Why Your Choice of Replacement Property Structure Matters
Completing a 1031 like-kind exchange is not simply a matter of selling one property and buying another. The structure of your replacement property can affect your tax treatment, your day-to-day involvement, your ability to finance the investment, and your eventual exit. Two structures that regularly come up for investors who want fractional ownership rather than sole ownership of replacement property are tenants-in-common (TIC) arrangements and Delaware Statutory Trusts (DSTs).
Both can qualify as like-kind replacement property for a 1031 exchange. Both allow multiple investors to share ownership of large commercial or investment real estate. But the similarities largely end there. Understanding how each structure operates - and where each can create problems - is essential before you lock in a replacement property decision. You can also review our 1031 Exchange Checklist and our foundational article on the nuts and bolts of a Section 1031 like-kind exchange to build your baseline knowledge.
-- - ## How a Tenants-in-Common Arrangement Works
A tenants-in-common arrangement is one of the oldest forms of co-ownership in real property law. Each co-owner holds a separate, undivided fractional interest in the property. That interest can be sold, gifted, or passed on to heirs independently of the other co-owners' interests.
The Revenue Procedure 2002-22 Framework
The IRS addressed the use of TIC interests as 1031 replacement property in Revenue Procedure 2002-22. Under that guidance, a TIC arrangement can qualify as a direct ownership interest in real property - rather than an interest in an entity - if it satisfies a series of conditions. Those conditions include: - No more than 35 co-owners in the arrangement - Each co-owner must have the right to approve certain major decisions about the property (sales, leases, financing) - The co-owners may not hold their interests through a business entity (no partnerships, LLCs, or corporations at the ownership level) - A single co-owner must be able to force a partition of the property - Decision-making by majority vote is limited to specific operational matters
This framework gives TIC investors meaningful rights. They can negotiate financing individually, pledge their interest as collateral, and take title directly. That direct ownership treatment is important for 1031 exchange qualification.
TIC Ownership in Practice
In practice, TIC arrangements often involve a sponsor who assembles the group of co-investors, acquires the property, and arranges a property management agreement. Each investor receives a deed reflecting their ownership percentage. Investors typically sign a co-tenancy agreement that governs how the group will make decisions.
Because each co-owner holds a direct real property interest, they can each conduct their own 1031 exchange into or out of the TIC. They also receive their proportionate share of income, expenses, and depreciation, which flows directly to their individual tax returns.
The challenges with TIC structures center on governance and liquidity. With up to 35 co-owners who each have approval rights over major decisions, reaching consensus can be slow or contentious. If one co-owner wants out and cannot sell their interest, they may have partition rights - which can force an unwanted sale of the entire property. TIC interests are also generally illiquid because the secondary market is thin.
-- - ## How a Delaware Statutory Trust Works
A Delaware Statutory Trust is a separate legal entity created under Delaware law. The DST holds title to the replacement property. Investors purchase beneficial interests in the trust rather than taking direct title to real estate. Because of IRS Revenue Ruling 2004-86, those beneficial interests qualify as like-kind real property interests for 1031 exchange purposes.
For a detailed breakdown of how DSTs interact with 1031 exchanges specifically, see our article on how a taxpayer can exchange investment real estate for an interest in a Delaware Statutory Trust, as well as our Delaware Statutory Trusts overview.
The Seven Deadly Sins of DST Ownership
To preserve the trust's treatment as a grantor trust for tax and 1031 purposes, DSTs must comply with what practitioners call the "seven deadly sins" - a set of restrictions the IRS imposed in Revenue Ruling 2004-86. These restrictions prohibit the trustee from:
- Accepting new contributions of cash or property after the offering closes
- Renegotiating the existing debt or entering into new debt obligations
- Reinvesting any proceeds from a property sale
- Making more than minor non-structural modifications to the property
- Entering into new leases (other than short-term leases of one year or less)
- Retaining cash other than for reasonable reserves
- Investing in new properties after closing
These restrictions make DSTs passive by design. Investors have no voting rights and no operational input. A professional asset manager handles the property. This passivity is precisely the feature that appeals to many exchangers - particularly those who are "tired landlords" looking to exit active management obligations.
