How to sell a rental property without paying taxes

Tyler Kert
Tamarack Wealth Management

Are you tired of dealing with the terrible T’s – Tenants, toilets, and trash?

Rental properties have historically been excellent investments. But there comes a time for many investors when the headaches of dealing with renters outweigh the benefits. When you get that third call from your rental management company while on vacation in a different time zone, you’ll know what I mean. 

So, if you’ve had enough and you’d like to get out of the rental game, there is good news and bad news. The good news is that, most likely, your rental property has gone up in value significantly since you purchased it. The bad news is that the IRS will want to take a chunk of those profits when you go to sell. Clients are often excited to sell their properties until they realize how much of their profit will go to taxes. But what if there was a way to get rid of the headaches and keep receiving your rental income all without taking the tax hit? If that sounds intriguing, a DST might be what you’re looking for.

What is a Delaware Statutory Trust (DST)?

A Delaware Statutory Trust is a legal entity established under Delaware law that allows multiple investors to hold fractional ownership in real estate assets. It is a professionally managed real estate portfolio similar to a Real Estate Investment Trust (REIT). However, unlike a REIT, a DST will allow you to use a 1031 exchange to sell your rental property and invest the proceeds into the DST without paying capital gains taxes.

When you sell your rental and invest in a DST, you aren’t trading your real estate for a different kind of investment. You’re trading real estate for other real estate. This is the reason that the 1031 exchange is allowed. DSTs are structured to hold real estate properties, typically high-quality commercial assets like apartment complexes, self-storage, retail centers, and industrial facilities. You can then purchase fractional shares in the DST and gain proportional ownership in the trust’s real estate holdings.

DSTs are managed by a professional sponsor who handles property acquisition, management, and eventual disposition. As the investor, you receive passive income distributions without the burden of managing the property yourself.

Benefits of Investing in a DST

So why should you consider using a 1031 exchange to invest in a DST when you sell your rental? Number one is the tax deferral that you can achieve while still receiving a passive income stream. You can kiss the terrible “T”s goodbye and keep your monthly income. 

Furthermore, DSTs provide access to institutional-grade real estate that you likely can’t afford on your own, helping lower your risk. You can divide your DST investment across different types of real estate in different locations across the country which allows you to achieve a level of diversification that is difficult without collaborating with other investors. 

DSTs are also an excellent estate planning tool. Rental properties can be difficult to pass on to heirs because they aren’t easily divisible. Beneficiaries may have to choose between either buying each other out or selling the property to evenly distribute the proceeds. Because DSTs are ownership interests, they can be easily split. Each beneficiary can either hold the investment or liquidate as they see fit. 

Key Considerations Before Investing in a DST

Before you invest in a DST, make sure that it will accomplish your goals. DST investments are generally illiquid, meaning you cannot easily sell your interest before the trust’s assets are sold. DSTs typically have a hold period of 7–10 years, so you should be prepared for a long-term commitment. Also, you will have no direct control over property management decisions. The DST sponsor will make all the choices. 

DSTs are real estate investments and are subject to market fluctuations and economic conditions. Just like the rental that you currently own, the monthly income is not guaranteed, and neither is market value appreciation.

Is a DST Right for You?

DSTs can be an excellent option if you’re looking for tax-deferral, passive income, diversification, and efficient estate planning solutions. However, they are best suited for those who can tolerate a long-term investment horizon and limited liquidity. Don’t invest in a DST if you know that you will need access to the principal amount in the near future.

As with any real estate investment, it is essential to do your due diligence before investing. If you're considering a DST investment or would like to learn more about them, work with a trusted financial advisor or CPA specializing in tax-smart investment strategies to help you make a wise choice. 

This material is for informational purposes only and does not constitute financial, investment, or tax advice. Please consult your tax advisor or financial planner to discuss your specific circumstances before making any decisions.

Tyler Kert, a licensed financial advisor and CPA, provides financial planning and tax consulting services at Tamarack Wealth Management in Cashmere, WA.