Selling a Real Estate Portfolio? What to Know About 1031 Exchanges and DSTs Before Closing
The difficult part is often not selling the property. It is deciding what should happen to the capital after the sale.
Owners of self-storage facilities and other appreciated investment real estate may eventually reach a point where selling makes sense.
The reasons can vary.
An owner may want less day-to-day management. Family members may not want to continue operating the properties. A portfolio may have become too concentrated in one market or property type. Or the owner may simply be ready to convert years of work into a more flexible financial plan.
When appreciated investment real estate is involved, however, the sale itself is only one part of the decision.
For some owners, a Section 1031 exchange may be worth evaluating before closing. In certain circumstances, a properly structured Delaware Statutory Trust, or DST, may also be considered as potential replacement property.
The important word is before.
Once the property is sold, the exchange timeline is already running.
The Short Answer
A 1031 exchange may allow an investor to defer recognition of certain gains when qualifying real property held for investment or productive use is exchanged for qualifying like-kind real property.
Under current law, replacement property generally must be identified within 45 days after the relinquished property is transferred, and the exchange generally must be completed within 180 days, or by the applicable tax-return deadline if earlier. (IRS Form 8824 Instructions)
Certain properly structured DST interests may qualify as replacement property under Section 1031 if the other requirements of the exchange are satisfied. That treatment is based in part on IRS Revenue Ruling 2004-86.
A DST is not automatically appropriate simply because an investor wants a 1031 exchange.
It is an investment security with its own risks, costs, liquidity limitations, property exposure, sponsor considerations, and suitability requirements.
Why Planning Before the Sale Matters
The 45-day identification window can move quickly.
That period is not necessarily the ideal time to begin deciding:
Whether you want to remain invested in real estate
How much liquidity you may need
Whether you want direct property ownership or more passive exposure
How debt on the relinquished property may affect the exchange
Whether concentration in one property or market still makes sense
How the sale fits with retirement, estate, or family planning goals
The earlier these questions are considered, the more time the owner may have to evaluate the available alternatives with the appropriate tax, legal, and financial professionals.
AtPaxton Financial Services, DST investment strategies and their potential use in connection with Section 1031 exchanges are considered as part of a broader financial-planning process rather than as a stand-alone tax solution.
Can Self-Storage Property Be Exchanged Into a DST?
Potentially, yes.
Section 1031 currently applies to qualifying real property held for productive use in a trade or business or for investment. The statute does not require the replacement property to be the exact same property type as the property sold.
IRS Revenue Ruling 2004-86 also provides that an interest in a Delaware statutory trust meeting the conditions described in the ruling may qualify as real property for purposes of a Section 1031 exchange when the other requirements are satisfied.
That means an owner selling self-storage property may, depending on the facts of the transaction, be able to evaluate DST interests holding other qualifying real-estate assets.
This does not mean every DST qualifies, every investor is eligible, or every exchange will receive the intended tax treatment.
The structure of the trust and the exchange matters.
What About Existing Debt?
Debt is an important part of many 1031 exchanges.
An owner who sells leveraged real estate should not look only at the equity received at closing. The treatment of debt and other consideration can influence whether some gain is recognized.
Some DST offerings use financing at the trust level, and an investor's proportionate share of that financing may be relevant when evaluating replacement-property value and exchange requirements.
However, leverage is not simply a tax-planning feature.
Debt can also increase investment risk and affect cash flow, property-level performance, and the amount of equity exposed to loss.
The appropriate structure should be reviewed with qualified tax and legal professionals before the exchange is completed.
Does a 1031 Exchange Eliminate Capital Gains or Depreciation Recapture?
No.
A properly completed 1031 exchange is generally a tax-deferral strategy, not a method for making a tax liability disappear.
The tax basis generally carries into the replacement property, subject to applicable rules, which means deferred gain may become relevant in a later taxable disposition.
This distinction is important.
The planning question should not simply be:
“How do I avoid paying tax at closing?”
A better question is:
“How does this exchange fit within my longer-term financial, investment, estate, and liquidity plan?”
Paxton Financial Services does not provide tax or legal advice. Owners should work with their CPA, tax attorney, qualified intermediary, and other appropriate professionals regarding their specific transaction.
Why Some Owners Evaluate DSTs
A DST may appeal to certain accredited investors who want to remain invested in real estate while reducing direct responsibility for property operations.
Depending on the offering, potential considerations may include:
Professional property management
Fractional ownership rather than acquiring an entire replacement property
Access to different property sectors or geographic markets
The ability to allocate exchange proceeds across more than one investment
Reduced direct involvement with tenants, leasing, repairs, and property operations
Those potential benefits need to be evaluated alongside the material risks.
DST investments are generally illiquid. Investors typically have limited control over management decisions. They may involve significant fees and expenses, leverage, tenant risk, market risk, sponsor risk, and the possible loss of principal.
