Delaware Statutory Trusts (DSTs): The Fully Passive 1031 Exchange Option for LA Apartment Owners

If you own an apartment building in Los Angeles and you are considering selling, you have probably heard about 1031 exchanges. You may also have heard the term "Delaware Statutory Trust" or "DST" and wondered what it means and whether it is right for you.

The short answer: a DST is a legal structure that lets you exchange your apartment building into fractional ownership of institutional-quality real estate, defer all capital gains taxes, collect monthly passive income, and never deal with a tenant, toilet, or maintenance call again. It qualifies as like-kind property under IRS Revenue Ruling 2004-86, so it works within a standard 1031 exchange.

After facilitating over 100 exchanges for LA apartment building owners, we have seen DSTs become one of the fastest-growing exchange strategies. Approximately 15% of our exchange clients choose DSTs, and those clients have averaged a 187% increase in net cash flow compared to what their LA apartment buildings were generating. Here is everything you need to know.

What Is a Delaware Statutory Trust?

A Delaware Statutory Trust is a legally recognized trust, established under the Delaware Statutory Trust Act of 1988, that holds title to real estate on behalf of multiple investors. Each investor owns a fractional interest in the underlying property. The IRS confirmed in 2004 (Revenue Ruling 2004-86) that this fractional interest constitutes direct real property ownership, making DSTs eligible for 1031 exchanges.

In plain terms: a professional sponsor company buys a large, institutional-quality property (a 300-unit apartment complex, a portfolio of net-leased retail buildings, an industrial park). They set up a trust, secure financing, and then sell fractional interests to individual investors. You invest your 1031 exchange proceeds, the sponsor manages everything, and you receive monthly distributions.

How DSTs Are Structured

Every DST has two types of participants:

The Sponsor (Trustee) holds legal title to the real estate, makes all management and disposition decisions, secures financing before investors close, and is generally a well-established real estate company with expertise in acquiring and managing institutional assets.

The Investor (Beneficial Owner) holds equitable ownership through a trust agreement, receives all the benefits of direct real estate ownership (income, depreciation, appreciation, tax deferral), and has zero management responsibilities. You are a passive investor.

Why LA Apartment Owners Are Choosing DSTs

We see four common profiles among our clients who choose DSTs:

The Retirement Transition. You have owned and managed an apartment building for 20 or 30 years. You are tired of RSO compliance, tenant calls, deferred maintenance on a 1960s building, and the prospect of Measure ULA eating into your sale proceeds. You want passive income without the headaches.

The Partnership Dissolution. Multiple partners want to go their separate ways after selling. DSTs allow flexible allocation because each partner can invest different amounts across different DSTs, rather than having to agree on a single replacement property.

The 45-Day Safety Net. You are in a 1031 exchange, your target property fell through on day 40, and you have five days to close on something or face a six-figure tax bill. DSTs close in as few as 3-5 business days. They are the best insurance policy against a failed exchange.

The Boot Solver. Your replacement property costs less than your sale proceeds. The leftover amount (called "boot") is taxable. Instead of paying capital gains on the difference, you invest it in a DST with a $100,000 minimum and defer the entire gain.

The Financial Case: Apartments vs. DSTs

The core math: your LA apartment building trades at a 3.5% to 4.5% cap rate, but after 40% to 50% in operating expenses, your actual return on equity is closer to 2% to 3%. DST investments in growth markets outside California target 5.0% to 7.0% yields with zero expenses and zero management. That gap — 2% net versus 5% to 6% net — is what drives the entire strategy.

Here is a simplified example based on patterns we see regularly:

	LA Apartment (Current)	DST Portfolio (Post-Exchange)
Property Value / Investment	$3,000,000	$3,000,000
Annual Net Income	$105,000 (3.5% cap)	$165,000 (5.5% blended)
Monthly Cash Flow	$8,750	$13,750
Management Required	Active (RSO, maintenance, tenants)	None (fully passive)
Tax Impact	Fully depreciated, minimal shelter	New depreciation schedule
Diversification	One building, one market	Multiple properties, multiple states

The cash flow increase comes from two factors: DST properties in growth markets outside California typically generate higher returns than LA apartment buildings trading at compressed cap rates, and the new depreciation schedule shelters more of your income from taxes.

