How Property Reserves Work in a Delaware Statutory Trust (DST)

Dwight Kay and the Kay Properties Team review a practical comparison to Direct Real Estate Ownership

LOS ANGELES, July 30, 2026 /PRNewswire/ -- A question sometimes asked by Delaware Statutory Trust (DST) investors is:

"Why am I paying taxes on more income than I actually received in cash?"

At first glance, it may seem confusing. However, this is not unique to DST investing—it is the same concept that has applied to direct real estate ownership for decades. Commercial real estate owners and landlords have long understood that not every dollar of rental income should be distributed immediately. Instead, prudent owners often retain a portion of rental income to prepare for future capital needs that preserve and enhance the value of their properties.

A Simple Example

For decades—indeed, for generations—real estate owners and landlords have followed the same basic financial principle: not every dollar of rental income should be distributed immediately. A prudent owner plans ahead by setting aside reserves for future expenses that potentially protect and preserve the property's value.

Imagine you personally own a commercial building that generates $200,000 in annual rental income. During the year, you discover the roof has reached the end of its useful life and will need to be replaced in the near future. Rather than distributing every dollar of rental income to yourself, you wisely retain a portion of the cash flow each month to build a reserve fund for the future roof replacement.

At year-end, you may have only withdrawn $150,000 in cash, with the remaining $50,000 held in the property's bank account as reserves.

Even though you didn't receive that $50,000 personally, it is still income generated by your property. Under IRS tax rules, you generally report the property's taxable income—not simply the cash you chose to distribute to yourself.

At first, this may result in you paying tax on income that remained in the property's reserve account. However, when those reserve dollars are ultimately used to replace the roof (or any other type of repair or investment in the property such as resurfacing the parking lot, renovating space for a new tenant or completing other improvements), those expenditures become investments back into the property. As those costs are recognized for tax purposes over time—major improvements are generally depreciated over their recovery periods rather than deducted all at once—they generally provide write offs, expenses and future tax benefits to the property's owners, making the earlier timing difference largely a matter of when the expense and tax benefit is realized rather than whether it is realized.

This has been standard practice among real estate owners for decades and is simply part of responsible property ownership and long-term asset management.

How Rental Income Is Reported in a DST

Just as with direct real estate ownership, a DST property receives rental income from its tenants throughout the year.

Business tenants that pay rent in the course of their trade or business generally report the rent paid to the property on IRS Form 1099. The DST asset manager receives these forms on behalf of the investors and typically prepares a Nominee 1099 allocating each investor's proportional share of the property's gross rental income.

The Nominee 1099 is primarily an informational reporting document that helps reconcile the rental income reported to the IRS. It is not the document used to calculate an investor's taxable income. Instead, it serves as a record-keeping tool that ties together the gross rents reported by tenants with each investor's ownership interest in the DST.

In addition, DST investors receive a calendar-year balance sheet and income statement for the property. These financial statements reflect the full year of property operations and are prepared by the DST sponsor. This financial information breaks down the entire DST property's financial information as well as further details each individual investor's percentage ownership of the DST and their corresponding pro rata numbers. Typical DST financial information at year end will include the property's gross rental income, operating expenses, net income and balance sheet.

The net income based on your pro rata percentage interest in the DST is an important starting point, but your CPA or tax preparer will adjust it—most notably for depreciation—when preparing your return, generally relying on the tax reporting package (often a grantor letter) provided by the sponsor rather than the operating statement alone. (See the sidebar below for why cash-basis net income and taxable income are not the same figure.)

Why Cash Distributions and Taxable Income May Be Different

DST investors may have questions if the amount of cash distributions they receive during the year is less than the taxable income reported by the DST property.

This difference is completely normal in commercial real estate whether the investor owns the property outright or a percentage of a DST.

One of the primary reasons is that prudent property management often requires retaining cash to build reserves for future property needs rather than distributing every available dollar to investors.

Those reserves may be accumulated for:

• Tenant improvements for lease renewals or new tenants.
• Leasing commissions to secure a new tenant.
• Roof replacements.
• Parking lot resurfacing.
• HVAC replacements.
• Landscaping and exterior improvements.
• Other major capital expenditures that preserve and improve the property.

Although these reserve dollars may temporarily reduce current cash distributions, they remain assets of the property and continue to belong to the DST investors collectively based on their proportional ownership interests. The reserves are not owned by the DST sponsor or asset manager—they are investor-owned funds being held at the property level for future capital needs. If reserve funds ultimately are not needed for their intended purpose, those funds remain property assets and will be distributed back to investors on a pro rata basis upon the sale or disposition of the property, consistent with the governing DST documents.

The Real Estate Ownership Timing Difference: Taxes Today, Tax Benefits Tomorrow

One point that is often overlooked is that reserve building generally creates a timing difference, not necessarily a permanent tax cost.

