What Is a 1031 Exchange? How DSTs Fit In.
Learn the rules, timelines, and risks—plus when a Delaware Statutory Trust (DST) might make sense as replacement property. 5‑minute read. No jargon.
Firms like Passco Companies specialize in providing turnkey, due-diligence-complete replacement properties
What is it and how does it work?
A 1031 exchange (named after Section 1031 of the U.S. Internal Revenue Code) allows real estate investors to defer paying capital gains taxes when selling one investment property — as long as they reinvest the proceeds into another “like-kind” property.
Instead of receiving the cash from your sale directly, you must use a qualified intermediary (QI) to hold the funds and use them to purchase your replacement property. This arrangement ensures the transaction is treated as a tax-deferred exchange rather than a taxable sale.
1031 Exchange Frequently asked questions
What properties qualify for a 1031 exchange?
Both the property you sell (relinquished property) and the property you acquire (replacement property) must be held for productive use in a trade, business, or for investment.
- Qualifying properties: This includes a wide range of real estate, such as single-family rentals, apartment buildings, commercial properties, raw land, and industrial warehouses.
- Non-qualifying properties: Personal residences, “fix-and-flips” (properties held primarily for resale), and foreign real estate do not qualify.
What is "like-kind"?
The term “like-kind” is broadly defined by the IRS for real estate. Any real property held for investment or business use is considered “like-kind” to any other. For instance, you can exchange a single-family rental for a retail space or undeveloped land for an apartment building.
What are the 1031 exchange timeline rules?
There are two critical deadlines that run concurrently and are non-negotiable, unless a federally declared disaster occurs:
- 45-day identification period: You have 45 calendar days from the closing of your relinquished property to identify potential replacement properties in writing.
- 180-day exchange period: You must close on the replacement property within 180 calendar days from the closing of the relinquished property. This period is shortened if your tax return for that year is due earlier.
What happens if I miss the deadlines?
If you fail to meet either the 45-day identification deadline or the 180-day closing deadline, the exchange is invalid. The sale is then treated as a taxable event, and you will owe capital gains tax and depreciation recapture on the proceeds.
Can I do a 1031 exchange on my primary residence?
No, a primary residence does not qualify for a 1031 exchange. However, it is possible to convert a primary residence into a rental property for a period of time to make it eligible. To do this, you must rent it out at fair market value for at least 14 days in each of the two years prior to the exchange and limit personal use to specific thresholds.
Do I have to reinvest all my proceeds?
To defer all capital gains taxes, you must reinvest all of your proceeds and purchase a replacement property of equal or greater value. Any cash you receive from the transaction is known as “boot” and is taxable.
Can I receive cash during the exchange?
Any cash you receive during the exchange process will be taxed as a capital gain. All sale proceeds must be held by your qualified intermediary. If you want to receive some cash, it must be handled correctly before the QI receives the funds.
What is a qualified intermediary (QI)?
A qualified intermediary is a third party who facilitates the exchange. The QI holds the proceeds from the sale and manages the transaction to ensure all IRS rules are followed. You cannot be related to your QI or have had a formal business relationship with them within two years of the exchange.
Is a 1031 exchange tax-free?
No, a 1031 exchange is a “tax-deferred” event, not “tax-free”. The capital gains tax is deferred until a later date, typically when the replacement property is sold without being rolled into another exchange. An exception is if the property is passed to an heir upon your death, as the property receives a “stepped-up” basis at that time.
Do I have to buy property in the same state?
No. You can acquire a replacement property in any state in the U.S. and still qualify for the tax deferral. However, you should consult a tax advisor about any potential state-level tax differences, as some states have “clawback” provisions that can tax the deferred gain at a later date.
DST (Delaware Statutory Trust)
What is it and how does it work?
A DST is a Legal entity used to hold title to investment real estate. It allows multiple investors to own fractional interests in large, institutional-quality properties — like apartment complexes, office buildings, or shopping centers — while maintaining eligibility for a 1031 exchange.
DST Frequently asked questions
How does a DST relate to a 1031 exchange?
Under IRS Revenue Ruling 2004-86, beneficial interests in a DST qualify as “like-kind” property for 1031 exchange purposes. This means investors can defer capital gains taxes from the sale of an investment property by reinvesting into a DST.
What types of properties are typically owned by a DST?
DSTs commonly hold institutional-quality, income-producing assets, such as:
Class A multifamily communities
Office and medical buildings
Industrial and logistics centers
Retail centers
Self-storage and hospitality properties
These properties are professionally managed and stabilized to provide predictable income streams.
What are the benefits of investing in a DST?
Tax Deferral: Qualifies for 1031 exchange tax benefits.
Passive Income: No management responsibilities.
Diversification: Ability to invest in multiple DSTs and asset types.
Accessibility: Access to institutional-grade real estate that individual investors typically can’t purchase alone.
Due Diligence: Properties are fully vetted and managed by experienced sponsors like Passco Companies.
How long is a typical DST investment held?
DSTs generally have a 5- to 10-year holding period, depending on market conditions and the sponsor’s strategy. At the end of the term, the property is usually sold, and investors may:
Receive sale proceeds (potentially taxed if not reinvested), or
Complete another 1031 exchange into a new property or DST.
Can I sell my DST interest before the property is sold?
DST interests are not easily liquidated. They are considered illiquid investments, meaning investors should be prepared to hold the investment for the full duration of the trust’s life cycle.
Are DST investments safe?
DSTs are backed by real property assets and managed by professional firms; however, they are not risk-free. Risks include market fluctuations, property performance, tenant stability, and interest rate changes. Investors should review offering documents carefully and consult financial and tax advisors before investing.
