state law: stock, bonds and notes, other securities or evidences of indebtedness, interests in a partnership, certificates of trust or beneficial interests, and choses in action.

An LLC with two or more members is a partnership for tax purposes by default under Reg. section 301.7701-3(b)(1), so an LLC unit in a crowdfunded apartment deal is a partnership interest. A debt offering secured by real estate is a note. Both fail the definition, and a qualified intermediary that wires your proceeds into one has bought non-like-kind property for you.

The detail on syndications and fund units is covered in whether you can 1031 into a syndication or LLC interest; this page compares the two products you are most likely to be shown side by side.

A DST passes because the IRS treats it as a grantor trust whose owners hold the building, not a business they invest in

In Rev. Rul. 2004-86 investors exchanged real property for interests in a Delaware statutory trust holding a single net-leased building. The IRS held that each investor was the owner of an undivided fractional interest in the property for federal tax purposes, so the swap was real property for real property, not real property for a certificate of trust.

The ruling depends on the trust staying passive. If the trustee could sell and buy new property, renegotiate the lease or sign new tenants, refinance the loan, invest cash to profit from market swings, or make more than minor non-structural changes, the trust would be a business entity and, with two or more owners, a partnership. Those limits are summarised as the DST seven deadly sins.

Tenancy-in-common is the other fractional route. Rev. Proc. 2002-22 sets the conditions for a ruling request, including a cap of 35 co-owners, and owners take title directly.

Online offerings come in both wrappers, so read the subscription documents rather than the marketing page

Some online platforms list DST interests next to their LLC deals, and a DST bought through a website is still a DST. The reverse is also true: an LLC sold by a broker you have used for years is still an LLC.

Before your intermediary wires anything, check what you would own and how you would report it.

• Name of the issuer: a Delaware statutory trust, a tenancy-in-common arrangement, or an LLC, LP or fund.
• Tax treatment stated in the private placement memorandum: grantor trust owning real estate, or partnership.
• Whether you would receive a deed or an assignment of beneficial interest in a trust, or a membership certificate.
• Whether the manager can refinance, buy more property or call more capital; any of those is a partnership feature.
• Whether the offering has a tax opinion addressing section 1031, and which property you would be identifying on your 45-day list.

Access, minimums and liquidity rules differ because the two products are usually sold under different securities exemptions

Regulation Crowdfunding lets an issuer raise up to $5,000,000 in any 12 months under 17 CFR 227.100, and caps what a non-accredited investor can put in across all such offerings in a year: the greater of $2,500 or 5% of income or net worth if either is below $124,000, otherwise 10% up to $124,000. Shares bought that way generally cannot be transferred for one year under 17 CFR 227.501.

DST offerings are usually private placements sold to accredited investors as defined in 17 CFR 230.501(a): net worth over $1,000,000 excluding your home, or income over $200,000, or $300,000 with a spouse, in each of the last two years. Sponsors set the minimum per trust; DST accredited investor rules explains the paperwork.

Neither product is liquid. DST interests have no public market and are generally held until the sponsor sells the property, as DST illiquidity and exits sets out.

Control, oversight and fees: a DST is fixed at closing, a crowdfunded LLC is managed

The passivity that makes a DST qualify also limits it. The loan, lease and property are set before you invest, and the trustee cannot fix a problem by refinancing or raising new money. An LLC manager can do both, which helps in a value-add plan but can also mean capital calls and dilution.

Fees in both are disclosed in the offering documents: acquisition fees, selling commissions, asset management fees and disposition fees vary by sponsor. Compare them line by line rather than relying on a headline figure; DST fees and loads lists where they sit.

Hypothetical: you have $500,000 of exchange proceeds and a $300,000 realized gain. Put the $500,000 into qualifying DST interests identified by day 45 and the gain stays deferred. Put it into an LLC deal through the intermediary and the exchange fails, so the whole $300,000 is taxed as on an ordinary sale. Run your own numbers with your CPA.

The practical split many owners use is simple: exchange dollars go to DST or direct real property, and money that has already been taxed can go anywhere, including crowdfunded deals.