There is a version of this business that nobody puts in a brochure, and it is the part that matters most to the people we actually work with.
A man buys a duplex in 1987. Trades into a small retail strip. Trades that into an apartment building. Trades that into a Delaware Statutory Trust at seventy-eight, because his knees are done and so is his patience. Across thirty-nine years he has never once paid the capital gains tax.
Then he dies. And the entire deferred bill dies with him.
That is not a loophole anyone is hiding. It is Section 1014, it is deliberate, and it is the actual endgame of the strategy people casually call swap till you drop. What is less well understood is how it works when the final position is a DST rather than a building, and what your heirs are genuinely holding the morning after.
What the step-up does
Under current law, property passing through an estate takes a new basis equal to its fair market value at the date of death. A DST interest is a beneficial interest treated as a direct interest in real property, and it receives that same treatment.
The practical consequence is severe, in the good direction. Every dollar of gain deferred across every exchange in the chain, plus every dollar of depreciation recapture accumulated along the way, is measured against a basis that has just been reset. There is essentially nothing left to tax.
Consider a position worth $2.4 million with an adjusted basis of $300,000 after decades of exchanges, carrying roughly $400,000 of accumulated depreciation recapture inside a $2.1 million deferred gain.
| During his lifetime | After death, for the heirs | |
|---|---|---|
| Value of the position | $2.4 million | $2.4 million |
| Adjusted basis | $300,000 | $2.4 million |
| Deferred gain exposed | $2.1 million | Effectively none |
| Depreciation recapture | $400,000 at up to 25% | Erased |
| Rough federal tax if sold | About $505,000 | About $0 |
Illustrative only, ignoring state tax and any estate tax exposure, which is a separate calculation entirely. Your CPA determines the actual figures.
The thing a DST does that a building cannot
Here is the part that surprises people, and it has nothing to do with tax.
Real estate is famously bad at being inherited by more than one person. Three children inherit an apartment building and immediately own a problem: one wants to sell, one wants to hold, one wants to move in, and none of them wants to manage it. Partition suits between siblings are a genuine category of litigation, and they are as unpleasant as they sound.
A DST interest divides cleanly. It is already fractional. It can be allocated among heirs in whatever proportion the estate plan specifies, without appraisal fights, without anyone becoming the reluctant property manager, and without a forced sale to split the value.
For a family where the real estate is most of the estate and the heirs are not all equally interested in real estate, that is often the strongest argument for the structure. It is doing estate work that a will alone cannot do.
What your heirs actually receive, and what they can do
They inherit beneficial interests, with a stepped-up basis, in a trust that continues on the sponsor's timeline rather than theirs. From there:
- Hold and collect distributions. The simplest path. Distributions continue, subject to the same risks that applied to you.
- Wait for the sponsor to sell. DSTs have finite lives, often somewhere in the five to ten year range. When the asset sells, proceeds are distributed. After a step-up there is usually little gain to tax.
- Exchange again. Heirs hold a real property interest and can generally 1031 into a replacement, though after a step-up there is often nothing left worth deferring.
- Sell the interest. Possible in principle, difficult in practice. There is no meaningful secondary market and any sale is likely at a discount.
The problems worth planning around
This is not a frictionless outcome, and the honest version includes the following:
- Illiquidity does not care that you died. An estate that needs cash for taxes, debts, or an uneven distribution cannot simply sell the DST position. If liquidity will be needed, it has to come from somewhere else in the estate.
- Your heirs inherit the sponsor's clock. They cannot force a sale, replace the sponsor, or accelerate an exit. Everything covered in the seven things a DST is forbidden to do applies to them exactly as it applied to you.
- A springing LLC conversion changes the answer. If the trust has converted, the interest is likely a partnership interest, and the heirs' options narrow considerably.
- Community property states may deliver more. In several states, community property can receive a full step-up on both halves at the first spouse's death rather than half. Whether that applies to you is a question of state law and titling.
- Section 1014 is a policy choice, not a law of nature. It has been proposed for change more than once. Plan for the rule as it stands, and revisit if it moves.
Make the mechanics match the intent
The step-up is automatic. Everything around it is not. Beneficiary designations, how the interest is titled, whether it sits in a revocable trust, and whether your sponsor's transfer process is documented all determine whether this goes smoothly or becomes a nine-month administrative ordeal for someone who is grieving.
Ask your sponsor, in writing, what their transfer-on-death process actually requires. The answers vary more than you would expect.
Related reading: swap till you drop and the step-up in basis, DST exit strategies, and 721 UPREIT exits. Our DST overview covers the structure itself.
DSTs are private placements offered only to accredited investors. They are illiquid, you cannot direct management or force a sale, distributions are not guaranteed, and you can lose principal. None of this is legal or estate planning advice. Work with your CPA and an estate attorney.
Common questions about inheriting a DST
Do my heirs owe the deferred capital gains tax?
Generally no. Under current law the basis steps up to fair market value at death, which effectively eliminates the deferred gain and the accumulated depreciation recapture.
Can DST interests be split among several children?
Yes, and this is one of the structure's real advantages. Fractional interests divide without the partition problems that come with a single physical building.
Can my heirs do a 1031 exchange with what they inherit?
Generally yes, since they hold an interest treated as real property. After a step-up there is usually little deferred gain remaining to make it worthwhile.
What if my heirs need cash quickly?
That is the structural weakness. DST interests are illiquid with no reliable secondary market, so estate liquidity should be planned from other assets.
Does the step-up apply to depreciation recapture as well?
Yes. Recapture accumulated during the decedent's ownership is generally eliminated along with the deferred gain, which is often the larger share of the benefit.