Your DST Is Going Full Cycle: Cash Out, Exchange Again or 721

The decision arrives on the sponsor's calendar, so make it before the notice comes

Rev. Rul. 2004-86 is the reason your trust interest counted as real property in your first exchange, and it is also the reason you cannot choose the sale date. The ruling treats each beneficial owner as owning an undivided fractional interest in the trust's real estate, and it conditions that treatment on a trustee who cannot sell and buy new property, renegotiate the lease or refinance the loan. The trust described in the ruling terminates when its property is sold.

So the manager or trustee decides when to sell, within what the trust agreement allows, and you are told through the notices it requires. What full cycle means and how you are told covers the notice mechanics; this page is about the choice those notices force.

Most investors learn the closing date weeks ahead, so treat the first hint of a sale, a listing, a broker opinion of value or a loan maturity, as the start of planning, with an intermediary engaged and a shortlist in hand before the closing statement is signed.

Door one, cash: what you actually owe when the chain stops

Taking cash means the gain you deferred when you first exchanged, plus any gain the trust added, is recognized in the year of the trust's sale. Your basis in the trust interest is the carried-over basis from the property you gave up, reduced by the depreciation the trust allocated to you each year, so the taxable gain is usually far larger than the trust's own appreciation.

The federal bill stacks in layers. IRS Topic 409 caps the rate on unrecaptured section 1250 gain, which is the depreciation layer, at 25%. The remaining long-term gain is taxed at 15% up to the thresholds in Rev. Proc. 2025-32, which for 2026 are $613,700 of taxable income on a joint return and $545,500 for a single filer, and at 20% above them. Section 1411 adds 3.8% on net investment income once modified adjusted gross income passes $250,000 joint or $200,000 single, and those thresholds are not indexed.

State tax is a separate line, and a state with a claw-back rule may also want its share of the gain you deferred when you left it. Cash suits an investor who needs the money, has a small gain or a low-income year; it is the expensive door for everyone else.

Door two, exchange again: the intermediary must be in place before the trust closes

A second exchange is timed like the first. Section 1031(a)(3) requires you to identify replacement property within 45 days of the date you transfer the relinquished property, and to receive it by the earlier of 180 days or the due date, with extensions, of your return for the year of the transfer. For a trust that closes in November, the second limb bites: without an extension, your deadline is the following April 15, not 180 days.

The relinquished property is your beneficial interest, and the transfer date is the trust's closing. The intermediary safe harbor in Reg. section 1.1031(k)-1(g)(4) works only if the exchange agreement is signed and your rights to the proceeds assigned before that closing; a distribution that lands in your bank account first is a sale. Sponsors will direct your share to the intermediary on written instruction.

Replacement debt is easy to forget. The trust's loan is repaid at closing, and your share of that repayment is debt relief that produces boot unless you replace it with new debt or add cash. An investor coming out of a leveraged trust usually needs a financed replacement, which is the job of a zero cash flow, cash out DST or a conventionally financed trust, while an investor whose trust was debt-free can stay all-cash in a traditional DST or a direct title security. The full mechanics of the second exchange, including how to identify a trust interest, are in exchanging from one DST into another.

Door three, units: available only in some programs, and it closes the exchange door behind you

Some trusts are sold by sponsors whose non-traded REIT holds an option to acquire the trust's interests. One such REIT's Form 10-K for 2025 describes a fair market value purchase option giving its operating partnership the right, but not the obligation, to acquire the DST interests later, with investors electing units, cash or a combination, and at least 15% of the consideration available in cash when both are offered.

Electing units is a contribution under section 721(a), so no gain is recognized on the swap. The units, however, are partnership interests, which Reg. section 1.1031(a)-3(a)(5) places outside the definition of real property, so no later exchange is possible for the units or the shares they become. Electing cash is a sale, which can be the first step of door two if the intermediary is already in place.

Whether to accept units has its own page: your sponsor offered a 721, take it or exchange again. If your trust has no such option, door three does not exist and the choice is cash or exchange.

Hypothetical: $500,000 of trust interest, a $150,000 carried basis, and three outcomes

Round, hypothetical numbers. You exchanged a rental into a trust interest for $500,000 in 2019, carrying a $150,000 basis. The trust allocated you $60,000 of depreciation over the hold, so your basis is $90,000. The trust sells and your share of net proceeds is $550,000; your share of the loan repaid at closing was $200,000.

Cash: $460,000 of gain. The depreciation layer, $60,000 from the trust plus whatever you took on the rental before 2019, is taxed at up to 25%; the rest at 15% or 20% depending on your bracket; and the 3.8% surtax applies on top if your income clears the threshold. On a joint return with other income already above $613,700, the federal bill alone approaches $120,000 before state tax.

Exchange: $550,000 goes to the intermediary. To defer everything you acquire at least $750,000 of replacement, $550,000 of equity plus $200,000 of debt, or you add cash in place of the debt. The $90,000 basis carries into the new interest and the chain continues.

Units: no tax now, no 45-day clock, no new debt, and no exchange ever again on that money; each later redemption is a taxable sale. Have your CPA price all three against your bracket and state before the sponsor's deadline, since your basis history moves these figures most.

Which door, and the structure that usually goes with it

Investors who want to keep deferring take door two, and the structure follows the debt: a financed or zero cash flow trust when a loan share must be replaced, an all-cash trust or a direct title security when it need not. Investors done with exchanging who accept taxable redemptions in slices take door three where offered. Investors who need the money take door one.

Any trust replacement is illiquid, with no public market and no right to force a sale, and principal can be lost if the property underperforms or the loan cannot be refinanced. A second exchange also restarts a hold whose end date is again the sponsor's, as parking money in a DST temporarily explains.

If part of the proceeds comes out as cash anyway, the gain on that part, and only the gain, can go into an opportunity zone fund within 180 days, as using 1031 funds for an opportunity zone fund explains.