How to 1031 Exchange Into a DST in California
Updated July 2026. Figures and law current as of this date.
You 1031 exchange into a DST the same way you exchange into any replacement property: sell through a qualified intermediary, identify the DST in writing within 45 days, and close within 180 days. IRS Revenue Ruling 2004-86 treats a properly structured DST interest as like-kind real estate. The extra gates are securities rules: DST interests are private placements sold only to accredited investors, and the deferral carries real trade-offs in liquidity, fees, and control.
Los Angeles investors usually meet the DST idea at the worst possible moment: escrow is closing on the relinquished property, the 45-day clock is running, and every replacement building in the identification file has a problem. This guide walks the entire process, from confirming you qualify through the year-after-year California filings, so you can decide with time to spare. If you are still weighing a DST against buying replacement property yourself, start with our DST versus traditional 1031 exchange comparison; this article is about how the DST route actually works.
Can You 1031 Exchange Into a DST?
Yes. The IRS answered this directly in Revenue Ruling 2004-86: an investor who exchanges investment real estate for a beneficial interest in a properly structured Delaware Statutory Trust is treated as acquiring an undivided fractional interest in the trust's real estate, not a security. That makes the DST interest like-kind replacement property, and the exchange qualifies for nonrecognition of gain under Section 1031, provided every other exchange requirement is met.
The qualifier "properly structured" is doing real work in that sentence. The ruling only blesses trusts whose trustees are stripped of almost every management power a normal owner has; the full list is covered in the seven deadly sins section below. Sponsors build their offerings to fit inside the ruling, but the structure is why DSTs behave so differently from direct ownership. The controlling guidance has not changed since the IRS issued it in August 2004.
What a DST Is, and Why California Investors Use One
A Delaware Statutory Trust is a legal entity formed under Delaware law (Del. Code Ann. title 12, Sections 3801 to 3824) that holds title to income real estate, typically institutional-grade property such as an apartment community, industrial building, or net-leased commercial asset. Investors buy beneficial interests in the trust and receive their proportional share of the income the property produces. For federal tax purposes the trust is an investment trust and each investor is treated as owning a slice of the real estate itself, which is the mechanism that makes the 1031 exchange work. The basics are covered in our plain-English guide to 1031 exchanges, and the Los Angeles-specific picture is in our LA DST exchange overview.
The draw for Los Angeles owners is a specific combination. Decades of appreciation have left large embedded gains; the Southern California rental business has grown harder to operate under layered rent regulation; and DSTs offer a way to defer the entire tax bill while exiting day-to-day management. The honest counterweight is that you trade control and liquidity for that convenience, which is why the risks section below deserves as much attention as this one. It is a legitimate tool with sharp edges, all of them defined by Revenue Ruling 2004-86.
Step-by-Step: How to 1031 Exchange Into a DST
Confirm You Qualify on Both Sides
Two separate tests apply. The tax side: the property you are selling must be held for investment or business use. The securities side: DST interests are private placements, so you must be an accredited investor, generally $1 million net worth excluding your primary residence, or $200,000 income ($300,000 joint) in each of the last two years (SEC accredited investor definition).
Engage a Qualified Intermediary Before Closing
Exchange proceeds can never touch your account. A qualified intermediary (QI) must hold the sale proceeds under an exchange agreement signed before your relinquished property closes. Touch the money once and the exchange is dead, with the full gain taxable that year.
Sell the Relinquished Property
Closing day starts both exchange clocks. Day 45 is your identification deadline; day 180 is your completion deadline. Both run on calendar days with no extensions for weekends or holidays.
Identify the DST in Writing Within 45 Days
Deliver a written, signed identification to your QI naming the DST offering (alone or alongside other candidate properties under the three-property or 200% rules). Many investors list a DST as a backup behind one or two direct-purchase buildings; the mechanics are in the deadline section below.
Read the PPM and Vet the Sponsor
Every DST offering comes with a private placement memorandum (PPM) disclosing the property, the debt, the fee stack, and the risk factors. Work through the sponsor due-diligence checklist below with your CPA and financial adviser before committing a dollar.
Close Through Your QI Within 180 Days
Your QI wires the exchange funds directly to the trust and you receive your beneficial interest. DST closings are typically fast because the sponsor has already bought and financed the property; there is no loan approval or escrow negotiation on your side.
Report and Keep Filing
File IRS Form 8824 with your federal return for the exchange year. If your relinquished property was in California and the DST's real estate is not, you also file Form FTB 3840 with California that year and every year after until the deferred gain is recognized.
None of the seven steps is optional, and the sequence matters: the QI agreement must exist before the sale closes, and the identification must be delivered before day 45 ends at midnight. Get the order wrong and there is no cure; the IRS deadlines in Section 1031(a)(3) have no good-faith exception, only the 180-day limit and the 45-day limit.