DSTs as Securities
Because DST investors hold beneficial interests rather than direct property rights, those interests are treated as securities under federal law. DST offerings are typically conducted as private placements under Regulation D. That means they are generally available only to accredited investors. It also means there is a formal offering process involving disclosure documents and broker-dealer involvement. For investors interested in how securities law intersects with real estate capital formation, our posts on accredited investor verification under Rule 506(c) and private capital raise address the regulatory framework in more detail.
-- - ## Head-to-Head Comparison: TIC vs DST
Control and Decision-Making
TIC investors retain meaningful control. They have approval rights over major decisions and can directly influence how the property is managed or when it is sold. DST investors have essentially no control. They are passive beneficiaries who rely entirely on the sponsor and trustee.
Number of Investors
TIC arrangements are capped at 35 co-owners under Revenue Procedure 2002-22. DSTs can accommodate hundreds of investors because the beneficial interest structure removes the cap.
Financing
TIC investors can obtain individual financing on their ownership interest and can pledge their interest as collateral. DSTs are structured with entity-level financing already in place. Individual DST investors cannot separately finance or encumber their beneficial interests.
Liability and Partition Risk
In a TIC, each co-owner has partition rights, which means one disgruntled investor can potentially force a sale of the entire property. In a DST, beneficial interests do not carry partition rights, so no single investor can disrupt the group's ownership.
Liquidity and Exit
Neither structure offers strong liquidity. TIC interests trade on a thin secondary market. DST interests are also generally illiquid, though some sponsors facilitate secondary transactions. Both structures typically anticipate a hold period followed by a group disposition.
Future 1031 Exchanges
This is a critical distinction. TIC investors hold direct real property interests, so when the property eventually sells, each co-owner can independently conduct their own 1031 exchange into another replacement property. DST investors hold beneficial interests that are classified as securities - not direct real estate. To do a subsequent 1031 exchange out of a DST, a special "721 exchange" or "UPREITing" structure is sometimes used, but it adds complexity and is not always available.
-- - ## Florida-Specific Considerations for South Florida Investors
For investors based in Boca Raton and throughout South Florida, both TIC and DST structures are accessible and widely used. Florida does not impose a state income tax, which simplifies the state-level analysis somewhat. However, documentary stamp taxes on deed transfers, Florida's intangible personal property considerations, and the interplay with estate planning objectives all deserve attention when choosing a structure.
The co-tenancy agreement in a TIC structure, or the trust agreement and subscription documents in a DST offering, each require careful review by counsel who understands both the real estate and securities dimensions. Because DST interests are securities, engaging with broker-dealers and reviewing disclosure documents is mandatory - not optional.
If you are working through a tax law question about whether gain deferral is available in your specific fact pattern, or how depreciation recapture interacts with your exchange, that analysis benefits enormously from the kind of integrated legal and financial perspective that combines transactional law, tax planning, and real estate expertise.
-- - ## Common Mistakes to Avoid
Waiting Too Long to Identify Replacement Property
The 45-day identification window and the 180-day exchange completion deadline apply regardless of which structure you choose. Neither structure extends those deadlines. The DST market moves quickly, and available offerings can close before your identification window expires.
Overlooking the Co-Tenancy Agreement in a TIC
Investors sometimes focus entirely on the real estate asset and underestimate how important the governance terms of the co-tenancy agreement are. A poorly drafted agreement can create deadlock, expose you to unexpected costs, or limit your ability to exit.
Treating DST Interests as Equivalent to Direct Ownership
DST beneficial interests are securities. They carry different legal characteristics than a deed. The restrictions baked into the trust structure limit flexibility significantly. Those limitations may be fine for your situation, but they should be understood clearly before you commit.
Ignoring Estate Planning Implications
Both TIC interests and DST beneficial interests can pass to heirs and receive a stepped-up basis at death. However, the mechanics of transferring each type of interest differ, and the co-tenancy agreement or trust documents may impose transfer restrictions. Coordinating your 1031 exchange strategy with your broader estate plan is important, and it is something that often falls through the cracks when the exchange is handled purely as a real estate transaction.
-- - ## Which Structure Is Right for You?
