Investors Doing their §1031/DST Research Overview ~ Part Five Questions for Your CPA  

We con­tin­ue the Investor Dri­ven Series research­ing a 1031 exchange with the uti­liza­tion of a Delaware Statu­to­ry Trust (DST) as the replace­ment prop­er­ty. Part Five will focus on top­ics of dis­cus­sion the investor may want to engage with their CPA or account­ing pro­fes­sion­al.

May 25, 2025

By Al DiNi­co­la, AIF®
1031 Tax Deferred Exchange Spe­cial­ist & DST Advisor/Specialist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

There may be a set of ques­tions, obser­va­tions, or repo­si­tion­ing of the investor real estate assets.   Under­stand­ing tax effi­cien­cies of real estate assets and engag­ing a CPA with proac­tive strate­gies can pro­duce poten­tial out­stand­ing results.  When con­sid­er­ing using a DST in a §1031 exchange, an investor should con­sult their CPA on a range of items such as §1031 qual­i­fi­ca­tion, tax impli­ca­tion, finan­cial (account­ing & report­ing), invest­ment con­sid­er­a­tion, estate plan­ning and due dili­gence. CPAs and tax pro­fes­sion­als are vital ser­vice providers for the indi­vid­ual and busi­ness investors. In recent sur­veys, CPAs have earned the des­ig­na­tion as a “most trust­ed advi­sor”. One of the ini­tial ques­tions or sit­u­a­tions to under­stand is if there is an over­all need to sell the cur­rent real estate. In addi­tion, if the prop­er­ty is sold what are the impli­ca­tions of cap­i­tal gains?  The CPA should be in a posi­tion to eval­u­ate the tax impli­ca­tion. The impli­ca­tion maybe fed­er­al cap­i­tal gains tax­es, recap­ture of depre­ci­a­tion, any state tax­es and depend­ing on the investors’ income the NIT (net invest­ment income tax) may also be due. This may be only part of the list of items.

§1031 Exchange Qual­i­fi­ca­tion. Start­ing with the end in mind, does the DST qual­i­fy as like-kind prop­er­ty? Investors should confirm that the DST struc­ture being offered qual­i­fies under IRS rules as like-kind real estate for §1031 pur­pos­es. CPAs that do not han­dle §1031 exchanges on a reg­u­lar basis (and the DST replace­ment) may need to review how to han­dle. DSTs often have min­i­mum invest­ment thresh­olds as low as $100,000.Thisallows investors to spread pro­ceeds from a relin­quished prop­er­ty sale across sev­er­al DSTs. This may occur by rein­vest­ing the sales pro­ceeds (held by a Qual­i­fied Inter­me­di­ary) from the sale of the relin­quished prop­er­ty and acquir­ing more than one DST.   An investor with $500,000 in sales pro­ceeds may acquire mul­ti­ple prop­er­ties.  Warn­ing, the CPA nor a title com­pa­ny can­not hold the sales pro­ceeds.

There are Tim­ing Require­ments to be con­sid­ered. How does the DST fit into the 45-day iden­ti­fi­ca­tion and 180-day clos­ing rules of a §1031 exchange? One of the require­ments for §1031 exchange to be valid is to replace the debt paid off on the relin­quished prop­er­ty.  This may be accom­plished by adding more cash (aka fresh cash) towards the replace­ment acqui­si­tion. How­ev­er, investors may seek a DST that has lever­age. If the DST uses lever­age, it is non-recourse to investors. This means investors are not per­son­al­ly liable for the loan this may be impor­tant for risk man­age­ment. This also means the investor does not need to apply for a loan since the DST with debt is prepack­aged and the investors will receive a pro rata share of the debt based on the equi­ty invest­ment.  Con­sult with the CPA if addi­tion­al debt that increas­es the basis may result in addi­tion­al tax effi­cien­cies.

The Exchange Struc­ture Com­pli­ance should be dis­cussed with your CPA. Mean­ing con­firm­ing thedi­rect inter­est in the DST (not part­ner­ship inter­est) being acquired will com­ply with IRS guide­lines.

Most CPAs will be con­cerned with the Tax Impli­ca­tions. Under­stand the Tax Defer­ral Mechan­ics. How will gains be deferred, and under what cir­cum­stances might they be rec­og­nized? Anoth­er ques­tion for the investor to ask the CPA may be what is the sta­tus of depre­ci­a­tion sched­ule of their cur­rent real estate prop­er­ty. In oth­er words, how much depre­ci­a­tion remains and under­stand­ing the basis in the cur­rent real estate port­fo­lio.

One of the most mis­un­der­stood issues for the investor is Depre­ci­a­tion Recap­ture. Regard­less if you, as the investor, declared the depre­ci­a­tion on your indi­vid­ual tax­es the IRS assumes you have tak­en depreciation.Will there be depre­ci­a­tion recap­ture from the relin­quished prop­er­ty? How is it han­dled in the DST invest­ment?