Distributions, appreciation, and future sale proceeds are not guaranteed.
Diversification also does not assure a profit or protect against loss.
Is Diversification a Reason to Use a DST?
It can be one factor to evaluate, but diversification by itself should not drive the decision.
An owner who sells several self-storage facilities may want to consider whether concentrating the replacement investment in another single property, sector, or geographic area still fits the broader financial plan.
Certain DST offerings may provide fractional exposure to different properties or sectors.
However, spreading capital among multiple properties does not eliminate real-estate or investment risk.
Each offering still requires its own due diligence.
That includes reviewing:
Sponsor experience
Property fundamentals
Tenant concentration
Lease structure
Financing
Fees
Reserves
Distribution assumptions
Exit provisions
Geographic and sector exposure
The SEC's marketing rule requires potential investment benefits to be presented together with fair and balanced treatment of material risks and limitations.
How Far in Advance Should an Owner Begin Planning?
There is no universal timeline.
But an owner does not have to wait until the property is under contract to begin the conversation.
If a sale is becoming a realistic possibility, it can be useful to begin considering:
Expected sale proceeds
Existing debt
Potential tax exposure
Desired level of liquidity
Whether continued real-estate exposure fits the plan
Retirement income needs
Estate and family considerations
Replacement-property alternatives
The role, if any, a DST might play
The goal is not to commit to a specific investment early.
It is to avoid making every decision under the pressure of a 45-day identification deadline.
How Paxton Financial Services Approaches 1031 and DST Planning
At Paxton Financial Services, the discussion begins with the client's broader financial objectives.
The question is not simply whether a DST is available.
It is whether the strategy fits the investor's goals, risk tolerance, liquidity needs, time horizon, tax considerations, and overall financial plan.
Where appropriate, Paxton can also coordinate with the client's tax advisor and other professionals so the investment discussion is considered alongside the tax and legal structure of the transaction. Paxton's current services include DST investment strategies, including potential use in connection with Section 1031 exchanges.
Questions to Ask Before Selling
Before completing the sale of appreciated investment real estate, consider discussing these questions with your advisory team:
What might the tax consequences look like if I sell without an exchange?
Do I actually want to continue owning real estate?
How much liquidity do I need after the sale?
What debt needs to be considered in the exchange?
Am I comfortable giving up direct control of the property?
How would a DST affect my liquidity and risk exposure?
How does this decision fit with retirement and estate planning?
Those questions are often more useful than starting with a product.
Frequently Asked Questions
Can a DST qualify as replacement property in a 1031 exchange?
Certain DST interests structured consistently with IRS Revenue Ruling 2004-86 may qualify as replacement property if the other requirements of Section 1031 are satisfied.
How long do I have to identify replacement property?
Under current Section 1031 rules, replacement property generally must be identified within 45 days after the transfer of the relinquished property. The exchange generally must be completed within 180 days or by the applicable tax-return deadline if earlier.
Does a 1031 exchange eliminate capital gains taxes?
No. A qualifying exchange generally defers recognition of gain rather than eliminating the underlying tax liability.
Are DST investments liquid?
Generally, no. DST interests are typically illiquid securities with limited secondary-market options. Investors should be prepared to hold the investment for an uncertain period.
Are DST distributions guaranteed?
No. Distributions, income, appreciation, and return of principal are not guaranteed.
Who should evaluate the tax side of the exchange?
A qualified CPA, tax attorney, and qualified intermediary should be consulted regarding the tax and legal aspects of a specific 1031 exchange. Paxton Financial Services does not provide tax or legal advice.
Considering a Sale?
If you own self-storage facilities or other appreciated investment real estate and a sale may be on the horizon, the time to understand your options is generally before the transaction becomes urgent.
Start a conversation with Paxton Financial Services to discuss how a potential sale, 1031 exchange, or DST investment may fit within your broader financial plan.
Important Disclosure
Securities and advisory services offered through Ausdal Financial Partners, Inc., 5187 Utica Ridge Road, Davenport, IA 52807 (563) 326-2064. Member FINRA/SIPC. Paxton Financial Services and Ausdal Financial Partners are independently owned and operated.
This material is provided for general educational and informational purposes only and is not intended as an offer to buy or sell any security, or as individualized investment, tax, legal, accounting, or financial advice.
Delaware Statutory Trust investments are securities and involve significant risks, including illiquidity, fees and expenses, lack of investor control, real-estate and market risk, sponsor risk, leverage risk, and the possible loss of principal. Distributions, income, appreciation, and tax outcomes are not guaranteed. Diversification does not assure a profit or protect against loss.
Section 1031 treatment depends on the facts and proper structure of each transaction. Tax laws and regulations are subject to change. Investors should consult their qualified tax and legal professionals regarding their individual circumstances before implementing any strategy.