Using Delaware Statutory Trusts (DSTs) for Out-of-State Real Estate Diversification: A Complete Guide for Los Angeles Investors
Los Angeles real estate investors increasingly turn to Delaware Statutory Trusts (DSTs) as a strategic solution for diversifying into out-of-state markets while maximizing tax advantages. This comprehensive investment strategy allows California property owners to defer capital gains taxes through 1031 exchanges while accessing stable, income-producing assets across the United States.
What is a Delaware Statutory Trust and How Does It Work?
A Delaware Statutory Trust is a legally separate entity that holds title to income-producing real estate properties. For tax purposes, DSTs are treated as direct property ownership, making them eligible as 1031 exchange replacement properties. This classification enables Los Angeles investors to sell California real estate and reinvest proceeds into fractional ownership of institutional-grade properties nationwide without immediate tax consequences.
DST investments typically feature professionally managed commercial real estate, including multifamily apartments, medical office buildings, retail centers, and industrial properties. Investors purchase beneficial interests in the trust, receiving proportional monthly income distributions and potential appreciation when properties are eventually sold.
Why Los Angeles Investors Choose Out-of-State DST Diversification
Market Conditions Driving Geographic Diversification
Los Angeles real estate faces unique challenges that make geographic diversification particularly attractive:
High Property Values: Median home prices in Los Angeles County exceed $800,000, creating significant capital gains exposure for long-term property owners. Out-of-state markets offer similar or better cash flow potential at substantially lower entry points.
Regulatory Environment: California's tenant-friendly regulations, rent control ordinances, and complex compliance requirements increase operational complexity and reduce net returns for rental property owners.
Market Volatility: Los Angeles real estate experiences pronounced boom-and-bust cycles. Diversifying across multiple markets reduces concentration risk and provides more stable long-term returns.
Tax Advantages of DST Diversification
California property owners face both federal and state capital gains taxes, with combined rates potentially exceeding 30% for high earners. DST investments through 1031 exchanges defer these taxes indefinitely, provided investors continue exchanging into like-kind properties.
Additional tax benefits include:
Geographic tax arbitrage: Some DST properties are located in states with no income tax, potentially improving after-tax yields
Depreciation benefits: Investors can claim depreciation deductions on their fractional ownership interests
Estate planning advantages: Deferred gains receive stepped-up basis for heirs
How DSTs Enable Tax-Deferred Real Estate Diversification
The 1031 Exchange Process with DSTs
The DST investment process follows strict 1031 exchange timelines and requirements:
Step 1: Property Sale and Qualified Intermediary Engagement When selling Los Angeles real estate, a Qualified Intermediary (QI) holds sale proceeds in a segregated account. Investors cannot receive funds directly without triggering taxable events.
Step 2: Identification Period (45 Days) Investors must identify replacement properties within 45 days of sale closing. DSTs offer advantages here since sponsors typically have multiple properties available, and fractional interests can be combined to meet exchange requirements.
Step 3: Exchange Completion (180 Days) Investment funds must be deployed into qualifying DST properties within 180 days of the original sale. Professional DST sponsors facilitate this process, handling legal documentation and fund transfers.
Step 4: Ongoing Income and Management Once invested, DST participants receive monthly distributions from rental income. Professional asset management teams handle all operational responsibilities, including leasing, maintenance, and tenant relations.
Strategic Benefits of DST Diversification for California Investors
Asset Class Diversification
DST investments provide access to institutional-grade commercial properties typically unavailable to individual investors. Common asset types include:
Multifamily properties in growing Sunbelt markets with strong job growth and population increases
Medical office buildings in markets with expanding healthcare systems
Industrial and logistics properties benefiting from e-commerce growth
Retail properties in stable, necessity-based locations
Geographic Risk Mitigation
Spreading investments across multiple markets reduces exposure to regional economic downturns. Popular DST markets include:
Texas: No state income tax, strong job growth, and business-friendly regulations
Florida: No state income tax, growing population, and diverse economy
Midwest markets: Affordable property values and stable rental demand
Southeastern states: Economic growth and favorable demographic trends
Professional Management Benefits
DST investments eliminate direct property management responsibilities while maintaining real estate investment benefits. Professional sponsors handle:
Tenant acquisition and retention
Property maintenance and capital improvements
Financial reporting and tax documentation
Strategic asset positioning and eventual disposition
Tax Implications for California DST Investors
California Tax Considerations
California continues to track deferred capital gains even when properties are located out-of-state. However, DST investments provide several advantages:
Simplified Compliance: DST sponsors provide comprehensive tax reporting, making annual filings straightforward compared to direct out-of-state property ownership.
Potential Tax Benefits: If DST properties are located in no-income-tax states, ongoing rental income may be subject to more favorable tax treatment than California rental income.
Continued Deferral Options: At DST disposition, investors can execute additional 1031 exchanges, further deferring California capital gains recognition.
Real-World Case Study: LA Investor Success Story
Consider a Los Angeles investor who sold a Beverly Hills duplex for $3.2 million, representing a $1.8 million gain from the original purchase price. Facing approximately $540,000 in combined federal and California capital gains taxes, the investor instead chose DST diversification.
Investment Allocation:
40% Southeast multifamily properties (Atlanta and Charlotte markets)
35% Texas industrial properties (Dallas and Houston)
25% Midwest medical office buildings (Chicago and Indianapolis)
Results After Three Years:
Deferred $540,000 in immediate tax liability
Receiving 6.2% annual income distributions ($198,400 annually)
No management responsibilities or tenant interactions
Portfolio positioned for potential appreciation across multiple growth markets
Key Considerations and Risk Factors
DST Investment Limitations
Lack of Control: DST investors cannot influence management decisions, tenant selection, or disposition timing.
Liquidity Constraints: DST interests are typically illiquid investments held for 5-10 years until property disposition.
Market Risk: While geographically diversified, DST investments remain subject to general real estate market cycles.
Due Diligence Requirements
Successful DST investing requires careful evaluation of:
Sponsor track record and experience
Property quality and market fundamentals
Financial projections and cash flow assumptions
Exit strategy and disposition timeline
Maximizing DST Investment Success
Sponsor Selection Criteria
Choose DST sponsors with:
Proven track records in target markets
Strong institutional relationships
Conservative underwriting practices
Transparent reporting and communication
Portfolio Construction Strategies
Optimize DST diversification through:
Geographic spread across multiple markets and regions
Asset type diversification among property sectors
Investment timing to spread market entry risk
Size allocation balancing minimum investments with diversification goals
Getting Started with DST Diversification
Los Angeles real estate investors considering DST diversification should begin with comprehensive planning at least six months before anticipated property sales. This timeline allows for:
Market research and sponsor evaluation
Tax planning and projection analysis
Qualified Intermediary selection and setup
Investment strategy development and refinement
Working with experienced real estate professionals familiar with both Los Angeles markets and national DST opportunities ensures optimal investment outcomes while maintaining compliance with all regulatory requirements.
Ready to explore DST diversification opportunities? The Borges Real Estate Team specializes in helping Los Angeles investors successfully navigate 1031 exchanges and DST investments. Our expertise in California real estate markets and national investment opportunities can help you defer taxes while building a diversified, income-producing portfolio. Contact us today to discuss your specific investment goals and explore available DST opportunities.