The 45-Day and 180-Day Deadlines When Your Replacement Is a DST
The deadlines are the same as any exchange: identify in writing within 45 days of closing, complete the acquisition within 180 days (or by your tax return due date, if earlier, unless you extend). The identification rules come from Treasury Regulation 1.1031(k)-1(c): you may name up to three candidate properties of any value (the three-property rule), or more than three if their combined value stays within 200% of what you sold (the 200% rule), or any number if you actually acquire 95% of the identified value (the 95% rule). Our full breakdown of the clock, with edge cases, is in the 45 and 180 day deadline guide.
DSTs interact with those rules in a useful way. Because a sponsor's offering is already purchased, financed, and open for investment, a DST can close in days rather than weeks. That is why exchange professionals often see DSTs listed as the third property in a three-property identification: if the primary purchase falls apart in week 20, the DST is a replacement that can still close before the deadline. The backup only works if you named it by day 45, so the decision to include one has to happen during the identification window, not at day 170.
DST interests are sold in dollar-denominated slices, so investors also use them to absorb leftover exchange funds. If you buy a replacement building that costs less than what you sold, the difference is taxable boot; placing that remainder into a DST identified within the window can defer it instead. The same three-property and 200% identification limits of Treasury Regulation 1.1031(k)-1(c) apply.
Who Can Invest: The Accredited Investor Requirement
DST interests are securities, and sponsors sell them as private placements under SEC Regulation D, most commonly Rule 506(b). That rule prohibits general solicitation and, in practice, limits DST offerings to accredited investors. You will complete an investor questionnaire before any sponsor accepts your money, and the selling firm is required to have a reasonable basis for believing you qualify.
The SEC's financial tests for an individual accredited investor are: net worth over $1 million, alone or with a spouse or spousal equivalent, excluding your primary residence; or income over $200,000 (or $300,000 jointly) in each of the two most recent years with a reasonable expectation of the same this year. Certain professional licenses also qualify. For a long-time Los Angeles landlord the net worth test is usually the easy one; equity in investment property counts, and the exclusion applies only to the home you live in. The thresholds themselves have been fixed by the SEC since 1982: $1 million, $200,000, and $300,000.
How DST Sponsors Work and How to Vet One
The sponsor is the real estate company at the center of every DST. It finds and buys the property, arranges any financing before investors arrive (which is why the trust's debt terms are fixed), forms the trust, writes the PPM, and sells beneficial interests through a network of broker-dealers and registered investment advisers. After the offering closes, the sponsor or an affiliate manages the property, sends investors their distributions and a grantor letter for tax reporting, and eventually sells the asset, at which point you can cash out and pay the deferred tax or exchange again into the next property.
The Fee Layers to Find in the PPM
Sponsors are paid through the structure, and every layer is disclosed in the PPM's estimated use of proceeds and compensation tables. Look for: selling commissions and dealer-manager fees paid to the distribution network; an acquisition fee on the property purchase; financing fees if the trust carries debt; an ongoing asset management fee; and a disposition fee when the property sells. The sum, often called the load, is the gap between what you invest and the real estate actually working for you. Comparing that load across offerings, line by line, is the single most useful exercise in the whole PPM.
A Due-Diligence Checklist
1. How many offerings has the sponsor taken full cycle (bought, operated, and sold), and what did investors actually receive? 2. What is the total fee load in the use-of-proceeds table? 3. Are projected distributions covered by the property's current income, or supported by reserves? 4. What are the debt terms, and does the loan mature before the expected exit? 5. Who is the tenant base, and what happens to cash flow if occupancy slips? 6. What do the PPM risk factors say in the sponsor's own words? 7. Is the person selling it to you registered? Check them on FINRA BrokerCheck or the SEC's adviser database before any other step.
Notice what is not on that list: brand names. Sponsor reputations are built and lost inside multi-year hold periods, so a firm's marketing footprint tells you far less than its full-cycle record and its documents. The checklist works on any offering because it relies on the PPM and two public registries, FINRA BrokerCheck and the SEC's Investment Adviser Public Disclosure database.
What DST Properties Are for Sale Right Now?
DST properties are not listed on any public market: each offering is a Regulation D private placement, available only through the broker-dealers and registered investment advisers in the sponsor's selling group, and only to accredited investors. There is no MLS for DSTs, and any list you find online is a marketing funnel, not an exchange. To see current inventory you work with a licensed adviser who has access to multiple sponsors' offerings and can match one to your exchange size and timeline.
The property types behind current offerings follow institutional demand: multifamily communities in growth markets, industrial and logistics buildings serving e-commerce, net-leased retail and pharmacy buildings with credit tenants, medical office, senior housing, and self-storage. Single-tenant net-lease trusts behave differently from a 300-unit apartment trust (one tenant's lease versus hundreds of short leases), so the sector choice is a real diversification decision. Whatever the sector, the legal wrapper is the same private placement structure under SEC Regulation D.