Depend­ing on your state of res­i­dence you may have State Tax Issues. What state tax impli­ca­tions should the investors be aware of, espe­cial­ly if the relin­quished and replace­ment prop­er­ties are in dif­fer­ent states? Also under­stand cer­tain states may have “Claw Back” pro­vi­sions.

Report­ing and Account­ing must continue.There will be Annu­al Tax Report­ing Requirements.What tax doc­u­ments (e.g., Sched­ule E, K‑1, Trust let­ter) will the investor receive from the DST spon­sor?

Under­stand­ing the Impact on Pas­sive Activ­i­ty Loss Rules may be crit­i­cal. Will my DST inter­est be con­sid­ered a pas­sive activ­i­ty, and how does that impact my abil­i­ty to use pas­sive loss­es?

Over­all Invest­ment Con­sid­er­a­tions must include Basis and Future Exchanges.How is my basis tracked in the DST? Can I lat­er do anoth­er §1031 exchange out of the DST?

If we return to hav­ing the end in mind there the Exit Strat­e­gy and Liq­uid­i­ty events must be a consideration.What hap­pens at the end of the DST hold­ing peri­od? Will I be able to do a future §1031 exchange or be forced to rec­og­nize gain?

There are many investors who con­sid­er Estate Plan­ning an impor­tant ele­ment to under­stand. The rec­og­nized Step-Up in Basis is a pro­vi­sion in the tax code. How will DST inter­ests be treat­ed upon death? Is there a step-up in basis for heirs? When we start a con­ver­sa­tion with a poten­tial investor, we also want to under­stand the long-range goals for the §1031. DST inter­ests can be passed on to heirs, who receive a step-up on cost basis, poten­tial­ly elim­i­nat­ing deferred tax­es alto­geth­er. Oth­er investors may seek to name a char­i­ty to be the ben­e­fi­cia­ry of spe­cif­ic DSTs. One of the new­er exit strate­gies cer­tain DST spon­sors may include in the offer­ing is the abil­i­ty for the DST to move into a REIT via a 721 UPREIT. This would be upon the full cycle (sale) of the DST.  There are a few new­er DST with accel­er­at­ed paths to a 721 UPREIT. We have writ­ten oth­er arti­cles on that top­ic

The tax­pay­er iden­ti­fi­ca­tion, Own­er­ship Title and Trusts need to be clear­ly estab­lished. Can the DST inter­est be held in a liv­ing trust or LLC? There may need to be plan­ning ahead of the sale of relin­quished prop­er­ty.

Rep­re­sen­ta­tives are tasked with the Due Dili­gence and suit­abil­i­ty of spe­cif­ic replace­ment assets.  CPAs may need to ver­i­fy accred­it­ed investor sta­tus. Finan­cial advi­sors and DST spe­cial­ists will review Spon­sor Fees and Expens­es. How do the fees (acqui­si­tion, man­age­ment, dis­po­si­tion) affect after-tax returns?

The record keep­ing needs to be clear­ly estab­lished to avoid Audit and IRS Risk. Are there any known IRS chal­lenges or audit risks asso­ci­at­ed with this spe­cif­ic DST struc­ture?

As a reminder we are not tax con­sul­tants, and we are not offer­ing tax advice. How­ev­er, we do inter­face with tax pro­fes­sion­als to pro­vide back­up mate­ri­als and exam­ples of redact­ed trans­ac­tions as well as due dili­gence mate­ri­als for review.  We wel­come the oppor­tu­ni­ty to speak with investor CPA and tax pro­fes­sion­als. 

In Part Six we will cov­er “What type of diver­si­fi­ca­tion can be sug­gest­ed for investors using a Delaware statu­to­ry trust in a 1031 exchange”.   

NAMCOA® is a SEC reg­is­tered invest­ment advi­so­ry firm that pro­vides com­pre­hen­sive port­fo­lio man­age­ment, finan­cial plan­ning, and fidu­cia­ry deci­sion-mak­ing ser­vices on behalf of retire­ment plan spon­sors. Our dif­fer­ence is sum­ma­rized by our fidu­cia­ry approach which enables us to bet­ter meet port­fo­lio and retire­ment plan objec­tives, result­ing in stronger risk adjust­ed returns for investors and peace of mind for Clients. We also focus on alter­na­tive real estate invest­ment. Many real estate investors are seek­ing tax deferred solu­tions uti­liz­ing §1031 exchanges or Oppor­tu­ni­ty Zones.

DSTs are not for all investors.  The acqui­si­tion of a DST is for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your §1031 Exchange and suit­ed for your invest­ment future. For more infor­ma­tion on how to prop­er­ly set up an IRC §1031 Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus.  Invest­ing in secu­ri­ties, real estate, or any invest­ment, whether pub­lic or pri­vate, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor.   NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion). Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 5 Cen­ter­pointe Dri­ve, Ste. 400 Lake Oswego, OR, 97035. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.