CPA Guide to DST Due Diligence and 1031 Exchanges

What tax advisors should evaluate before their clients write a check into a Delaware Statutory Trust.

When a high-net-worth client sells an appreciated real estate asset, the CPA is almost always the first call. The 1031 exchange decision comes minutes later. And increasingly, the Delaware Statutory Trust decision comes after that, because the 45-day identification window doesn’t leave time to source, underwrite, and close on a traditional replacement property.

That puts CPAs in a position they’re often asked to fill but rarely formally trained for: weighing in on whether a specific DST sponsor and a specific DST offering are the right fit for a specific client. Tax counsel handles the technical opinion. The financial advisor handles the suitability conversation. But the CPA, the person who knows the client’s entire tax picture, basis history, depreciation recapture exposure, and estate plan, is often the one whose reservations or endorsement actually drive the decision.

This article is a practical framework for CPAs in that position. It’s written from the sponsor side of the table by someone who has been in the conversations a lot. It’s not tax advice; for any specific transaction, your own tax counsel and the sponsor’s offering documents are the authoritative sources.

First, the structural baseline: does this DST qualify?

Before any deeper analysis, confirm the structural baseline. The DST must satisfy the requirements of IRS Revenue Ruling 2004-86 to qualify as “like-kind” replacement property under Section 1031. The PPM should explicitly state this and the trust agreement should be drafted to comply. The sponsor’s tax counsel should have issued an opinion on this point; the FactRight or other third-party DD report should reference it.

If a DST is structured incorrectly, no amount of post-close planning rescues the 1031 treatment. This is the single most important question CPAs should confirm before anything else. The good news is that the answer is almost always yes for any DST sold through a registered broker-dealer, but it’s worth verifying rather than assuming.

Five tax considerations worth evaluating before subscription

Once the structural baseline is confirmed, here are the five tax-specific items CPAs should walk through with the client (and ideally with the client’s tax counsel for any meaningful position).

1. K-1 reporting: timing and quality

Beneficial Owners receive an annual Schedule K-1 from the DST. Ask the sponsor when historical K-1s have been delivered, ideally before the March 15 / April 15 personal filing deadlines, but in practice many DST K-1s arrive late, often requiring extensions. A pattern of late K-1s is a sponsor-quality signal worth weighing. The PPM should disclose the expected K-1 delivery timeline.

2. Basis treatment and depreciation pass-through

DST investors receive their pro-rata share of the property’s depreciation deductions, which can be substantial in the early years of a hold. The investor’s basis in the DST interest carries over from the relinquished property under 1031 mechanics, then is adjusted for share of liabilities, distributions, and depreciation through the hold. Walk the client through how these figures will appear on the K-1 and how they’ll affect the client’s reported income each year. Some clients are surprised by the interplay between cash distributions and reported taxable income; better to set expectations now than to field a confused phone call in April.

3. Disposition tax treatment - three pathways at exit

This is the area where the most planning value is created or destroyed. At the end of the DST hold period, the typical disposition pathways are:

•   Cash sale: the property is sold to a third-party buyer; investors receive their pro-rata share of net sale proceeds and recognize their deferred gain as a taxable event in that year.

•   1031 rollover: the investor uses their pro-rata share of sale proceeds as relinquished property in another 1031 exchange, identifying replacement property within 45 days of the DST sale.

•   Section 721 contribution: under the FMV Option provision in the trust agreement, the sponsor (or its designee) may acquire investors’ interests in exchange for partnership units in an entity taxed as a partnership, generally intended to qualify for nonrecognition treatment under Section 721. Where the receiving partnership is the operating partnership of a REIT, this may take the form of a classic UPREIT contribution; where it isn’t, it may still qualify as a Section 721 contribution but the structural details and tax treatment depend heavily on the facts.

The right pathway depends on market conditions at exit, the investor’s liquidity needs, the sponsor’s ability to deliver the structure, and the receiving entity’s status. Tax treatment for any specific pathway depends on transaction documentation, liability allocation, the receiving entity’s qualification, and other facts that can’t be assessed at the time of subscription. The CPA’s job at subscription is to confirm that all three pathways are at least structurally available, so the client retains optionality.