Delaware Statutory Trust California Rules: State Taxes and Form FTB 3840
California conforms to Section 1031 deferral, so a valid DST exchange defers your state tax too. But almost every DST holds property outside California, and that triggers the state's clawback rule: when you exchange California real estate for out-of-state replacement property, the California-source gain is determined at the time of the exchange and preserved. Whenever that deferred gain is finally recognized, even years later on the sale of a Texas apartment complex, California taxes its share, and at ordinary income rates of 1% to 13.3%, because the state has no preferential capital gains rate (Franchise Tax Board).
The enforcement mechanism is Form FTB 3840, California Like-Kind Exchanges. You file it for the year of the exchange and every year afterward until the deferred California gain is recognized, reporting the properties and the gain allocation. Stop filing and the Franchise Tax Board can issue an assessment on the deferred amount. It is an information return, not a tax bill, but treat it as a standing appointment: the requirement has applied to exchanges of California property for out-of-state property since January 1, 2014.
The Seven Deadly Sins: What a DST Trustee Cannot Do
Revenue Ruling 2004-86 only treats DST investors as owning real estate because the trustee's powers are frozen. The industry calls the resulting prohibitions the seven deadly sins, and every one of them traces to the ruling's text:
| Prohibition | What It Means for You |
|---|---|
| 1. No new capital contributions after the offering closes | A struggling property cannot be rescued with a cash call |
| 2. No renegotiating or refinancing the trust's debt | Loan terms are fixed for the life of the trust, whatever rates do |
| 3. No new leases or renegotiated leases (except tenant bankruptcy or insolvency) | The trustee cannot chase better tenants or restructure rents |
| 4. No reinvesting sale proceeds | When the property sells, the trust ends and cash is distributed |
| 5. Capital spending limited to normal repair, minor non-structural improvements, and legally required work | No renovations or repositioning plays |
| 6. Idle cash only in short-term government obligations or CDs | Reserves cannot be invested for yield between distributions |
| 7. All cash beyond reserves must be distributed on schedule | Income flows out; it cannot be stockpiled inside the trust |
These are not sponsor preferences; they are the conditions of tax qualification. The ruling states that if the trustee holds prohibited powers, the trust becomes a business entity taxed as a partnership, and partnership interests are expressly excluded from like-kind treatment under Section 1031(a)(2). Sponsors handle a genuine crisis through a conversion sometimes called a springing LLC, which can save the property but replaces the trust structure and may complicate a future exchange. Every one of the seven restrictions comes straight from Revenue Ruling 2004-86.
What Are the Risks of a DST 1031 Exchange?
The risks are real, disclosed, and structural. Illiquidity leads the list: your money is committed until the sponsor sells, commonly 5 to 10 years, and there is no established secondary market for DST interests. Control is second: you cannot influence management, refinancing, or sale timing, because nobody can; the seven deadly sins bind the trustee too. Fees are third: the load described above reduces the real estate behind each invested dollar, and it is larger than the transaction costs of buying a building directly.
The rigidity risk is the one investors underestimate. Direct owners respond to a bad year by refinancing, re-leasing, or investing new capital. A DST trustee is prohibited from all three. The structure that qualifies the trust under Revenue Ruling 2004-86 is the same structure that removes every steering wheel when conditions turn.
Round out the list with ordinary market risk (values and occupancy move with the economy), concentration risk (many trusts hold a single property with a single business plan), sponsor risk (projections, fee behavior, and execution vary widely), and distribution risk (payments are not guaranteed and can be reduced or paused). Interest-rate conditions at exit matter as well, since the trust must sell into whatever financing market exists when the hold ends. Weigh all of it against the tax bill you are deferring; the worked example below quantifies that side at $423,630.
A Worked Example: What a DST Exchange Defers on an LA Fourplex
The numbers below are a hypothetical illustration with stated assumptions, not a client transaction. Assume a married couple bought a Los Angeles fourplex for $600,000 in 2005, claimed $330,000 of straight-line depreciation, and sells in 2026 for $1,500,000 net of selling costs. For scale, the Los Angeles County single-family median stood at $838,350 in May 2026 (C.A.R. Home Sales and Price Report), so a long-held small multifamily building at this price is unremarkable. Assume their other income already fills the 20% federal bracket and a 9.3% California marginal rate applies.