What You Can Invest In

DSTs are not limited to apartment buildings. The range of available asset types is one of the most compelling features:

• Multifamily apartments: 200-400 unit Class A and B complexes in growth markets (Charlotte, Las Vegas, Phoenix, Atlanta)
• Self-storage facilities: High-occupancy portfolios across multiple states
• Industrial and logistics: Net-leased warehouse and distribution portfolios
• Single-tenant NNN retail: FedEx, Tractor Supply, BioLife, Dollar General, and other credit tenants
• Senior housing and assisted living: Demographic-driven demand in high-net-worth markets
• Manufactured housing communities: Stable, recession-resistant cash flows
• Medical office: Essential-service tenants with long-term leases
• Mineral rights and energy: Oil and gas royalty interests in producing basins

A typical DST portfolio might include $500,000 in a multifamily DST in the Southeast, $500,000 in an industrial portfolio in Texas, $300,000 in a self-storage DST in Florida, and $200,000 in a net-leased retail DST. That kind of diversification across property types, geographies, and sponsors is nearly impossible to achieve buying individual properties.

The 12 Benefits of DST Investing

1. Freedom from management. Professional third-party firms handle every aspect of property management. You receive monthly distributions and quarterly reports. No tenants, no maintenance calls, no RSO compliance.
2. No personal liability. Debt in a DST is non-recourse to individual investors. The sponsor guarantees all recourse obligations. Your personal assets are protected by the trust's bankruptcy-remote provisions.
3. Pre-packaged financing. The sponsor secures the mortgage before you invest. You are allocated your pro-rata share of debt automatically, satisfying the 1031 exchange requirement to replace debt without having to personally qualify for a loan.
4. Low minimums. Most DSTs accept investments starting at $100,000, compared to the millions required to buy individual replacement properties. This makes diversification practical.
5. Access to institutional real estate. Pooled equity lets you own a piece of $50M-$100M+ properties that individual investors could never acquire alone.
6. Portfolio diversification. Invest across multiple DSTs, property types, geographies, and sponsors to reduce concentration risk.
7. Full tax benefits of ownership. Mortgage interest deductions and depreciation flow through to individual investors on a pro-rata basis, reducing your tax liability on distributions.
8. No add-on costs. All transaction costs (legal, financing, title, escrow, appraisals, commissions, reserves) are included in the DST offering price.
9. Indefinite tax deferral. Unlike a 721 Exchange into a REIT, DSTs allow you to continue doing 1031 exchanges over and over again. Upon your death, your heirs receive a step-up in basis, potentially eliminating all deferred capital gains.
10. Exchange deadline protection. Since DSTs are already acquired and operating, you can close in as few as 3-5 business days. This virtually eliminates the risk of missing the 45-day identification or 180-day exchange deadlines.
11. Estate planning advantages. Fractional interests are easier to distribute among heirs than a physical building. Each heir can independently decide whether to exchange again or sell and receive cash.
12. Pre-vetted properties. Sponsors provide comprehensive financial information, leases, appraisals, property condition reports, and projections before you invest. You can make informed decisions without the pressure of the 45-day clock.

DSTs as a Safety Net: The 3-Property Rule Strategy

This is one of the most practical uses of DSTs, and one that too few apartment owners know about.

Under the 1031 exchange rules, you can identify up to three replacement properties within the 45-day identification period regardless of their value. Most investors focus on finding one target property. The problem: if that deal falls through due to financing issues, failed inspections, or seller cold feet, you have no backup and face a massive tax bill.

The solution: identify your primary replacement property as one of your three nominations, then add two DSTs as backup options. There is no cost to nominate them. If your primary deal closes successfully, you simply ignore the DST nominations. If it falls through, you close on one or both DSTs within days, saving your exchange.

We recommend this strategy to virtually every client doing a 1031 exchange, regardless of whether they intend to invest in DSTs. It is free insurance against a failed exchange.

The Seven Deadly Sins: IRS Restrictions on DSTs

When the IRS approved DSTs for 1031 exchanges, it imposed seven restrictions on how the trust can be managed. These are known in the industry as the "Seven Deadly Sins," and they are important to understand:

1. No new capital contributions. Once a DST offering closes, no additional equity can be raised from existing or new investors.
2. No additional borrowing. The trustee cannot borrow more money or renegotiate existing loan terms.
3. No reinvestment of sale proceeds. If the property is sold, proceeds must be distributed to investors rather than reinvested.
4. Limited capital improvements. Only normal repair and maintenance, minor non-structural improvements, and legally required improvements are permitted.
5. Short-term investment of reserves only. Cash reserves between distribution dates can only be placed in short-term debt obligations.
6. Mandatory cash distributions. All cash beyond necessary reserves must be distributed to investors on a regular basis.
7. No new leases or lease renegotiation. The sponsor cannot enter new leases or renegotiate existing ones after the offering closes.

