Delaware Statutory Trusts and § 1031 Exchanges: The Rest of the Story

Building on “Leverage the Delaware Statutory Trust Alternative in a § 1031 Like-Kind Exchange,” Journal of The Missouri Bar, Vol. 82, No. 2 (March–April 2026).

Benjamin Newhouse’s article in the March–April 2026 issue of the Journal of The Missouri Bar is a welcome addition to the conversation about Delaware Statutory Trusts (“DSTs”) and their role in IRC § 1031 like-kind exchanges. For an area of practice that remains surprisingly underappreciated among lawyers and CPAs alike, the article does an excellent job of pulling back the curtain. It lays out the mechanics of § 1031 exchanges clearly, introduces the DST structure in accessible terms, and identifies real advantages that practitioners should have on their radar.

What I want to do here is pick up where the article leaves off. I think there are a few areas — particularly on the risk side — that deserve a deeper look. Not because the article gets them wrong, but because the downside of these investments warrants at least as much attention as the upside. Our clients are counting on us to give them the full picture.

A Strong Foundation

The article covers the essential legal framework well. The like-kind requirement of § 1031(a)(1), the 45-day identification and 180-day acquisition deadlines, the reinvestment and debt replacement requirements, the role of the Qualified Intermediary, and the entity consistency rule are all presented accurately. The discussion of Revenue Ruling 2004-86 — the 2004 IRS ruling that recognized DST beneficial interests as qualified replacement property — is solid, and the treatment of the “Seven Deadly Sins” (the structural restrictions DSTs must observe to maintain trust classification) gives practitioners a useful framework for understanding what makes these vehicles tick.

The article is also right to emphasize that DSTs remain a significantly underutilized strategy. Many experienced real estate lawyers and CPAs have never encountered a DST in practice, and their clients are missing out on what can be a genuinely valuable tool — particularly for investors looking to move from active property management into a passive role without triggering a taxable event. If the article motivates practitioners to learn more about DSTs, it will have accomplished something worthwhile.

A Few Technical Clarifications

In the spirit of building on a good foundation, a couple of technical points are worth flagging for practitioners who may be digging deeper into the authorities.

The article states that taking constructive receipt of exchange proceeds would “violate IRC § 1001.” The more precise citation is § 1031(a) itself, together with the safe harbor provisions of Treasury Regulation § 1.1031(k)-1(f), which specifically address constructive receipt in the deferred exchange context. Section 1001 is a general gain-recognition provision and doesn’t contain the constructive receipt rules that practitioners will need to navigate. A small point, but worth noting for anyone advising on a live transaction.

Similarly, the article’s statement that “debt must be replaced with equal or greater debt” is correct as a practical matter but could benefit from a nuance. Under Treasury Regulation § 1.1031(b)-1(c), debt relief can be offset by either assuming equal or greater debt on the replacement property or by contributing additional cash equity. That distinction matters for clients who have the liquidity to avoid taking on new debt — and it’s the kind of option that a well-informed practitioner should be putting on the table.

Giving the Risks Their Due

The article acknowledges DST disadvantages, and it deserves credit for including them. But I think the balance of the discussion could leave a practitioner with the impression that the advantages clearly outweigh the risks for most clients. In my experience, that is not always the case, and a few of these risks warrant a closer look.

Illiquidity. The article correctly notes that DST interests are illiquid and that no public secondary market exists. What bears emphasizing is how long “illiquid” really means in practice. Typical holding periods run five to ten years, and the investor has no control over when the sponsor decides to sell. During the 2008 financial crisis, DST investors experienced property value declines exceeding 30% with no ability to exit. Distressed secondary buyers, when they appear at all, offer deeply discounted prices. For any client considering a DST, the threshold question is whether they can genuinely afford to have this capital locked up for the better part of a decade. If the answer is anything other than an unqualified yes, a DST is probably not the right fit.

Fees. The article mentions “relatively high management fees.” The numbers tell a sharper story. The median load-to-equity ratio for DST investments is approximately 19.82% — meaning nearly 20 cents of every dollar invested is consumed by upfront commissions, acquisition fees, and costs before a single rent check is collected. Front-end commissions alone typically range from 7% to 10%, with additional layers of acquisition fees, ongoing asset management fees, and disposition fees. Over a seven-to-ten-year hold, the compound drag on returns is meaningful. Clients deserve to understand these numbers in dollar terms, not percentages buried in a Private Placement Memorandum.

