Put two offerings side by side. Both are Delaware Statutory Trusts. Both say 5.0%. On $500,000 that is $25,000 a year in each case, paid monthly, and the two look interchangeable on a comparison sheet.
They may not be remotely interchangeable. A distribution rate tells you how much cash shows up. It says nothing about where that cash came from, and that second question is the one that decides whether the number survives year three.
Where the money actually comes from
A distribution is cash the trust sends to investors. In a healthy offering it is funded by rental income after operating expenses, after debt service, and after reserves are topped up.
But it does not have to be funded that way. Sponsors can and do support distributions from capital reserves, meaning cash raised at the offering and set aside. When that happens, part of what arrives in your account each month is not income at all. It is your own subscription money, returning to you on a schedule.
That is not automatically improper, and it is often disclosed plainly in the offering documents. A property in lease-up, or one with a known tenant gap in year one, may reasonably use reserves to smooth distributions until operations catch up. The problem is an investor who reads 5.0% and assumes the building produced it.
The comparison nobody runs
Here are those two offerings with the coverage broken out.
| DST A | DST B | |
|---|---|---|
| Stated distribution | 5.0% | 5.0% |
| Annual cash on $500,000 | $25,000 | $25,000 |
| Funded by property operations | $25,000 | $17,500 |
| Funded from capital reserves | $0 | $7,500 |
| Coverage ratio | 1.0x | 0.7x |
| If reserves run dry | Distribution continues | Distribution falls to about 3.5% |
Same headline. Very different asset. DST B is paying you 3.5% from the building and 1.5% from your own pocket, and the day the reserve is exhausted, the distribution reprices to what the property actually earns.
The metric to ask for is coverage: what portion of the projected distribution is supported by operations. Sponsors who run at or above 1.0x will tell you readily. A reluctance to answer is itself an answer.
The separate question of what is taxable
Now a second meaning of the phrase, and this one is a good thing rather than a warning.
DSTs are typically structured so that investors report their pro rata share of the property's income, expenses, and depreciation directly, rather than receiving a corporate-style dividend. Depreciation is a real deduction that costs no cash, so your taxable income from the trust is normally far lower than the cash you received.
Run it through:
- Cash distributed to you in the year: $25,000
- Your share of depreciation: $18,000
- Taxable income reported: roughly $7,000
- The remainder is treated as a return of capital
That excess is not tax-free. It reduces your basis, which means it surfaces later as additional gain when the DST sells. It is deferral, not forgiveness, and it behaves exactly like the depreciation you were taking on the property you exchanged out of. Keep exchanging, or hold to a step-up at death, and it can stay deferred indefinitely.
So the same three words describe two entirely different situations. Return of capital in the tax sense is ordinary and usually favorable. Return of capital in the funding sense, where reserves are propping up a headline rate, is something to price in before you invest.
What to ask before you subscribe
- What portion of the year-one distribution is covered by operations? Ask for the coverage ratio, not the rate.
- How large are the reserves, and what are they earmarked for? Reserves funding capital repairs are a strength. Reserves funding distributions are a subsidy with an end date.
- What happens at lease expiration? A single-tenant asset with a lease ending inside the hold period has a distribution cliff built into it, which is the same risk we cover in NNN properties versus DSTs.
- Is the distribution projected or contractual? It is projected. Always. No DST distribution is guaranteed, and sponsors can reduce or suspend them.
- What has this sponsor actually paid, across full cycles, versus what they projected? Track record on distributions is a different question from track record on acquisitions, and it belongs in your sponsor diligence.
DSTs are offered to accredited investors through private placement and carry real risks, including illiquidity, fees, loss of principal, and complete dependence on the sponsor's execution. Distributions are not guaranteed and may be reduced or suspended. Your CPA determines the tax treatment of your distributions and basis.
None of this makes a reserve-supported distribution disqualifying. It makes it a different investment from the one the headline number implies, and comparing two offerings on that headline alone is how investors end up surprised in year three. Sorting that out before the 45-day clock forces a decision is the point of the diligence sequence in our exchange process.
Common questions about DST distributions
Is a DST distribution the same as a return?
No. A distribution is cash paid out. Your return depends on where that cash came from and on what the property is ultimately worth at sale.
What does return of capital mean on a DST statement?
Two different things. In the tax sense it is the portion of cash exceeding your taxable income, which reduces your basis. In the funding sense it is distribution paid from reserves rather than operations.
Is return of capital tax-free?
It is tax-deferred rather than tax-free. It lowers your basis, so it increases the gain reported when the DST eventually sells the property.
How do I know if reserves are funding the distribution?
Ask the sponsor for the coverage ratio and read the offering documents on reserve usage. A distribution covered below 1.0x by operations is being supported by something else.
Are DST distributions guaranteed?
No. They are projections based on the sponsor's business plan, and they can be reduced or suspended if the property underperforms.
Disclosure: Numerical example is for illustration purposes only; individual circumstances will vary.