The seventh restriction sounds severe, but there is a widely used workaround: the Master Lease structure. The DST leases the entire property to a "master tenant" (typically a sponsor affiliate), who then has full authority to enter into new leases and renegotiate terms with sub-tenants. This gives the property operational flexibility while keeping the DST in compliance with IRS rules.

Risks and Honest Downsides

No investment guide is complete without a candid discussion of risks. DSTs have real downsides that you should understand before investing:

Illiquidity. DSTs are illiquid investments with no secondary market. Typical hold periods are 5-7 years. You cannot sell your interest early if you need the money. Do not invest funds you may need before the anticipated disposition date.

No control. You are a passive investor with no say in management decisions, capital expenditures, tenant relations, or the timing of the property sale. The sponsor makes all decisions. If you are the type of investor who wants hands-on control, DSTs are not for you.

No voting rights. Unlike a REIT or partnership, DST investors have no voting rights on property matters.

Market risk. Real estate values can decline. Tenants can default. Economic conditions can deteriorate. DSTs are subject to the same market forces as any real estate investment. There is no guarantee of returns, and you can lose principal.

Sponsor risk. The quality and experience of the DST sponsor matters enormously. Not all sponsors are created equal. A poorly managed DST can underperform or lose value regardless of market conditions. Due diligence on the sponsor's track record, financial strength, and management capabilities is essential.

Distribution risk. Monthly distributions are not guaranteed. If a property loses tenants or sustains damage, distributions can be reduced or suspended.

Fee impact. DST front-end fees (offering costs, broker-dealer placement, financing fees) typically total 10% to 15% of your investment. This fee drag can reduce your effective return by 1% to 2% annually over the hold period compared to direct property ownership. All fees are disclosed in the Private Placement Memorandum (PPM) and should be carefully reviewed and compared across sponsors.

Exit Strategies: What Happens When the DST Sells

DSTs are not permanent investments. The sponsor typically sells the property after a 5-7 year hold period. When that happens, you have three options:

Option 1: Another 1031 Exchange. Roll your proceeds into a new DST, a direct property purchase, or another like-kind investment and continue deferring capital gains taxes. This is the most common choice and allows indefinite tax deferral.

Option 2: Cash Out. Take your proceeds and pay capital gains taxes (federal, California state, depreciation recapture, NIIT). For a California resident, the total tax burden can exceed 40% of your gain.

Option 3: 721 UPREIT Exchange. Some DSTs are structured to offer conversion into a Real Estate Investment Trust (REIT) through a Section 721 exchange. This is an advanced strategy worth understanding:

• Your DST interest converts into operating partnership (OP) units in an UPREIT
• The exchange is tax-deferred under IRC Section 721
• You gain access to a much larger, diversified portfolio (REITs typically own hundreds of properties)
• OP units can eventually be converted to REIT shares, providing potential liquidity
• Professional REIT management, laddered financing, and dividend income
• Estate planning: REIT shares receive a step-up in basis at death and are easily divided among heirs

Critical warning about the 721 UPREIT: It is a one-way door. Once you convert from a DST into REIT shares, you can never do another 1031 exchange with those shares. If you sell REIT shares, you will pay capital gains taxes. The IRS also generally requires a minimum 2-year holding period in the DST before a 721 conversion. This exit strategy makes the most sense for investors who never want to do another exchange and prefer long-term REIT ownership with liquidity.

Zero-Coupon DSTs: Replacing Debt Without a New Loan

One of the most powerful but least understood DST strategies is the zero-coupon DST. Here is the problem it solves:

In a 1031 exchange, you must replace the debt on your relinquished property. If you sell an apartment building with a $2 million mortgage, your replacement property must carry at least $2 million in debt (or you add equivalent cash). For many sellers, qualifying for a new loan at current interest rates is challenging or undesirable.

A zero-coupon DST uses high leverage (up to 85% loan-to-value) to provide substantial debt replacement with a small equity investment. For example, if you need to replace $4.25 million in debt, investing just $750,000 in an 85% LTV DST satisfies the entire debt replacement requirement. The remaining $4.25 million is non-recourse DST debt allocated to you on a pro-rata basis. This frees the rest of your equity to be invested as all-cash into other DSTs or direct properties.

