1031 Exchange Blog

Written by Ashley Romiti | GCA 1031

Documents, deadlines and the questions I would ask each professional before closing a 1031 exchange into a Delaware Statutory Trust.

When most investors think about a 1031 exchange, they think about the deadlines. Day 45. Day 180.

Those dates matter. But when the replacement property is a DST, there is a lot more happening behind the scenes than most people expect, and the investors who have the smoothest closings are usually the ones who understood the whole process before their sale ever closed.

This article walks through that process step by step, who handles what, and the checklist I would want every investor to have in hand.

How Does a 1031 Exchange Work When the Replacement Property Is a DST?

A 1031 exchange into a Delaware Statutory Trust is really two processes running side by side: the tax-deferred exchange and the investment closing.

On one side, the qualified intermediary manages the exchange funds and the identification mechanics.

On the other side, the investor is separately evaluating the DST, subscribing to it and closing on it.

The goal is to get both of those moving early enough that your due diligence does not get squeezed into the last few days of the 45-day identification period.

How a DST 1031 exchange comes together

1. 1Sell property
2. 2QI holds exchange funds
3. 3Identify within 45 days
4. 4DST due diligence + subscription
5. 5QI funds DST
6. 6Complete exchange by applicable deadline

Key parties:InvestorQICPA / Tax ProfessionalDST SponsorSecurities Professional

The Big Picture: From Property Sale to DST Closing

Before we get into the details, here is what a simplified 1031 + DST transaction generally looks like from start to finish:

1. Before the sale closes, engage a qualified intermediary and sign the exchange documents.
2. Sell the relinquished investment property.
3. Have the exchange proceeds go to the qualified intermediary, not to you.
4. Evaluate potential replacement properties, including DSTs if they are appropriate for you.
5. Identify replacement property within the 45-day identification period.
6. Complete DST due diligence, investor paperwork and subscription documents.
7. Coordinate the final investment amount and any debt-replacement requirements.
8. Have the qualified intermediary transfer exchange funds for the DST closing.
9. Complete the replacement-property acquisition within the 180-day exchange period, keeping in mind the tax return due-date rule.

The deferred exchange timeline

Day 0Day 45Day 180

Identify
Replacement property identified within 45 days

Close
Replacement property received within 180 days, or by the tax return due date if earlier

Every transaction is a little different, so confirm your specific deadlines and structure with your qualified intermediary and tax professionals.

Step 1: Set Up the Exchange Before the Sale Closes

This is the step people most often underestimate.

Some of the most important work in a 1031 exchange happens before the relinquished property sale is complete. In general, you need your exchange structure and qualified intermediary in place before closing, not after.

What the Qualified Intermediary Does

The qualified intermediary, or QI, sits at the center of a delayed 1031 exchange. Among other things, the QI typically:

• Enters into the exchange agreement with you, the taxpayer
• Coordinates receipt and custody of the exchange proceeds
• Receives your replacement-property identification
• Transfers exchange funds to acquire the replacement property
• Provides documentation of the exchange mechanics

What the QI does not do is replace your CPA, your attorney or your investment professional. Its job is the mechanics of the exchange, and that is where its role ends.

Questions to Ask Your QI

I recommend getting clear answers to these early:

• What is my exact 45-day identification deadline?
• What is my exact exchange-completion deadline?
• What identification format do you require?
• How should a DST be described on the identification form?
• What wiring documents will you need before funding?
• How much exchange cash is currently available?
• What records will I receive after the exchange closes?

Step 2: Know Where the Sale Proceeds Go

Here is something that surprises some first-time exchangers: in a properly structured delayed exchange, you generally do not take possession of your sale proceeds.

The money is held through the qualified intermediary structure until it is used to buy your replacement property.

That distinction matters. Receiving or controlling the funds can create tax problems. So please do not assume you can deposit the sale proceeds into your own bank account and move them into a DST later.