4. Estate planning - basis step-up at death

A meaningful percentage of DST investors are using the structure as a multigenerational tax planning tool: defer gain through 1031 / DST / 721 mechanics during life, and let beneficiaries inherit at the stepped-up fair-market-value basis. CPAs are uniquely positioned to evaluate whether this strategy fits the client’s overall estate plan. The DST sponsor doesn’t handle this; the client’s estate attorney and CPA do. Worth raising explicitly with the client at subscription so the strategy is documented in the broader estate plan.

5. State tax considerations

DST investors with K-1 income from out-of-state property may have multi-state filing obligations. A Florida-based investor in a Texas DST may owe Texas margin tax filings; a California-based investor in a Florida DST may have Florida and California implications. The PPM should disclose the property states. Walk through any state-specific considerations with the client, these are often overlooked at the subscription stage and create administrative friction at filing time.

Sponsor evaluation: what CPAs can uniquely assess

Most due-diligence frameworks for DST sponsors focus on real estate fundamentals, lease quality, and capital structure. Those questions matter, but they’re also assessable by financial advisors and BD due-diligence officers. CPAs bring a different lens, inancial-statement quality, audit relationships, and the discipline of reading what’s in the disclosures (and what isn’t).

If the sponsor is a private LLC, ask for audited financials. Some private sponsors will provide them; many won’t. The willingness to share, and the quality of the audit firm if they do, is itself a signal.

If the sponsor is publicly-traded, as Medalist Diversified, Inc. (NASDAQ: MDRR) is — the audited financials are publicly filed on SEC EDGAR. Pull the most recent Form 10-K and Form 10-Q. Read the auditor’s opinion (Cherry Bekaert LLP audits Medalist). Read the related-party transactions disclosure. Read the executive compensation discussion. The depth and clarity of public-company disclosures gives CPAs a window into sponsor financial health that simply isn’t available with private sponsors.

Three specific items to focus on in a sponsor’s public filings:

•   Sponsor-level balance sheet: is there corporate debt? What’s the cash position? Is the sponsor capitalized to support its DSTs in a stress scenario?

•   Cash flow statement: is there real fee-income generation from the DST platform, or is the sponsor losing money on the DST business itself?

•   Risk factors and MD&A: read these carefully, they’re where any honest disclosure of operational risks lives.

A note on suitability

DSTs are restricted to accredited investors. They’re illiquid, they require multi-year holds, they offer no investor control, and they carry real-estate-specific risks that most clients don’t encounter in their other holdings. Before signing off on a DST allocation, walk through the client’s liquidity timeline, their alternative uses for the capital, and their tolerance for sponsor-specific concentration risk. A DST is right for some clients and wrong for others; the CPA’s broader view of the client’s situation often surfaces fit issues the sponsor and the financial advisor can’t see.

Closing thought

CPAs are quietly some of the most influential gatekeepers in the 1031 / DST ecosystem. When a CPA recommends a DST sponsor to a client, the decision usually sticks. When a CPA raises a concern, the deal usually doesn’t happen. From the sponsor side, we want CPAs to feel they have enough framework to evaluate the decision quickly and confidently, because every DST that goes wrong because of a bad fit hurts the entire industry, and every DST that goes right because of a thoughtful CPA-advisor partnership strengthens it.

If you’re a CPA evaluating a DST sponsor and you have questions about the sponsor’s structure, financial position, or disclosure cadence, reach out. The Medalist team is available as a resource for any CPA in the 1031 / DST ecosystem, regardless of whether your client ultimately invests with us. All of our financial materials are public on SEC EDGAR.

The views in this article are the author’s and are not investment, tax, or legal advice. Medalist Diversified, Inc. is not a tax or legal advisor. Investors and their advisors should review specific Delaware Statutory Trust offerings only through the confidential Private Placement Memorandum and consult their own qualified tax counsel for any transaction-specific question. Any DST offering is made only to accredited investors. For more information about Medalist, visit www.medalistdst.com.