Investor’s Guide to Deferring Taxes with DSTs and UPREITs
As a real estate investor, you understand the power of growing your assets. But as your portfolio appreciates, so does your potential tax liability. Capital gains taxes can significantly reduce your returns when you sell a property. Fortunately, strategic financial tools exist to help you defer these taxes, allowing your wealth to continue working for you.
This guide explores two powerful options for tax deferral: Delaware Statutory Trusts (DSTs) and Umbrella Partnership Real Estate Investment Trusts (UPREITs). We will explain how these structures work, their benefits, and how they can be used to preserve your wealth, simplify your investments, and secure your financial legacy.
The Power of the Delaware Statutory Trust (DST)
A Delaware Statutory Trust is a legal entity that holds title to one or more investment-grade properties. As an investor, you can purchase a beneficial interest in the trust, making you a passive owner of high-quality, professionally managed real estate. This structure is particularly valuable for investors looking to complete a 1031 exchange.
Key Benefits of Investing in a DST:
Passive Ownership: The properties within a DST are managed by a professional sponsor. This eliminates the day-to-day responsibilities of being a landlord, freeing you to focus on your broader financial goals.
Portfolio Diversification: Instead of concentrating your capital in a single property, a DST allows you to invest in a diversified portfolio of assets. These may span different property types (like multifamily, industrial, or medical facilities) and geographic locations, helping to manage risk.
Access to Institutional-Quality Real Estate: DSTs often hold large-scale, high-value properties that are typically inaccessible to individual investors. This gives you a stake in premium real estate assets managed by experienced operators.
Simplified Estate Planning: Your beneficial interest in a DST can be easily transferred to heirs, simplifying the estate planning process. This provides a clear path for wealth transfer without the complexities of deeding physical properties.
How a 1031 Exchange with a DST Works
The 1031 exchange, named after Section 1031 of the IRS code, allows you to defer capital gains taxes when you sell an investment property and reinvest the proceeds into a "like-kind" property. DSTs are recognized by the IRS as a valid like-kind replacement property, making them a popular choice for investors seeking a simple and efficient exchange process.
The mechanics are straightforward:
Sell Your Property: You sell your appreciated investment property and engage a Qualified Intermediary (QI) to hold the proceeds. This is a critical step to ensure the funds are not constructively received by you, which would trigger a taxable event.
Identify Replacement Properties: Within 45 days of the sale, you must identify potential replacement properties. Investing in a DST simplifies this step, as you can select from a pre-vetted portfolio of properties offered by a sponsor.
Close on the New Investment: Within 180 days of the initial sale, you must close on the purchase of your replacement property. With a DST, this involves finalizing your investment and acquiring your beneficial interest in the trust.
By following these rules, you can defer 100% of your capital gains taxes, allowing your entire investment to continue growing. This makes the 1031 exchange a cornerstone of long-term real estate investment strategy.
Advancing Your Strategy with UPREITs
An Umbrella Partnership Real Estate Investment Trust (UPREIT) offers another powerful layer of flexibility and tax deferral, especially for owners of DSTs. An UPREIT is a structure where a publicly traded Real Estate Investment Trust (REIT) owns and operates properties through an "umbrella partnership."
Investors can contribute their property interests—including their beneficial interests in a DST—to the UPREIT's operating partnership in exchange for partnership units. This transaction is typically tax-deferred.
The UPREIT Advantage:
Enhanced Liquidity: One of the main challenges of direct real estate ownership is illiquidity. UPREIT partnership units can often be converted into shares of the publicly traded REIT. This provides you with the option to sell your shares on the open market, giving you access to cash without the lengthy process of selling a physical property.
Continued Tax Deferral: Exchanging your DST interest for UPREIT units is generally not a taxable event. Your tax deferral continues, allowing your investment to grow within the larger, diversified portfolio of the REIT.
Further Diversification: By joining an UPREIT, your investment becomes part of a much larger and more diverse portfolio. This spreads your risk across a wide array of properties, sectors, and markets, managed by the REIT's experienced team.
Potential for Growth and Income: As a holder of UPREIT units, you are entitled to receive distributions, which can provide a steady stream of passive income. You also benefit from any appreciation in the value of the REIT's shares.
Securing Your Legacy Through Smart Planning
The combination of DSTs and UPREITs offers a seamless path for managing and growing your real estate wealth. This strategy is not just about deferring taxes today; it's about building a durable legacy for tomorrow.
By converting illiquid real estate into passive, professionally managed investments, you simplify your financial life. You move from being an active landlord to a strategic investor. When you eventually exchange your DST interests for UPREIT units, you gain access to public market liquidity, giving you and your heirs flexibility and control.
For estate planning, these tools are invaluable. Transferring UPREIT units or REIT shares to your beneficiaries is far simpler than dividing physical properties. This clear and efficient process helps ensure your wealth is passed on smoothly, preserving the legacy you worked so hard to build.
By using DSTs for 1031 exchanges and leveraging UPREITs for long-term flexibility, you can create a powerful, tax-efficient strategy that supports your goals for income, growth, and estate planning.