During the period reserves are being accumulated, an investor may report more taxable income than the amount of cash actually distributed because some of the property's cash flow has been retained for future capital needs.

However, when those reserve dollars are eventually used—for example, to replace a roof, resurface a parking lot, install HVAC systems, renovate space for a new tenant through tenant improvements, pay leasing commissions upon securing a new tenant, or complete other capital projects—the property incurs those expenditures on behalf of its owners. Because each DST investor owns a beneficial interest in the property, each investor will receive his or her proportional share of the expenses and write offs associated with those capital expenditures. As those reserve dollars are invested back into the property, the related expenses and write offs are passed through to investors based on their ownership interests, helping offset taxable income over time. Because most of these items are capital in nature, the related deductions are generally realized gradually through depreciation and amortization rather than entirely in the year the reserves are spent.

In other words, while a DST investor may have paid tax earlier because reserves were accumulated instead of distributed (the same way as when they directly owned real estate and built reserves), those future expenses will help offset taxable income in later years. What initially appears to be paying tax on "income you didn't receive" is often simply a matter of tax timing rather than an additional permanent tax burden. This is the case whether you own an interest in a DST or own a property outright yourself.

Example Timeline: How a Reserve Timing Difference Works

Imagine you own a 1% interest in a DST.

Year 1

Rental income allocated to you: $100,000

Cash distributed to you: $95,000

Reserved by the property for future capital improvements: $5,000

Although you only received $95,000 in cash, the property earned $100,000, so you may report taxable income based on the property's operations rather than simply the cash distributed. (This illustration is simplified; your actual taxable income would reflect operating expenses, mortgage interest – if it were a leveraged DST but not if it was a debt free DST, and depreciation.) The $5,000 was not paid to the sponsor—it remained your money as part of the property's reserve account, along with the reserves attributable to the other DST investors.

Year 2

The property uses the reserve funds to:

• Replace the roof
• Resurface the parking lot
• Complete tenant improvements for a new lease
• Pay leasing commissions to secure a new tenant

Because you are a beneficial owner of the DST property, your proportional share of those capital expenditures is reflected in the property's tax reporting. Those expenditures generally create future tax benefits that help offset taxable income in later years, generally realized through depreciation and amortization over the assets' recovery periods.

The result: Although you may have paid tax on the additional $5,000 in Year 1 because it remained in reserves, those reserve dollars were ultimately invested back into the property for your benefit. The associated future expenses help offset taxable income over time, making the difference between taxable income and cash distributions a matter of timing rather than a permanent additional tax burden.

The Bottom Line

The difference between DST cash distributions and taxable income is often misunderstood, but it is simply a reflection of how commercial real estate ownership has worked for decades regardless of if it is owned outright by the investor or owned by a DST.

Think back to the example of the landlord who owned a building and prudently retained a portion of rental income to build reserves for a future roof replacement. Although that owner received less cash in hand during the year, the reserve funds still belonged to the owner, remained invested in the property, and were ultimately used to preserve and enhance the value of the real estate. Those expenditures ultimately generated expenses associated with those improvements, helping offset taxable income over time.

A Delaware Statutory Trust operates under this very same concept.

When a DST sponsor builds reserves for future tenant improvements, leasing commissions, roof replacements, parking lot resurfacing, landscaping, HVAC systems, or other capital improvements, it is no different than the prudent landlord setting aside rental income for a future roof replacement. The cash has not disappeared, nor has it become the sponsor's money. Those reserves remain investor-owned assets of the DST property and are being preserved for future investments that help protect income, maintain competitiveness, preserve property value, and potentially support long-term DST investor returns.

As those reserves are ultimately invested back into the property, investors receive their proportional share of the expenses associated with those expenditures. In many cases, this helps offset taxable income in future years, illustrating that the earlier difference between taxable income and cash distributions is often a matter of timing rather than a permanent additional tax burden.

If all or a portion of those reserves ultimately are not needed, they remain assets of the DST property that are distributed back to investors on a pro rata basis as part of the property's final liquidation and distribution, in accordance with the terms of the DST.

This approach has been utilized successfully by commercial real estate owners, landlords, and professional property managers for generations. A DST simply follows that same long-established and widely accepted real estate ownership practice through a professionally managed ownership structure. While temporary reserve building may reduce current cash distributions, the reserves continue to belong to the investors and represent an important component of prudent asset management designed to potentially preserve and enhance the long-term value of the investment for all owners.

As always, because every investor's tax situation is unique, investors should consult their CPA or qualified tax advisor regarding the tax treatment of their individual DST investment.

At Kay Properties, we have helped over 4,000 investors nationwide invest in DSTs for nearly 20 years. Due to our specialization in DSTs and 1031 exchange investments, our firm and sister companies have an on-staff CPA, attorney, accountants, asset managers and finance professionals. These professionals have dedicated their careers to DST investors, and we would be happy to provide them as a resource to you, your CPA and attorney as you are considering a 1031 exchange into DSTs. We have found that this level of specialization and expertise can greatly benefit investors as they make one of the most important financial decisions of their lives.

