What Your Heirs Actually Inherit When You Die Holding a DST

For many investors, the plan behind repeated 1031 exchanges ends the same way: hold until death, let the basis reset, and pass property to heirs without the deferred tax ever coming due.

Delaware Statutory Trust interests fit that plan well in one respect and awkwardly in another. The tax outcome is usually excellent. The practical experience for heirs depends on decisions made long before.

What happens to the deferred gain at death?

Property owned at death generally receives a basis adjustment to fair market value. For an investor who has exchanged repeatedly, that typically eliminates the entire chain of deferred gain and the accumulated depreciation recapture that came with it.

Heirs who later sell at a price close to that value owe little or no income tax on the gain. The deferral became permanent.

In community property states, both halves of community property may be adjusted at the first spouse's death, which can make the benefit larger for married couples.

Estate tax is a separate question from income tax, and larger estates need their own planning.

Does a DST interest qualify for the basis reset?

A DST interest is treated as an interest in real property for exchange purposes, and it is an asset owned at death. The general rules on basis adjustment apply to assets included in the estate. The mechanics of valuing and reporting the adjusted basis need a CPA, particularly where the trust holds leveraged property.

What is easier for heirs than owning a building?

No management. The trustee continues running the property. Heirs do not inherit tenant calls, repairs or lender relationships.

Simpler division. Interests can usually be divided among heirs in whatever proportions the estate plan specifies, without partitioning a building or forcing a sale.

No immediate decisions. Heirs can leave the investment in place while the estate is administered.

What is harder?

Illiquidity. Heirs cannot sell a DST interest on demand. There is no exchange, no redemption right and no obligation on anyone to buy. If an heir needs cash, they may have to wait until the sponsor sells the property, which could be years.

Someone else controls the timing. The sponsor decides when the property is sold. Heirs receive proceeds when that happens, not when it suits them.

Valuation. Establishing fair market value at the date of death for a fractional interest in a specific property is less straightforward than valuing listed securities. An appraisal is usually needed, and discounts for lack of control and marketability may be relevant.

Transfer procedures. Sponsors have their own processes for transfers at death, requiring documentation from the estate. Those take time and should be started early.

What happens when the property is later sold?

Heirs receive their share of the proceeds. With a stepped up basis, the taxable gain is generally measured from the date of death value rather than the original investment, so tax is usually modest.

At that point heirs can take the cash or complete their own 1031 exchange, with new 45 and 180 day deadlines from the sale. Heirs who do not want to continue in real estate usually take the cash, which is often the point of the plan.

What should the estate plan cover?

• ›How interests are titled, including trusts, so transfer does not wait on probate
• ›Who has authority to deal with the sponsor after death
• ›Whether interests are divided by percentage or allocated to specific heirs
• ›A written list of sponsors, contacts and account details that heirs can find
• ›Instructions on whether heirs are expected to hold or sell
• ›A plan for liquidity elsewhere in the estate, since DST interests cannot be sold quickly

That last point matters most. An estate holding mostly illiquid interests may struggle to pay expenses or taxes.

How do heirs value the interest?

Because there is no public market, valuation usually relies on the sponsor's reported value, an independent appraisal of the underlying property applied to the fractional share, or a combination, sometimes with adjustments for lack of control and lack of marketability.

Getting a defensible valuation matters twice: it establishes the basis heirs will use when the property is eventually sold, and it supports the estate's reporting. Sponsors can usually provide a date of death statement, but that is a starting point rather than an appraisal.

What if several heirs inherit different proportions?

Most sponsors can split an interest among beneficiaries, subject to any minimum investment size in the offering documents. Where a minimum applies, small allocations may not be possible, and the estate may need to allocate whole interests to particular heirs and balance the difference with other assets.

That is worth checking now rather than leaving to an executor. A plan that assumes an interest can be divided five ways may not survive contact with a 25,000 dollar minimum.

What to do first

List the DST interests you hold, with sponsor contacts, and put that list with your estate documents. Tell your executor that these are illiquid and that the sponsor controls the sale timing. Ask your estate attorney whether the current titling allows a successor to act without delay, and make sure the estate has liquidity from other assets.

Nothing here is tax, legal or investment advice. Estate and basis rules are technical and change over time. DST interests are securities with risk including loss of principal. Confirm your plan with your CPA and estate attorney.