The money flow is simple to visualize

Sale ClosingRelinquished property

→

Qualified IntermediaryHolds exchange funds

→

Replacement Property ClosingDST investment

Step 3: Start DST Due Diligence Before Day 45

Forty-five days goes by faster than you think.

If you wait until the final week to start looking at DSTs, you may end up making a complex real estate and securities decision under a lot of unnecessary pressure. That is not where I want any investor to be.

When I review a DST, I like to break the analysis into three questions.

1. Does the DST solve the exchange problem?

• Does the equity amount fit?
• Does the DST provide enough replacement value?
• If you have debt-replacement needs, does the assigned debt fit your exchange plan?
• Can the investment close within the required timeframe?

2. Is the underlying real estate attractive?

A DST is still real estate, and the underlying asset matters. I want to know:

• What did the sponsor pay for the property?
• How does the purchase price compare with the appraisal and market comparables?
• What are the occupancy, tenant and lease risks?
• Are the rent growth and expense assumptions realistic?
• What are the financing terms, reserves and exit assumptions?

3. Is the investment right for you?

• How much of your net worth would go into this investment?
• How much liquidity will you have outside the DST?
• Does the projected income fit your objectives?
• Are you comfortable with an illiquid, passive investment?
• Does the expected exit strategy fit your future plans?

If you want to go deeper on how I work through these questions, take a look at How I Evaluate 1031 Replacement Property Options and How to Evaluate a DST Sponsor.

Step 4: Complete the DST Investment Documents

Buying into a DST is not as simple as wiring money to a property seller.

DSTs are typically offered through private-placement documents, so there is real paperwork involved. The exact list varies by sponsor, broker-dealer and investor, but you can expect some combination of:

• Private Placement Memorandum (PPM)
• Subscription agreement
• Investor questionnaire and suitability information
• Accredited-investor verification or representations, when applicable
• Ownership entity and taxpayer information
• Statement of net worth or other financial information
• Direct-deposit instructions for future distributions
• Investor acknowledgments and required disclosures
• Qualified intermediary and exchange-funding information

Of everything on that list, the PPM deserves the most attention. It describes the investment structure, the property, the sponsor, the financing, the fees, the risks and the material assumptions.

An executive summary or a projected distribution is not a substitute for reading it.

Step 5: Confirm the Numbers Before Funding

Before the DST closes, the investment amount needs to line up with your 1031 exchange plan. I look at three pieces.

Equity

How much exchange cash is going into the investment, and will any be left over?

Receiving cash or other non-qualifying value can create taxable boot, so make sure you understand the consequences with your tax professional.

Debt

If the property you sold had debt on it, your replacement plan deserves a careful look.

DSTs with financing may allocate a share of nonrecourse property debt to you for tax purposes. But the debt amount and how it is treated should be confirmed for your specific exchange.

Purchase Price

It is easy to focus only on the equity number. In 1031 planning, though, the purchase price and debt relationships can matter just as much.

Your CPA and QI should confirm how the proposed replacement transaction affects the exchange.

Questions to Confirm Before the Wire

• Final DST investment amount
• Exchange cash being applied
• Any additional cash being contributed
• Assigned property debt, if applicable
• Ownership name and taxpayer ID
• QI wiring instructions
• DST closing date
• Remaining 1031 funds, if any
• Any potential boot or tax issue to discuss with your CPA

Who Handles What? A 1031 + DST Responsibility Guide

There are a lot of people involved in one of these transactions. Here is how I think about who does what, and what to ask each of them.

Not sure who should be handling which piece of your exchange? GCA 1031 can walk through your timeline, documents and replacement-property options with you. Schedule a call to get started.

Common Closing Problems to Avoid

Most closing problems I see are not complicated. They are timing and coordination issues that could have been caught earlier.

Waiting Until the End of the 45-Day Period

A deadline creates urgency. But urgency should not decide which real estate investment you own for the next several years.

