For financial advisors, attorneys, and accountants working with clients who own appreciated investment real estate, the Delaware Statutory Trust (DST) has become an increasingly familiar alternative to purchasing replacement property outright. But DSTs are not the only way to acquire a fractional interest in real estate while potentially preserving eligibility for a Section 1031 exchange.
Tenants in Common (TIC) ownership can also provide a path to fractional real estate ownership, and for an investor who wants a greater degree of control over the underlying investment, it may be the better fit.
The distinction matters because the two structures can look similar from a distance. Both can allow an investor to own a fractional interest in real estate rather than an entire property. Both can potentially qualify as replacement property for purposes of Section 1031. Yet the economic and practical experience of the investor can be dramatically different.
For advisors helping clients evaluate these alternatives, the central question is not simply whether a TIC or DST “qualifies” for a 1031 exchange. The more important question is: Which ownership structure best matches the client’s desired level of control, willingness to accept management responsibilities, available capital, financing needs, and investment objectives?
The Tax Foundation: Both Structures Can Support a 1031 Exchange
A properly structured TIC interest can qualify as an interest in real property for federal tax purposes. IRS Revenue Procedure 2002-22 establishes conditions under which the IRS would consider a request for a private letter ruling that a TIC arrangement is not an entity separate from its owners. Among other requirements, each co-owner must hold title to the property as a tenant in common, and the arrangement cannot be treated as a partnership or corporation. The revenue procedure also limits the number of co-owners to 35 and requires unanimous approval from the co-owners for most management decisions.
DSTs received specific IRS recognition through Revenue Ruling 2004-86, where the IRS concluded that a properly structured Delaware Statutory Trust could constitute qualifying replacement property for purposes of Section 1031, assuming the other requirements of Section 1031 were satisfied.
That distinction is important. A DST is not simply an LLC with a different name. Its structure and the limitations imposed on the trustee are critical to preserving the intended tax treatment.
For the advisor, however, the tax qualification is only the beginning of the analysis.
Investor Control: TIC Ownership Provides More, DST Ownership Provides Less
Perhaps the most important practical distinction between a TIC and a DST is control.
With a TIC investment, the investor directly owns an undivided fractional interest in the underlying real estate. The co-owners collectively retain significant rights regarding the property. Under the framework of Revenue Procedure 2002-22, certain major decisions, including the sale of the property, leasing decisions, hiring a manager, and certain financing decisions, require unanimous approval from the co-owners.
This gives the TIC investor something that is largely absent from a DST: a meaningful voice in major decisions concerning the underlying property.
That control can be attractive to an investor who has substantial real estate experience and wants to participate in decisions concerning leasing, financing, property management, capital expenditures, or a future sale.
But control comes with a price. A TIC investor is not simply buying an economic interest in real estate. The investor is becoming one of the owners responsible for making decisions about that real estate. Disagreements among co-owners can create delays, particularly when the owners have different investment horizons, financial circumstances, or opinions about the property’s future.
The DST model takes the opposite approach. In a DST, the investor has virtually no control over the underlying property. The trustee and sponsor are responsible for operating the investment within the restrictions necessary to preserve the intended tax classification. Revenue Ruling 2004-86 is based in part on a trust structure in which the trustee has limited powers.
For many investors, that lack of control is not a disadvantage; it is the reason for the investment.
A client who has spent many years managing rental properties may view the inability to make property-level decisions as frustrating. Another client who is tired of dealing with tenants, contractors, leases, refinancing, and property management may view the same limitation as the primary reason for choosing a DST.
The advisor should therefore avoid characterizing “control” as inherently good or bad. It is a preference, and one that often correlates closely with the client’s experience as a real estate owner.
Management Burden: Active Ownership vs. Passive Ownership
The distinction in control leads directly to the second major difference: management responsibility.
A TIC arrangement can employ a professional property manager, so TIC ownership does not necessarily mean that each investor personally manages the property. Revenue Procedure 2002-22 specifically contemplates management and brokerage arrangements.
Nevertheless, TIC investors remain owners of the underlying property. They may have to participate in significant decisions, review property-level information, approve certain actions, and coordinate with the other owners.
The management burden is therefore lower than owning an investment property individually, but it remains higher than owning a DST interest.
A DST is designed specifically to provide a more passive investment experience. The sponsor (or a third-party property manager) typically handles property management, leasing, financing, and other operational matters, subject to the restrictions imposed by the trust structure and offering documents.
For a client whose principal objective is to exchange out of an actively managed property and reduce the day-to-day responsibilities associated with real estate ownership, this distinction can be decisive. This is also why DSTs can be particularly relevant in retirement planning. A client may still want exposure to real estate income and appreciation but no longer want the responsibilities associated with being a landlord or active property owner.
Minimum Investment Requirements: Capital Efficiency Matters
Investment minimums can materially affect which structure is practical for a particular 1031 exchanger.
There is no single federally mandated TIC investment minimum. Instead, the economics of a particular property and the number of permitted co-owners largely determine the practical minimum. Because a TIC arrangement cannot exceed 35 co-owners under the conditions of Revenue Procedure 2002-22, a property must be divided among a relatively limited number of investors. As a result, TIC investments have historically tended to require substantial amounts of capital, although actual minimums vary considerably depending on the property, sponsor, and offering.
DSTs can be more accessible from a minimum-investment standpoint because a sponsor can divide the beneficial ownership of a large property among a substantially larger pool of investors. Current market offerings commonly establish minimum investments around $100,000 for 1031 investors, although minimums vary by sponsor and offering and some offerings may establish different thresholds. Additionally, because DSTs are sold as securities, Securities and Exchange Commission Regulation D (“Reg D”) only permits “accredited investors” to participate in DST offerings.