To view available DST investments through Kay Properties and access DST property due diligence materials, investors can register at www.kpi1031.com. The Kay Properties marketplace is unique in that there are over 25 different DST sponsor companies that have posted between 25-50 different specific DST investments on the platform at any given time.

FAQ Section

Frequently Asked Questions About DST Reserves and Taxation

1. Why am I paying taxes on money I never received?

You're paying tax on the property's earned income, not on the cash you actually received. When the property sets aside reserves for future capital needs, that money is still income generated by your property—it simply hasn't been distributed to you yet. This is the same treatment you'd receive if you owned the building directly.

2. Does the DST sponsor keep my reserve money?

No. Reserve funds remain assets of the DST property and belong to the investors collectively based on their proportional ownership interests. The sponsor does not own or control these funds for their own benefit.

3. What happens if reserve funds are never used?

If reserves ultimately aren't needed for their intended purpose, those funds remain property assets and are distributed back to investors on a pro rata basis upon the sale or disposition of the property, consistent with the governing DST documents.

4. Will I eventually get the tax benefit from reserves that were built up?

Yes. When reserve dollars are spent on capital improvements (roof replacement, parking lot resurfacing, tenant improvements, etc.), those expenditures generate future tax benefits through depreciation and amortization that help offset taxable income over the assets' recovery periods.

5. Is the reserve timing difference the only reason my taxable income differs from my cash distributions?

No. Two other major factors are:

• Depreciation: A non-cash deduction that often makes taxable income lower than cash flow in early years
• Mortgage principal payments (in leveraged DSTs): Principal repayment uses cash but isn't tax-deductible, which can make taxable income higher than cash flow

6. Is this tax treatment unique to DSTs?

Not at all. This is exactly how direct commercial real estate ownership has worked for decades. A DST follows the same long-established real estate ownership principles through a professionally managed structure.

7. What tax documents will I receive from my DST investment?

You'll typically receive:

• A Nominee 1099 (informational document showing gross rental income allocated to you)
• A calendar-year balance sheet and income statement for the property
• A tax reporting package (often a grantor letter) that your CPA uses to prepare your return

8. Should I consult a tax professional about my DST investment?

Absolutely. Every investor's tax situation is unique. You should always consult your CPA or qualified tax advisor regarding the specific tax treatment of your DST investment.

9. How does a DST's reserve strategy benefit me as an investor?

Building reserves helps:

• Fund tenant improvements for lease renewals or new tenants
• Pay leasing commissions
• Cover major capital expenditures (roof, HVAC, parking lot, etc.)
• Preserve and potentially enhance property value
• Maintain the property's competitiveness in the market

10. How can I learn more about available DST investments?

You can register at www.kpi1031.com to view available DST investments through Kay Properties, which features 25-50 different DST offerings from over 25 sponsor companies at any given time.

About Kay Properties & Investments

For nearly two decades, Kay Properties & Investments has specialized in 1031 exchanges, Delaware Statutory Trusts (DSTs), and 721 UPREIT investments. Our team is licensed in all 50 states and has had the privilege of serving over 4,000 investors nationwide, completing more than 10,000 transactions across the 1031, DST, and 721 space.

We are proud to hold an A+ rating with the Better Business Bureau and maintain a 4.9 out of 5-star investor approval rating from the thousands of investors we have had the opportunity to serve.

What sets Kay Properties apart is our commitment to independent guidance. We offer access to over 25 different DST and 721 UPREIT sponsor companies, paired with a proprietary due diligence process designed to help investors evaluate opportunities with clarity and confidence.

Thank you for considering Kay Properties. We look forward to earning the opportunity to serve you.

*Diversification does not guarantee returns and does not protect against loss. 

*Past performance is no guarantee of future results.

Please speak with your attorney and CPA before considering an investment. All DST properties shown are Regulation D Rule 506(c) offerings. All Offerings are subject to availability. There can be no assurance that any DST properties and offerings will be available for purchase. DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million exclusive of primary residence, and/or possessing an annual income of over $200,000, or $300,000 with a spouse and expects the same or greater for the current year) and accredited entities (generally described as an entity owned entirely by accredited investors and/or owning investments in excess of $5 million). Please check with a qualified CPA or attorney to determine if you are accredited.

This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the "Memorandum"). Please read the entire Memorandum paying special attention to the risk section prior investing. IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax codes therefore you should consult your tax or legal professional for details regarding your situation. There are material risks associated with investing in real estate securities including illiquidity, vacancies, general market conditions and competition, lack of operating history, interest rate risks, general risks of owning/operating commercial and multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, potential returns and potential appreciation are not guaranteed.

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