Starting earlier gives you room to compare sponsors, property pricing, debt, reserves and alternatives.

Using the Wrong Ownership Name

1031 exchanges generally require continuity of the taxpayer, subject to specific rules and exceptions.

Coordinate your ownership entity with the QI and your tax and legal professionals before closing, rather than trying to fix it at the last minute.

Treating Debt Replacement as an Afterthought

I have seen investors identify a DST that fits the equity amount perfectly, only to find later that the debt structure does not work for the overall exchange.

Debt and purchase price belong in the analysis from day one.

Incomplete Investment Paperwork

Missing financial information, entity documents, tax IDs or suitability forms can hold up an investment, even when the exchange itself is ready to fund.

Confusing a Potential 721 Strategy With the Current 1031 Closing

A future 721 / UPREIT strategy may be relevant for certain DSTs, but it is a separate, potential future transaction.

Your current 1031 exchange has to stand on its own. A future conversion should never be assumed or treated as guaranteed.

Where Does a 721 / UPREIT Fit Into This Process?

I get this question a lot, so it is worth addressing directly.

You generally cannot complete a 1031 exchange by exchanging directly into REIT shares.

However, some strategies start with a qualifying real estate interest, like a DST, and later contemplate contributing that real estate to an operating partnership in a potential Section 721 transaction.

So 721 planning may influence which DST you look at today. It just should not distract from the questions that matter right now:

• Is the DST appropriate for you?
• Is the underlying real estate sound?
• Does the exchange structure work?
• Are you comfortable with the risks and liquidity limitations?

If a potential 721 path is part of why you are considering a particular DST, you should also evaluate the future REIT or operating partnership, the conversion mechanics, the valuation methodology, distributions and liquidity provisions. And keep in mind that moving from direct real estate ownership into OP units is generally a one-way move.

1031 + DST Closing Checklist

Here is everything above in one place. Use it to keep the exchange and the investment moving together, from your first conversation through the years after closing.

Frequently Asked Questions

When does the 45-day identification period begin?

It generally begins on the date the relinquished property is transferred and ends 45 days later. Confirm the exact date with your qualified intermediary, because weekends and holidays generally do not extend the deadline.

How long do I have to close a 1031 exchange?

You generally must receive the replacement property by the earlier of two dates: 180 days after the transfer of the relinquished property, or the due date (including extensions) of your tax return for the year of the transfer. Confirm your specific deadline with your tax professional and QI.

Can I receive the sale proceeds before buying the DST?

In a delayed exchange, investors generally use a qualified intermediary specifically so they do not receive or control the exchange proceeds. The exchange structure should be set up before the relinquished property closes.

Does identifying a DST mean I am committed to buying it?

Identification and subscribing to the investment are separate steps. The identification rules can be complex, and your ability to choose among identified properties depends on the identification method you use and the transaction. Your QI and tax professional should guide the exchange mechanics.

Can a DST later convert into a REIT?

Some DST strategies contemplate a future contribution into an UPREIT in exchange for operating partnership units. Any future 721 transaction depends on the specific structure and future circumstances, and it should never be represented as guaranteed.

The Goal Is a Clean Exchange and a Sound Investment

A successful 1031 exchange is not just about hitting Day 45 and Day 180.

You also have to end up with replacement property that fits the exchange, your portfolio and your long-term goals.

When a DST is involved, the best process is almost always the one that starts early. Coordinate with your QI. Understand the tax and debt requirements. Review the underlying commercial real estate. Complete the investment paperwork. And confirm the money flow well before the final funding date.

Do that, and you end up with two things working together: a properly coordinated exchange and an investment decision that holds up on its own merits.

Ready to talk through your 1031 exchange and DST closing? Tell us a little about your property, exchange timeline and investment goals, and GCA 1031 will reach out to discuss DST, 721 UPREIT and other passive real estate strategies that may fit your objectives. To get started, you can learn more about Ashley Romiti or contact GCA 1031 to request a consultation.