DSTs vs. NNN Properties vs. Out-of-State Apartments

LA apartment owners doing a 1031 exchange typically consider three replacement options. Here is how they compare:

	DSTs	NNN Properties	Out-of-State Apartments
Passivity Level	Fully passive	None (tenant handles everything)	Active management required
Minimum Investment	$100,000	$1M-$5M+ typical	$500K-$2M+ typical
Diversification	Multiple properties, types, states	Single property, single tenant	Single property, single market
Control	None	You own it outright	Full control
Financing	Pre-packaged, non-recourse	Must qualify personally	Must qualify personally
Closing Speed	3-5 business days	30-60 days typical	30-60 days typical
Typical Returns	5.0-7.0% projected	5.5-7.0% cap rates	6.0-8.0% cap rates
Liquidity	Illiquid (5-7 year hold)	Liquid (sell anytime)	Liquid (sell anytime)
Value-Add Potential	None (passive)	Limited	High (renovate and raise rents)
Best For	Retirement, partnerships, backup	Passive income seekers	Active investors wanting growth

Many of our clients use a combination: 60% into NNN properties for passive income, 25% into an out-of-state apartment for growth, and 15% into DSTs as a diversifier or backup. There is no single right answer. The best strategy depends on your age, risk tolerance, income needs, and how involved you want to be. For a complete guide to NNN investing, see our NNN Property Guide. For a detailed head-to-head comparison of NNN and DST, see our NNN vs. DST Decision Guide.

Real-World Case Studies

Wealth Preservation: Avoiding a $700,000 Tax Bill

An investor purchased a commercial property for $600,000. After 30 years, the property appreciated to $1.8 million and was fully depreciated. Selling and paying taxes would have cost nearly $700,000. By exchanging into DSTs at a 6% return, the investor generates $108,000 annually. Had they sold outright, paid taxes, and reinvested the remaining $1.1 million at the same 6%, their income would have been just $66,000. DSTs delivered nearly 40% more retirement income.

Partnership Exit: From 12 Units to $1.2 Billion in Assets

A couple purchased a 12-unit apartment building in San Francisco for $480,000. After 23 years, they sold for approximately $3.3 million. Facing retirement and wanting out of active management, they exchanged into seven different DSTs with a combined asset value exceeding $1.2 billion. Their portfolio now spans multiple property types and geographies, all fully passive.

Debt Leverage: Non-Recourse Debt Without a Personal Loan

An owner had a $1.5 million apartment building with a $750,000 mortgage (50% LTV). Selling and reinvesting only the $750,000 in equity would have triggered taxes on the debt. Instead, by investing in DSTs that carried non-recourse debt, the owner replaced the full $1.5 million in property value across four diversified DSTs without personally qualifying for any new loan.

DST vs. NNN: Why One Investor Chose DSTs at Age 78

An investor inherited six single-family homes valued at $5.5 million. She initially considered NNN properties but encountered challenges: each property was valued under $1 million (hard to find quality NNN at that price point), single-tenant NNN carried vacancy risk, and future lease renegotiations would still be required. She chose DSTs instead, exchanging each property into three DSTs for a total of 18 positions. At 78, she now has a diversified portfolio of institutional-quality real estate with predictable passive income and no management burden.

How to Evaluate a DST Sponsor

The quality of the sponsor is the single most important variable in a DST investment. Before investing, ask these questions:

• How long has the sponsor been in business? Look for at least 10 years of track record.
• How many DST offerings have they completed? What were the outcomes?
• What is their assets-under-management total? Larger sponsors have more resources and buying power.
• What is their acquisition criteria? Are they buying quality assets in strong markets?
• What is their debt strategy? Conservative LTV (below 60%) or aggressive leverage?
• What are the total fees (upfront and ongoing)? Compare across sponsors.
• Do they offer a 721 UPREIT exit option?
• What is their communication cadence? (Monthly distributions, quarterly reports, annual tax packages)

California Tax Considerations

For LA apartment owners specifically, the tax motivation for DSTs is particularly strong:

• Federal capital gains: Up to 20% (long-term)
• Net Investment Income Tax (NIIT): 3.8%
• California state capital gains: Up to 13.3% (no separate capital gains rate in CA)
• Depreciation recapture: 25% on accumulated depreciation
• Measure ULA: 4% on sales $5.3M-$10.6M, 5.5% above $10.6M (City of LA only)

The combined federal and state tax burden on a sale without a 1031 exchange can exceed 40% of your gain. On a $2 million gain, that is $800,000+ in taxes. A DST exchange defers the entire amount, and upon your death, your heirs receive a step-up in basis that can eliminate the deferred taxes entirely.