| Line | Amount | How It Is Computed |
|---|---|---|
| Adjusted basis | $270,000 | $600,000 cost minus $330,000 depreciation |
| Total gain | $1,230,000 | $1,500,000 sale price minus $270,000 adjusted basis |
| Federal tax on appreciation | $180,000 | 20% on the $900,000 long-term gain above the depreciation |
| Depreciation recapture | $82,500 | 25% on $330,000 of unrecaptured Section 1250 gain |
| Net investment income tax | $46,740 | 3.8% on $1,230,000 (IRC Section 1411, assuming income over the $250,000 threshold) |
| California tax | $114,390 | 9.3% ordinary-income treatment on $1,230,000 |
| Total deferred by completing the exchange | $423,630 | Sum of the four tax lines |
Selling with no exchange sends roughly that amount to the IRS and the Franchise Tax Board in a single tax year. Completing a 1031 exchange into a DST (or any qualifying replacement property) defers all of it, leaving the full $1,500,000 working. Deferral is not forgiveness: the gain resurfaces when the DST property sells unless you exchange again, and heirs receive a stepped-up basis at death under current law, which is the deep dive in our guide to capital gains on inherited California property. On these assumptions the deferral is worth $423,630.
What Changed for 1031 Exchanges and DSTs in 2026
The headline is that nothing changed, and for 1031 investors that is genuinely news. The One Big Beautiful Bill Act (Public Law 119-21, signed July 4, 2025) rewrote large parts of the tax code and left Section 1031 untouched for real property. The proposal from the prior administration's fiscal 2025 budget to cap deferral at $500,000 of gain per exchange was never enacted, and as of July 2026 no bill limiting like-kind exchanges has passed either chamber of Congress. Revenue Ruling 2004-86 remains the controlling DST guidance, unmodified.
What did move are the inflation-indexed numbers around the exchange decision. The 2026 federal long-term capital gains thresholds (IRS Rev. Proc. 2025-32) are:
| 2026 Federal Rate | Single Filer (Taxable Income) | Married Filing Jointly |
|---|---|---|
| 0% | Up to $49,450 | Up to $98,900 |
| 15% | $49,451 to $545,500 | $98,901 to $613,700 |
| 20% | Above $545,500 | Above $613,700 |
Stack the 3.8% net investment income tax (thresholds of $200,000 single and $250,000 joint, fixed by statute and never indexed) and California's ordinary-income treatment at 1% to 13.3%, and a high-bracket Los Angeles seller still faces a combined marginal rate that can reach 37.1% on a large gain. That arithmetic, not any new law, is what keeps exchange volume steady, and it is all anchored to figures published in Rev. Proc. 2025-32.
Frequently Asked Questions
Yes. IRS Revenue Ruling 2004-86 treats a properly structured DST interest as an undivided interest in the trust's real estate, so it qualifies as like-kind replacement property. You still must follow every standard exchange rule: a qualified intermediary, the 45-day identification window, and the 180-day closing deadline.
The big five are illiquidity (plan on 5 to 10 years with no guaranteed resale market), zero management control, layered sponsor fees, ordinary real estate market risk, and the structural rigidity of Revenue Ruling 2004-86, which bars the trustee from raising new capital or refinancing when a property hits trouble. Each offering's private placement memorandum lists its own risk factors; read that section before wiring funds.
A sponsor buys the property, places it into the trust, arranges any financing, and sells beneficial interests to accredited investors through broker-dealers and registered investment advisers as a Regulation D private placement. The sponsor or an affiliate then manages the property for disclosed fees, distributes cash to investors, and sells the asset at the end of the hold period, commonly 5 to 10 years.
Each offering sets its own minimum in the private placement memorandum. Commonly reported minimums run $25,000 to $100,000, with $100,000 the figure most often quoted for 1031 exchange investors. That is far below the cost of buying institutional real estate directly, which is part of the appeal.
Yes, as long as it is investment property. A single-family rental, condo, duplex, or commercial building can all be exchanged into a DST because like-kind treatment covers any real property held for investment or business use. Your primary residence does not qualify.
Plan as if you cannot get it out. DST interests have no established secondary market; some sponsors facilitate resales, but pricing is typically discounted and nothing is guaranteed. Only exchange money you can leave invested for the full hold period.
As rental income on your return, reported through a grantor letter from the trust rather than a K-1. You keep proportional depreciation deductions, which can shelter part of the cash flow in the early years. California taxes that income at ordinary rates of 1% to 13.3% (Franchise Tax Board).
Eventually, yes, on the gain you deferred. California preserves the California-source gain when you exchange into out-of-state property and requires an annual information return, Form FTB 3840, every year until the deferred gain is recognized. Skipping the filing invites the FTB to assess the deferred tax early.
Selling an LA Property Before a 1031 Exchange?
The exchange starts with the sale. Whether you own a fourplex in Highland Park or a rental in Pasadena, Justin Borges helps LA investors position the relinquished-property sale so the exchange clock works in your favor.
The Borges Real Estate Team | 680 E Colorado Blvd Suite 180, Pasadena, CA 91101
