Glossary

In the context of a Delaware Statutory Trust (DST), a pass-through entity (also called a flow-through entity) means the DST itself does not pay federal income taxes on its earnings. Instead, all income, expenses, deductions (such as depreciation), losses, and credits from the underlying real estate “pass through” directly to the individual investors (beneficial owners) on a pro rata basis.

How It Works in a DST

• The DST holds legal title to the real estate (e.g., an apartment complex or commercial property).
• Investors own beneficial interests in the trust (fractional ownership), not shares in a corporation or partnership units.
• For federal tax purposes, a properly structured DST is treated as a grantor trust (disregarded entity). This means the IRS views investors as if they directly own their proportionate share of the property.
• At year-end, investors typically receive a grantor trust letter (sometimes with a 1099 or operating statement) that breaks down their share of:
• Rental income
• Operating expenses
• Depreciation (often enhanced by cost segregation, as discussed previously)
• Mortgage interest (if debt-financed)
• Any other items
• Investors report these items on their personal tax return (usually on Schedule E, Supplemental Income and Loss), just like they would for directly owned rental property. Taxes are paid only at the individual level, at the investor’s ordinary income tax rates.

Key Advantages of This Pass-Through Structure

• No double taxation: Unlike a regular C-corporation (taxed at the entity level and again on dividends), the DST avoids corporate-level tax. More net income flows to investors.
• Tax benefits flow directly: Investors can claim their share of depreciation, interest deductions, and other expenses to offset taxable income. This is especially valuable in 1031 exchanges, where DSTs qualify as “like-kind” replacement property.
• 1031 exchange compatibility: Because investors are treated as direct owners of real estate for tax purposes, they can defer capital gains taxes when selling a property and investing proceeds into a DST (and later exchange out of a DST into another like-kind property).
• Passive nature with tax transparency: Management is handled by the DST sponsor/trustee, but tax reporting remains straightforward and individualized.

Note that while the DST is a “pass-through” for income tax purposes, it is a separate legal entity that provides limited liability to investors (creditors generally can’t go after personal assets). Exact tax reporting can vary slightly by sponsor, and depreciation calculations are often based on each investor’s individual cost basis from their 1031 exchange.

This structure is one reason DSTs are popular for offering pass-through tax advantages, such as accelerated depreciation through cost segregation studies. Always consult a qualified tax advisor or CPA, as individual results depend on your specific tax situation, basis, and current IRS rules.