DST Tax Reporting for Real Estate Investors

For federal income tax purposes, an investment in a Delaware Statutory Trust (DST) that holds real estate is treated as if the investor owns a direct fractional interest in the property. This principle, established in IRS Revenue Ruling 2004-86, allows the trust to be classified as a grantor trust, meaning it is disregarded for tax purposes.

Consequently, all financial activities of the real estate—including income and deductions—flow through the trust directly to individual investors on a pro-rata basis. This direct ownership treatment is what characterizes the income as rental income and allows the investment to qualify for tax-deferral strategies.

Understanding Your Annual DST Tax Package

Each year, the DST sponsor provides investors with a tax package containing a detailed operating statement. This package is not a standard Form 1099 or K-1, but is often referred to as a “grantor trust letter” or a “substitute 1099.” The format can vary between sponsors, as the IRS does not mandate a specific layout for this report. The statement breaks down an investor’s proportionate share of the property’s financial activities for the year.

Gross Rental Income

The report will state your share of the gross rental income collected from the property’s tenants before any expenses are deducted. This figure is the starting point for calculating your net taxable rental income or loss.

Operating Expenses

The annual statement provides a detailed breakdown of your share of the property’s operating expenses. Common expense categories listed include property taxes, property insurance, and management fees. Other itemized costs can include repairs, maintenance, utilities, and administrative expenses.

Mortgage Interest

If the DST used a mortgage to acquire the property, the tax package will include your pro-rata share of the mortgage interest paid. This is a deductible expense for real estate investors. The sponsor may report this figure within the main operating statement or on a separate Form 1098, Mortgage Interest Statement.

Depreciation

A non-cash deduction detailed in your tax package is depreciation. This is a tax allowance that accounts for the wear and tear of the physical building and certain other assets. The DST sponsor calculates the total depreciation and allocates your proportionate share to you. While not an out-of-pocket expense, it reduces your taxable income. The statement should also provide information to help allocate the cost basis between the non-depreciable land and the depreciable building.

Reporting Annual Income and Deductions

The financial activity from a DST investment is reported on Schedule E (Form 1040), Supplemental Income and Loss. This is the same form used for reporting income from individually owned rental properties. For each DST property, you will use a separate column on Schedule E to list the address and then report the financials.

The gross rental income figure from your statement is entered on Line 3 of Schedule E. The various operating expenses are entered on the corresponding expense lines, from Line 5 through Line 18. Your share of the mortgage interest is entered on Line 12, and the depreciation amount is entered on Line 18.

After entering all income and expenses, you will calculate the net income or loss for the property on Line 21. Because rental real estate is considered a passive activity under IRS Section 469, any net loss from the DST may be subject to passive activity loss (PAL) limitations. These rules mean that passive losses can only be used to offset income from other passive activities, not nonpassive income like wages.

If you have a net passive loss, you may need to file Form 8582, Passive Activity Loss Limitations. This form is used to track your passive losses and determine the amount you can deduct. A special allowance may permit you to deduct up to $25,000 in rental real estate losses against nonpassive income if your modified adjusted gross income (MAGI) is below $100,000. This allowance phases out completely once your MAGI exceeds $150,000. Any losses you cannot deduct are suspended and carried forward to future years.

Tax Reporting When the DST Sells a Property

When the DST sells its underlying real estate asset, the tax reporting process is distinct from the annual income reporting. The sponsor will provide a final operating statement and a detailed closing statement. This closing statement will show the gross sales price, selling expenses like broker commissions, and your pro-rata share of the net sales proceeds.

To determine your tax liability, you must calculate the total gain or loss from the sale. The formula is your share of the net sales price minus your adjusted basis in the property. The adjusted basis is calculated as your original investment amount, plus any capital improvements, minus all the accumulated depreciation you have deducted over the years of ownership.

The sale of business or rental property is reported on Form 4797, Sales of Business Property. A portion of the gain, equal to the total accumulated depreciation you have taken, is subject to depreciation recapture. This part of the gain is taxed at a maximum rate of 25 percent. Any remaining gain above the recapture amount is treated as a long-term capital gain, which is taxed at lower rates. The final gain or loss from Form 4797 flows through to Schedule D (Form 1040).

A benefit of the DST structure is its eligibility for a Section 1031 like-kind exchange upon sale. If you choose to defer the tax on your gain, you can roll your sales proceeds into a new like-kind property, which can include an interest in another DST. To execute this deferral, you must report the transaction on Form 8824, Like-Kind Exchanges, and file it with your tax return for the year the sale occurred. This form requires detailed information, including descriptions of the relinquished and replacement properties, the dates of the sale and replacement, and a calculation of the deferred gain.