There are three different kinds of DSTs, and they all start with a successful 1031 exchange to mitigate taxes.

DST Type One: A Single Location Property (That requires flipping every 3-7 years to continue tax deferral)

This type of DST invests in a single property that becomes illiquid for five to seven years. This is an attractive option for investors who want to gain exposure to a particular investment type or location. An investor can choose several different DSTs to build a portfolio, which can vary by property type or location. You may choose from various property types, such as multifamily housing, senior living, medical, or self-storage facilities.  Most kinds of real estate are available for purchase; the primary rule is that the real estate must be used for business purposes.

The expected liquidation date for a DST is unique to the product, with 5-7 years being the most common. To avoid taxes, once a DST liquidates, you must conduct another 1031 exchange into a new DST. Alternatively, you can roll the proceeds into a real estate investment that you can directly manage on your own (where you become an active landlord again). If you take direct possession of the proceeds from the liquidation of the DST, taxes will be owed, so you must carefully follow the 1031 exchange process. Many investors prefer to keep swapping DSTs until the end of their lives since the investments qualify for a step-up transaction (at death), so you never end up paying the taxes from your original sale, and neither do your beneficiaries when you pass away.

Single-location DSTs are occasionally available, but it's more common for one DST to hold 2-5 separate properties, sometimes located in different states.  When a DST owns several properties, it may help reduce concentration risk.  Since most DSTs directly own several institutional-grade investment properties within them, you do not need to own many different DSTs to build a diversified portfolio; sometimes, one to three will suffice.

DST Type Two: Cash-Out Property (Quickly get back most of your investment tax-free)

This type of DST allows investors to receive up to 85% of their cash back tax-free from their sale while purchasing a new investment property with appreciation potential. The rent from the newly acquired property is then used to pay down the loan.

The process starts after a successful 1031 exchange into a DST. For a few months, you will have equity in a DST scheduled to do a cash-out refinance. In many cases, the proceeds you receive back from this cash out would be higher than the after-tax net proceeds from your original sale. The loan is not a traditional loan. The refinance cash-out loan is against your investment and is a nonrecourse loan to you. The DST pays the interest payments. The DST is not held for income; instead, its purpose is to gradually pay down the loan over time, sometimes for 20 years. 

In addition to paying down the loan, the DST underlying investment is also expected to appreciate over time. This makes us question why you would not want to consider this tool instead of just selling a property and paying the taxes. You can come out ahead after tax, and your investment property is like a free bonus. 

DST Type Three: A permanent solution (Using both the 1031 exchange process followed by a 721 exchange)

Consider a permanent solution through a 721 exchange, which typically offers liquidity in 3 years. The investment starts as a 1031 exchange and follows the same process as a DST. The difference is that the property is not held for 5-7 years like a single DST product; rather, the property gets acquired after 2 years and becomes part of a partnership that may own hundreds of rental properties nationwide.

Instead of the partnership giving you cash for the sale, you are given shares of the partnership.  Your investment becomes part of the partnership, so you gain partial ownership in the 100s of properties the partnership owns. Once the partnership acquires your property, typically about a year later, you can sell some of your shares to raise additional cash if needed. Each time you opt to sell shares of your partnership, you will create taxable capital gains.

If you continue to keep your investment, the partnership will pay you interest, typically in the 4-7%+ range. A good portion of this interest is expected to be tax-free. The partnership will likely continue to appreciate in value over time, and your investment will remain in perpetuity. You can sell your shares to exit or keep them for the rest of your life to continue to receive income benefits. When you pass, your heirs can inherit this from you and will receive a step up in their cost basis, which can eliminate all taxes owed when sold.

>>What are the benefits of owning a DST, read about it here

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