Delaware Statutory Trusts (DSTs) are a popular investment vehicle in real estate, yet they are often shrouded in complex tax implications. DSTs fall under the general real estate tax rules, including the passive loss rules articulated in Code Section 465. The pivotal IRS Revenue Ruling 2004-86 outlines the structural requirements for DSTs to qualify for an IRC Section 1031 exchange, ensuring they are treated properly in tax scenarios.
While there is no specific IRS guidance addressing the Section 179 deduction in the context of DST investments, the general application of Section 179 expense rules applies. As DST investors defer gains on the sale of relinquished properties, they must carry over their adjusted tax basis to the DST. Without a new asset, Section 179 deductions are generally unavailable. However, if an investor adds cash or assumes more debt than what was on the relinquished property, they effectively create a new tax basis. This new basis could qualify for Section 179 deductions—provided the DST sponsor supplies a cost segregation study allocating some purchase price to assets with shorter useful lives, as defined by the Internal Revenue Code.
For individuals with modified adjusted gross income (MAGI) exceeding $200,000 (or $250,000 for married couples filing jointly), a 3.8% Net Investment Income Tax (NIIT) may apply to net investment income, including rental income derived from DSTs. Notably, this tax is not universal to all investors but specifically targets those with higher MAGI. Fortunately, DST investments typically qualify for the 20% Deduction for Qualified Business Income under Section 199A, providing some relief against the NIIT. This recognition has grown within the industry since the introduction of the provision, adding clarity to the benefits that DSTs can deliver to investors.
Cost segregation studies are increasingly recognized as best practice in the DST landscape, with approximately 75% of DST offerings—including multifamily, industrial, and retail—conducting these studies. A cost segregation study allows investors to benefit from accelerated depreciation by identifying and reclassifying personal property assets and land improvements, thereby enhancing tax efficiency and overall returns.
Investors in DSTs must navigate complex tax rules, from understanding Section 179 eligibility to evaluating the impact of the NIIT. As the industry evolves, leveraging cost segregation studies will become essential for optimizing tax outcomes and maximizing investment returns. Staying informed and proactive will empower investors to make the most of their DST participation.
Please see a lengthy discussion on why DSTs should qualify for the QBI deduction in our first book, Modern Real Estate Investing, pages 78-82.