That difference can become especially important in a partial 1031 exchange.
Suppose a client has $600,000 of net exchange proceeds but does not want to acquire a $2 million property. A DST may allow the client to allocate the proceeds among one or more fractional real estate investments, subject to the applicable offering minimums and the client’s suitability considerations. A TIC can also provide fractional ownership, but the combination of property value, co-owner limitations, and transaction structure can make it less flexible for smaller allocations.
The practical takeaway for advisors is that the client’s available equity and potential status as an accredited investor should be considered early in the analysis, rather than after the client has developed a preference for one structure.
Financing: A Particularly Important Distinction
Financing is one of the areas where advisors should look beyond the headline investment amount.
With TIC ownership, the investor owns a proportionate undivided interest in the real estate and shares in the property’s liabilities in proportion to the ownership interest. Revenue Procedure 2002-22 addresses the sharing of debt and liabilities as part of the conditions for the TIC structure.
The financing arrangement can therefore require more investor involvement. Depending on the particular structure and lender requirements, TIC investors may be borrowers or otherwise have obligations associated with the property’s financing. The precise terms must be reviewed in the loan documents and offering materials.
A DST typically takes a more centralized approach. The sponsor arranges financing at the property or trust level before investors acquire their beneficial interests. The investor’s economic and tax position generally reflects the investor’s proportionate interest in the trust, including an allocated share of property-level debt when applicable.
This can make a DST particularly attractive to a client who needs replacement debt to satisfy the economic requirements of a fully tax-deferred exchange but does not want to negotiate or participate directly in obtaining a new mortgage. However, advisors should be careful not to equate “passive” with “risk-free.”
A DST investor can have exposure to property-level leverage without personally controlling the financing decisions. Interest rates, maturity dates, refinancing risk, loan covenants, and the sponsor’s ability to sell the property can all affect the investment.
The financing question therefore becomes a tradeoff between control and convenience. A TIC investor generally has greater involvement in financing decisions. A DST investor generally accepts financing that has already been established as part of the offering.
The Decision Often Comes Down to the Client, Not the Property
From an investment-planning perspective, the most useful way to compare TICs and DSTs is to start with the client rather than the structure.
Consider a client who has successfully owned and managed commercial real estate for decades. The client has a strong understanding of leasing, property valuation, capital expenditures, and financing. The client is comfortable participating in major decisions and wants meaningful influence over the eventual sale of the property. That investor may find a TIC structure attractive because the additional control is valuable.
Now consider a different client who owns a highly appreciated apartment building, has accumulated significant capital gain, and wants to complete a 1031 exchange but is approaching retirement. The client has little interest in finding tenants, negotiating leases, dealing with property managers, or participating in financing decisions. For that investor, the limited-control nature of a DST may be a significant advantage rather than a limitation.
Neither conclusion is universally correct.
Advisors Should Also Consider the Exit
The differences between TICs and DSTs extend beyond acquisition. With TIC ownership, a sale of the underlying property requires coordination among the co-owners. The same control that gives an investor a voice in the property’s operation makes consensus more important when it comes time to sell. With a DST, the investor does not control when the underlying property is sold. The sponsor and trustee operate within the governing documents and applicable tax rules, and the investment’s exit is largely determined by the offering’s business plan and market conditions.
This creates a fundamental tradeoff.
A TIC investor accepts more responsibility in exchange for more control. A DST investor gives up much of that control in exchange for greater passivity. That tradeoff should be discussed explicitly with clients before an investment is selected.
The Role of the Financial Advisor, Attorney, and Accountant
The most effective professional advice in this area is interdisciplinary. The financial advisor should evaluate whether the investment fits the client’s portfolio, liquidity needs, risk tolerance, income objectives, time horizon, and overall financial plan. The attorney should focus on the legal structure, governing documents, ownership rights, transfer restrictions, financing arrangements, and other legal considerations. The accountant or tax advisor should analyze the client’s basis, gain, depreciation recapture exposure, debt replacement requirements, boot considerations, and the tax consequences of the proposed transaction. The Qualified Intermediary can help facilitate the 1031 exchange itself, but the QI should not be substituted for the client’s investment, legal, or tax advisors. (Note that under the 1031 Exchange Regulations, the QI cannot give tax or legal advice.)
A Better Way to Frame the TIC vs. DST Conversation
Rather than asking a client, “Do you want a TIC or a DST?” advisors can begin with a more revealing series of questions.
How much control does the client want? How much time does the client want to spend dealing with real estate? How much capital is available for each replacement investment? Does the client need to replace debt? Is the client comfortable with sponsor-controlled financing? Does the client need flexibility to diversify exchange proceeds among multiple properties? And perhaps most importantly, is the client trying to remain an active real estate owner or transition toward a more passive investment model?
Those questions often make the appropriate structure much clearer.
A TIC and a DST can both play valuable roles in a Section 1031 strategy, but they solve somewhat different problems. The TIC model preserves a greater degree of direct ownership and investor involvement. The DST model emphasizes passive ownership, centralized management, and operational simplicity.
For clients who want control, a TIC may be worth the additional complexity. For clients who prioritize simplicity and freedom from property-level management, a DST may be the more compelling alternative.
The best recommendation is therefore not necessarily the structure with the lowest minimum investment, the highest projected distribution, or the most attractive property. It is the structure that best aligns the client’s tax objectives with the client’s broader financial and investment objectives.
And that is ultimately the most critical role for the advisor: not simply helping a client find replacement property but helping the client determine what kind of real estate ownership makes sense for the next stage of the client’s financial life.