Frequently Asked Questions About DSTs

What is the minimum investment for a DST?

Most DST offerings have a minimum equity investment of $100,000. This low minimum makes it possible to diversify across multiple DSTs, property types, and geographies rather than concentrating your exchange proceeds in a single property.

How long is my money locked up in a DST?

DSTs are illiquid investments with typical hold periods of 5-7 years. There is no secondary market for DST interests. You should not invest funds you may need before the anticipated disposition date. When the sponsor sells the property, you receive your pro-rata share of proceeds and can exchange again or cash out.

What returns should I expect from a DST?

First-year targeted cash-on-cash returns for DSTs typically range from 4.5% to 7.0%, depending on property type, leverage, and market conditions. These are projections, not guarantees. Actual returns depend on property performance, occupancy, expenses, and market conditions. Our exchange clients who chose DSTs have averaged a 187% increase in net cash flow compared to their prior LA apartment buildings.

Can I do another 1031 exchange when the DST sells?

Yes. When the DST property is sold, you receive your share of proceeds and can do another 1031 exchange into a new DST, a direct property, or any other like-kind real estate. This allows indefinite tax deferral. The only exception is if you choose a 721 UPREIT conversion, which is a one-way exit from the 1031 exchange cycle.

What is a zero-coupon DST?

A zero-coupon DST uses high leverage (up to 85% LTV) to help investors replace debt from their relinquished property with a relatively small equity investment. It is called "zero-coupon" because distributions may be minimal or zero while the property is held. The primary purpose is debt replacement, not income.

What is the 3-Property Rule and how do DSTs fit?

In a 1031 exchange, you can identify up to three replacement properties within 45 days regardless of their total value. We recommend nominating your target property plus two DSTs as backups. If your primary deal falls through, the DSTs can close in 3-5 days, saving your exchange. There is no cost to nominate DSTs you do not ultimately purchase.

What is a 721 UPREIT and should I consider one?

A 721 UPREIT allows you to convert your DST interest into shares of a Real Estate Investment Trust (REIT), providing diversification across hundreds of properties and potential liquidity. However, it is a one-way door: once you convert, you can never do another 1031 exchange with those shares. It is best suited for investors who want permanent passive ownership without future exchange obligations. The IRS generally requires a minimum 2-year hold in the DST before conversion.

How are DST distributions taxed?

DST distributions are taxed similarly to direct real estate ownership. A portion of each distribution is typically sheltered by depreciation, reducing your current tax liability. The specific tax treatment depends on your individual situation and should be reviewed with your tax advisor.

What happens if the DST sponsor goes bankrupt?

DSTs are structured as bankruptcy-remote entities, meaning the trust's assets are legally separate from the sponsor's other business operations. However, a sponsor's financial distress can impact property management quality and decision-making. This is why sponsor due diligence is critical.

Is a DST right for someone under 50?

DSTs are most popular with investors over 55 who are transitioning to passive income. Younger investors with longer time horizons may prefer the value-add potential of direct property ownership. However, DSTs can make sense at any age as a diversification tool, a backup nomination strategy, or a solution for partnership dissolutions. There is no age requirement.

What is the Master Lease structure?

A Master Lease addresses the IRS restriction that prevents DST sponsors from entering new leases after the offering closes. The DST leases the entire property to a "master tenant" (usually a sponsor affiliate), who then has full authority to negotiate subleases with individual tenants. This preserves the DST's tax status while allowing normal property operations.

Do I need to be an accredited investor?

Yes. DSTs are offered as Regulation D private placements and are only available to accredited investors as defined by the SEC. Generally, this means an individual with a net worth exceeding $1 million (excluding primary residence) or annual income exceeding $200,000 ($300,000 combined with a spouse) for the past two years.

Next Steps

If you are considering selling your LA apartment building and want to explore DSTs as part of your 1031 exchange strategy, contact Glen Scher at (818) 212-2808 or email Glen.Scher@marcusmillichap.com. We will walk you through the entire process, from pricing your building to identifying the right mix of replacement investments.

For a head-to-head comparison of NNN and DST investments, see our NNN vs. DST Decision Guide. For an overview of all 1031 exchange strategies, visit our 1031 Exchange page.