DST vs. REIT: Which One Actually Qualifies for a 1031 Exchange?

If you’re selling an investment property and want to stay invested in real estate without becoming a landlord again, you’ve probably run into two options that sound almost interchangeable: a Delaware Statutory Trust (DST) and a Real Estate Investment Trust (REIT). Both let you own real estate passively. Both spread your money across professionally managed properties. So why does it matter which one you choose?

Here’s the short answer: a DST can serve as replacement property in a 1031 exchange. A REIT, in almost every case, cannot. If deferring capital gains tax on the sale of your property is the goal, that single distinction changes everything.

This guide explains what each vehicle is, why only one qualifies for a 1031 exchange, how they differ on taxes, liquidity, and control, and how some investors eventually use both.

What a DST Is

A Delaware Statutory Trust is a legal entity that holds title to one or more income-producing properties. When you invest, you buy a fractional beneficial interest in that trust. A sponsor handles acquisition, financing, and day-to-day management, so you collect your share of income without managing tenants or toilets.

The key point for exchange purposes is how the IRS treats that interest. Under Revenue Ruling 2004-86, a properly structured DST beneficial interest is treated as a direct interest in real estate. That means it counts as “like-kind” replacement property, so you can exchange into it and defer capital gains tax and depreciation recapture. DSTs are offered as securities to accredited investors, typically with minimums around $100,000.

What a REIT Is

A Real Estate Investment Trust is a company that owns or finances income-producing real estate and passes most of its taxable income to shareholders as dividends. Publicly traded REITs trade on stock exchanges like any other stock; non-traded REITs are sold through advisors and sponsors.

When you buy a REIT, you own shares of a company, a security, not a direct interest in real estate. And that’s exactly why a REIT generally cannot be used as 1031 replacement property. Section 1031 requires you to exchange real property for real property. REIT shares are personal property (securities), so buying them with your sale proceeds is a taxable event, not a deferral.

The Core Difference: The 1031 Test

The distinction comes down to legal structure. A DST interest is treated as a direct real estate interest, so it qualifies as 1031 replacement property and you can later exchange out of it into other real estate. A REIT is a security, so it does not qualify as 1031 replacement property. DSTs are limited to accredited investors and are illiquid, held to term; publicly traded REITs are open to anyone and offer daily liquidity. Both are fully passive. The difference that matters for a 1031 exchange is that one is real estate in the eyes of the IRS, and the other is a stock.

A Simple Example

Suppose you sell a rental property and net $500,000 in proceeds, with a $200,000 gain you’d like to defer.

If you roll that $500,000 into a DST through a qualified intermediary, identifying it within your 45 days and closing within 180 days, the $200,000 gain and any depreciation recapture are deferred. Your basis carries over into the DST interest.

If instead you take that $500,000 and buy shares of a REIT, the sale is fully taxable. Depending on your holding period and state, you could owe federal capital gains tax, the 25% rate on unrecaptured Section 1250 depreciation, the 3.8% net investment income tax, and state tax, potentially tens of thousands of dollars that a DST exchange would have deferred.

Same amount of money, same passive outcome, very different tax bill.

Where REITs Still Fit: The 721 Bridge

REITs aren’t off the table entirely. Some DSTs are structured so that, after a holding period, the sponsor can move the property into a REIT through a 721 exchange (also called an UPREIT). This lets an investor convert an illiquid DST interest into REIT units, gaining diversification and potential liquidity.

The trade-off is important: a 721 exchange is generally a one-way door. Once you’ve made the move into the REIT, you typically can no longer do future 1031 exchanges with that investment. It can be a sensible exit for investors ready to stop exchanging, but it ends the deferral chain, so it’s a decision to make with your advisors, not a default.

Honest Pros and Cons

DSTs offer 1031 eligibility, hands-off ownership, and access to institutional-quality properties, but they’re illiquid, sponsor-dependent, carry fees, and are restricted to accredited investors. Publicly traded REITs offer daily liquidity, low minimums, and broad diversification, but they can’t defer your gain in a 1031 exchange and their share prices move with the stock market. Neither is universally “better.” They solve different problems.

The Bottom Line

If your priority is deferring capital gains on the sale of investment real estate, a DST is the vehicle built for that job, because the IRS treats it as real property. A REIT is a fine way to own real estate broadly, but buying REIT shares with exchange proceeds is a taxable event, not a 1031. Some investors use a DST first and later transition to a REIT through a 721 exchange when they’re ready to stop deferring, but that’s an endpoint, not a starting move. As always, the mechanics of your 45- and 180-day deadlines and your specific tax picture matter, so plan before you sell, not after.

Weighing a DST against other replacement-property options? Talk to a Specialist about your timeline and goals, and map out your deadlines with the free 1031 Deadline Calculator.

This article is for informational and educational purposes only and is not tax, legal, or investment advice. My1031Options.com is an educational resource published by Medalist Diversified, Inc. (NASDAQ: MDRR), a publicly traded company and DST sponsor. This is not an offer to sell or a solicitation of an offer to buy any security. Securities are offered only by means of a Private Placement Memorandum (PPM) and only to accredited investors as defined in Rule 501 of Regulation D under the Securities Act of 1933. All investments involve risk, including the possible loss of principal. Consult your own CPA, tax attorney, and qualified financial professional before selling investment property or executing a 1031 exchange.