A Delaware Statutory Trust (DST) 1031 Exchange is a process through which an individual can potentially defer any otherwise due capital gains taxes from the sale of rental real estate property. The actual process itself is outlined in the Internal Revenue (IRS) Code Section 2004-86 and isn't without very strict requirements that must be met. In particular, it can only be done with what is called real property (e.g. an actual, physical building or property) and only one whose principal use is to generate rental income. Moreover, in order to meet the necessary standard for a DST 1031 Exchange, the property must be a net "Triple N" (NNN) rent generating building. A NNN property is one in which the tenant (not the owner) is responsible for paying property taxes, all maintenance costs, and any property insurance. As such, many rental properties do not meet this standard.
If, however, the property does meet the NNN standard, then it is eligible for the DST 1031 process. What would traditionally happen with a property sale is, any difference between the price paid for a property and the price received for selling the property would result in either a capital gain or a capital loss. If the amount is less, it's a capital loss and can potentially be used to offset other capital gains. If the amount is greater than the original amount, then taxes would normally be due at applicable capital gains rates. For example, if a twelve unit apartment complex were originally purchased by the owner for $650,000 dollars, and then ten years later the same owner sold that apartment complex for $1 million dollars, there would be a long-term capital gain of $350,000. And, with most long-term capital gains rates being about fifteen percent, that would equate to roughly $52,500 dollars in taxes due from the sale. Obviously, most people would prefer to either avoid paying those taxes (if possible) or defer them to a later date. A DST 1031 Exchange allows a person to do the latter.
One of the key aspects of the how a DST 1031 Exchange works is that it must be done through a qualified intermediary and the proceeds from the sale of the first property (that would otherwise have the applicable capital gains taxes due) must be used to purchase a "like-kind" property within 180 days of the sale of the first property. A "like-kind" property isn't entirely a black-and-white definition, and can be open to subjective interpretation; however, in general, it must be a similar type of property and have a relatively similar property value. For example, if one sold a commercial office building with a value of $500,000 dollars, a "like-kind" property would be another commercial office property (not a residential building, or some other classification of building) with a purchase price around $500,000 dollars. The qualified intermediary's services are key, as the IRS code dictates that the owner cannot have any sort of material access to the proceeds from the sale of the first property prior to purchasing the second "like-kind" property. The intermediary takes possession of the assets and accomplishes both the sale and later purchase on the behalf of the owner.
If the process is completed correctly and following all the IRS regulations, (using the aforementioned $650,000 dollar apartment complex example) the otherwise owed long-term capital gains of $52,500 dollars would be deferred, as long the second purchased property remains owned. The net effect to the owner would be that they wouldn't have to pay the $52,500 in capital gains taxes at that time. And, even is they later sold the second property, they would still be potentially eligible to conduct another DST 1031 exchange, and further defer those taxes to an even later date.