The honest answer is: it depends on your priorities. If you want retained control, the ability to independently finance your interest, and a clean path to a future 1031 exchange, a TIC arrangement may serve you better - provided you can work constructively with co-owners and tolerate the governance complexity. If you want to step away from active management entirely, access institutional-quality properties with a smaller capital commitment, and benefit from a professionally managed passive income stream, a DST may be the better fit despite its restrictions.
For many exchangers, the choice also comes down to what replacement property is actually available within the identification window. Having counsel who can evaluate both structures quickly - and who understands the real estate, tax, and entity law dimensions simultaneously - can be the difference between a clean exchange and a costly mistake.
Disclaimer: This article provides general legal and tax information for educational purposes only. It does not constitute legal advice and does not create an attorney-client relationship. Tax laws and regulations are subject to change, and outcomes vary based on individual circumstances. Consult a qualified attorney and tax advisor before making any decisions regarding a 1031 exchange or investment structure.
-- - ## Ready to Explore Your 1031 Exchange Options?
Peter P. Lindley brings a rare combination of legal, CPA, and business credentials to 1031 exchange planning and real estate transactions. Whether you are evaluating a tenants-in-common arrangement, a Delaware Statutory Trust, or a direct replacement property acquisition, Peter can help you analyze the tax, legal, and structural considerations from every angle. Contact us today to schedule a consultation and get clear guidance tailored to your specific situation.
Frequently Asked Questions
Can I use either a tenants-in-common interest or a DST interest as replacement property in a 1031 exchange?
Yes. Both qualify as like-kind replacement property under current IRS guidance. TIC interests qualify under Revenue Procedure 2002-22, which treats a properly structured co-ownership interest as a direct real property interest. DST beneficial interests qualify under Revenue Ruling 2004-86, which confirmed that those interests are treated as real property for 1031 exchange purposes. However, each structure has strict requirements that must be met to preserve that treatment.
What is the biggest practical difference between a TIC and a DST for a Florida investor?
Control and flexibility are the key differences. In a TIC, you hold a direct ownership interest and retain approval rights over major decisions. You can also independently finance your interest and conduct a future 1031 exchange when the property sells. In a DST, you are a passive beneficiary with no voting rights and no ability to separately finance your interest. The DST trustee manages everything under strict operational restrictions. A DST is designed for investors who want to exit active management, while a TIC suits those who want more influence over the asset.
How many investors can participate in a TIC arrangement versus a DST?
Revenue Procedure 2002-22 limits TIC arrangements to a maximum of 35 co-owners. This cap exists to ensure the arrangement reflects co-ownership of real property rather than an investment in an entity. DSTs have no comparable investor cap because the beneficial interest structure is already recognized as a trust, not a direct co-ownership arrangement. As a result, DSTs can pool hundreds of investors and offer access to much larger institutional properties than a typical TIC can accommodate.
Can I do another 1031 exchange when a DST eventually sells its property?
This is more complicated with a DST than with a TIC. Because DST beneficial interests are securities rather than direct real estate, a straightforward 1031 exchange out of the DST is not always available. Some sponsors facilitate an exchange of DST interests into an operating partnership interest in a REIT through a 721 exchange structure, but that results in a non-real-estate interest that cannot be further exchanged under Section 1031. TIC investors, by contrast, hold direct real property interests and can each independently conduct a 1031 exchange when their TIC interest is sold.
Are DST interests regulated as securities?
Yes. DST beneficial interests are classified as securities under federal law. DST offerings are typically conducted as private placements under Regulation D of the Securities Act, making them available only to accredited investors. This means the investment process involves formal disclosure documents, broker-dealer involvement, and regulatory compliance requirements that are not present in a standard real estate purchase. Investors should review all offering documents carefully and work with qualified legal counsel before investing.
How do I decide between a TIC and a DST for my 1031 exchange?
The decision depends on several factors: how much control you want to retain, whether you plan to use financing on your ownership interest, whether you want to remain eligible for a future 1031 exchange, how many other co-investors will be involved, and how much time you have within your 45-day identification window. A TIC is generally better for investors who want direct ownership rights and future exchange flexibility. A DST suits investors who prioritize passive income and professional management over control. A qualified attorney with both real estate and tax expertise can help you match the right structure to your specific goals.