Sponsor risk. This may be the single most important variable in a DST investment, and it’s one the article could have spent more time on. The quality and integrity of the DST sponsor determines everything — the quality of the underlying real estate, the prudence of the financing, the competence of property management, and the timing of the exit. When sponsors fail, investors lose, and the structural rigidity of the DST means there is often no path to recovery. Recent litigation — including a $47 million judgment against Crew Enterprises in July 2025 for lender obligation breaches and a separate $56 million lawsuit alleging fraud and misappropriation — underscores that this is not an abstract risk. Any practitioner recommending a DST should independently investigate the sponsor’s track record, financial condition, and litigation history. This is not optional due diligence — it is the standard of care.

Two Structural Risks That Deserve the Spotlight

Two structural features of DSTs deserve more attention than they typically receive, in the article or in practice generally.

The “springing LLC” conversion. The article mentions that DSTs typically contain provisions for “springing” into a limited liability company if a prohibited action is needed. What it does not fully convey is the tax consequence. When a DST springs into an LLC taxed as a partnership, every investor’s beneficial interest converts into a partnership interest — and partnership interests are specifically excluded from § 1031 eligibility under § 1031(a)(2)(D). In plain terms, a springing event permanently eliminates every investor’s ability to conduct a future § 1031 exchange with those proceeds. And springing events are not remote contingencies; they are triggered by ordinary commercial events like loan maturities, anchor tenant departures, and major repairs. Practitioners reviewing a DST offering should evaluate the likelihood of a springing event and make sure the client understands what it means.

The § 721 UPREIT option. The article does a good job identifying this as a ”§ 1031 dead end,” and I want to reinforce that point. Some sponsors present the UPREIT conversion as an attractive “liquidity” feature — the REIT may offer a share repurchase program, after all. But these programs are almost always limited, discretionary, and subject to suspension. Converting DST interests into OP units under § 721 is a one-way door. When the REIT eventually sells the property, all previously deferred capital gains, depreciation recapture, and NIIT become immediately due. Clients need to understand this before they consent.

One Issue the Article Didn’t Cover: Passive Activity Losses

One topic worth adding to the conversation is the passive activity loss limitation under IRC § 469. Because DST interests are passive investments, losses generated by DST interests — including depreciation deductions — can generally only offset other passive income, not active or portfolio income. Unlike active real estate investors who may qualify for the $25,000 rental loss allowance under § 469(i), DST investors do not “materially participate” in the trust’s operations and cannot access this allowance. For clients without significant other sources of passive income, this limitation meaningfully reduces the tax efficiency of a DST investment. It’s the kind of issue a CPA will catch — but ideally, the lawyer flags it first.

The Bottom Line

DSTs are a legitimate and increasingly important tool in the real estate practitioner’s toolkit. Revenue Ruling 2004-86 remains good law. The One Big Beautiful Bill Act (Pub. L. 119-21) did not alter § 1031 or DST treatment. For the right client — one with a long time horizon, no near-term liquidity needs, a well-vetted sponsor, and a clear-eyed understanding of the trade-offs — a DST exchange can be a powerful estate planning and tax deferral strategy.

The Newhouse article is a valuable introduction that will bring this strategy to the attention of practitioners who may not have encountered it before. My hope is that this post serves as a useful companion piece — one that encourages practitioners to dig into the risks with the same enthusiasm they bring to the advantages. Our clients are best served when we give them both sides of the story.

At a minimum, any practitioner advising a client on a DST-based § 1031 exchange should:

1. Verify accredited investor status and conduct a documented suitability analysis — meeting the financial thresholds alone does not establish suitability.
2. Independently investigate the DST sponsor’s track record, financial stability, and litigation history.
3. Read the full Private Placement Memorandum and trust agreement, with particular attention to the springing LLC provision and any § 721 UPREIT option.
4. Analyze the underlying property fundamentals: lease terms, tenant creditworthiness, debt maturity, and the sponsor’s projected exit strategy.
5. Discuss the passive activity loss limitations, the springing LLC risk, and the fee structure in plain terms with the client.
6. Provide a comprehensive written risk disclosure that goes beyond the PPM’s standard boilerplate.

The legal community benefits from articles that introduce useful strategies. It benefits even more when practitioners engage with those strategies thoroughly enough to give their clients the full picture.