How to Handle Delaware Statutory Trust Tax Reporting

A Delaware Statutory Trust, or DST, is a legal entity that holds title to investment-grade real estate. It often serves as a vehicle for completing a 1031 exchange, allowing for the deferral of capital gains taxes from the sale of a previous property. As a beneficial owner of a DST, you hold a fractional interest in the trust’s assets, which are managed by a third-party sponsor.

The Tax Structure of a Delaware Statutory Trust

For federal income tax purposes, a Delaware Statutory Trust that qualifies under IRS Revenue Ruling 2004-86 is treated as a grantor trust. This classification means the trust itself is disregarded for tax purposes; it does not file its own income tax return or pay federal income taxes. Instead, the DST operates as a pass-through entity, where all items of income, expense, and deductions flow directly to the individual investors, known as beneficial owners.

You are responsible for reporting your pro-rata share of the trust’s financial activities on your personal tax return. The income generated, primarily from rent, is taxed at your individual ordinary income tax rate. This structure is different from investing in a corporation or partnership, where you would receive a Form 1099 or a Schedule K-1.

The grantor trust status allows investors to take advantage of deductions associated with direct property ownership. This includes a deduction for depreciation, which is a non-cash expense that can reduce your taxable income from the investment. You are also allocated your share of other operating expenses, such as property taxes and mortgage interest.

Required Tax Reporting Documents

Each year, typically between late February and mid-March, the DST sponsor will provide you with a comprehensive tax information packet. The central document is an annual “Tax Information Letter” or “Grantor Letter,” which may also be referred to as a substitute 1099. Since the IRS does not mandate a specific format for this letter, its appearance can vary between sponsors, but the core information remains consistent.

This Grantor Letter provides a detailed operating statement that breaks down your proportionate share of the DST’s financial activity for the year. It will list your share of gross rental income and itemize your share of the deductible expenses. These commonly include:

• Mortgage interest paid to the lender
• Property management fees
• Real estate taxes assessed on the property
• Insurance premiums
• General repair and maintenance costs

A significant component of the letter is the depreciation figure. For residential properties, this is typically calculated over 27.5 years, while commercial properties use a 39-year schedule. The letter will also include a year-end mortgage statement summary, detailing your share of the outstanding loan balance.

Reporting DST Activity on Your Personal Tax Return

The information from your Grantor Letter is reported on Schedule E (Supplemental Income and Loss), which is filed with your Form 1040. You will treat the DST investment as if you personally own the rental property, using the figures provided by the sponsor to complete Part I of the form. For each DST property you own, you will use a separate column on Schedule E.

You begin by entering the property’s address on Schedule E as provided in your tax packet. The “Gross Rents” figure from your Grantor Letter is reported in the income section. Next, you will itemize the expenses in their corresponding categories. For example, the mortgage interest figure from your letter is entered under “Mortgage Interest,” and the property tax amount is entered under “Taxes.”

The depreciation deduction detailed in your letter is also entered in the expense section. You may also need to complete Form 4562, Depreciation and Amortization, the first year you invest in the DST, and attach it to your return. After listing all income and expenses, you will calculate your total expenses and subtract this from your gross income to arrive at your net income or loss, which is then carried to your Form 1040.

If the DST holds property in a state where you do not reside, you may be required to file a non-resident state income tax return to report your share of the income. Your tax advisor can determine the specific filing requirements, as some states have minimum income thresholds that may exempt you from filing.

Tax Reporting for the Sale of a DST Interest

When you sell your interest in a DST, or when the trust itself sells the underlying property, the tax reporting differs from the annual income reporting. The transaction is reported on Form 4797, Sales of Business Property. The primary calculation involves determining your total gain, which is the difference between the sales price and your adjusted basis in the property. Your basis starts with your original investment amount and is adjusted over time by being reduced by the accumulated depreciation you have claimed each year.

A specific component of the gain is subject to a different tax treatment known as depreciation recapture. When you sell the property, the IRS requires you to “recapture” the depreciation deductions you have taken over the years. This portion of your gain, called unrecaptured Section 1250 gain, is taxed at a maximum federal rate of 25%. Any remaining gain above the recaptured amount is treated as a long-term capital gain, taxed at 0%, 15%, or 20%, depending on your overall income.

The calculations from Form 4797 flow through to Schedule D, Capital Gains and Losses, on your Form 1040. The ordinary income from depreciation recapture is reported on Part II of Form 4797, while the capital gain portion is reported on Part III and then transferred to Schedule D. Many investors choose to defer these taxes by using the proceeds from the sale to enter into another 1031 exchange, purchasing a new replacement property.