A Little-Known Tax Buster for Rich Retirees: Zero-Coupon DST

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published 27 February 2025

For retirees with substantial incomes, managing tax obligations is a critical aspect of financial planning. One strategy that offers both tax advantages and the potential for long-term wealth preservation is investing in zero-coupon Delaware statutory trust (DST) properties. Unlike traditional real estate investments, a zero-coupon DST combines the tax deferral advantages of a DST structure with unique financial benefits suited for high-income retirees.

Here’s an overview of how zero-coupon DSTs work, the specific tax benefits they offer and why they can be a strategic addition to a high-income retiree’s portfolio.

How is a zero-coupon DST different from a traditional DST?

A Delaware statutory trust is a legal structure used in real estate investing that allows multiple investors to hold fractional interests in large, institutional-grade properties, such as commercial buildings, multifamily complexes or industrial assets. DSTs have become particularly popular among investors using 1031 exchanges, a section of the U.S. tax code that allows for the deferral of capital gains taxes on the sale of investment properties, provided the proceeds are reinvested in like-kind real estate.

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A zero-coupon DST differs from a traditional DST in that it does not pay regular distributions to investors. Instead, all income generated by the property is used to pay down debt. This approach leads to a more favorable loan-to-value (LTV) ratio, providing a substantial tax benefit and the potential for wealth accumulation. For high-income retirees who prioritize tax efficiency, zero-coupon DSTs offer a compelling way to manage income and maximize after-tax returns.

Key tax benefits of investing in a zero-coupon DST

1. Capital gains tax deferral through a 1031 exchange

One of the primary tax benefits of investing in a zero-coupon DST is the ability to defer capital gains taxes through a 1031 exchange. When retirees sell highly appreciated real estate assets, they face substantial capital gains taxes, which can erode a significant portion of their wealth. By reinvesting proceeds from the sale into a zero-coupon DST, retirees can defer these taxes indefinitely, preserving more of their capital for reinvestment.

By choosing a zero-coupon DST as the replacement property, retirees gain access to institutional-grade assets while minimizing the tax burden associated with selling appreciated property. This deferral strategy can be repeated across generations, allowing investors to pass down a tax-deferred asset base to heirs, which can further enhance legacy and estate planning.

2. Enhanced depreciation deductions

Depreciation is a powerful tax deduction available in real estate investing, allowing property owners to deduct a portion of the property’s cost over its useful life, thereby reducing taxable income. Zero-coupon DST properties, which typically include high-value assets with substantial building and improvement costs, offer enhanced depreciation deductions.

For high-income retirees, depreciation can offset passive income from other investments, creating an effective way to reduce tax obligations. Since zero-coupon DSTs are structured with no income distributions during the term, depreciation deductions can often exceed any remaining taxable income, resulting in significant tax savings. These “paper losses” can be especially advantageous for retirees in high tax brackets, as they reduce overall taxable income and provide relief in terms of current-year tax liabilities.

3. No additional taxable income until sale or maturity

A unique feature of zero-coupon DSTs is their lack of ongoing income distributions, which means there’s no regular taxable income to report while the investment is held. Instead, the income generated by the property goes toward paying down the loan on the property, increasing the investor’s equity over time without increasing their tax liability. This structure is advantageous for high-income retirees who want to minimize additional taxable income.

Unlike traditional real estate investments or income-generating DSTs, a zero-coupon DST doesn’t require investors to report ongoing income, which can push retirees into higher tax brackets or expose them to additional Medicare surcharges. By deferring income until the end of the investment period, zero-coupon DSTs help retirees maintain control over their income and taxes, creating a more predictable and manageable tax situation.

4. Debt paydown leading to increased equity

Because all income generated by a zero-coupon DST is directed toward debt repayment, the investor’s share of equity in the property increases over time. This gradual increase in equity creates a wealth accumulation effect without producing taxable income. When the property is eventually sold or matures, investors benefit from a higher equity position, which can lead to a more favorable return on investment (ROI) when the asset is liquidated.

For retirees, this debt paydown structure is particularly beneficial, as it provides a path to wealth growth without the annual tax obligations typically associated with other investment income. High-income retirees can preserve cash flow and delay taxation until the asset is sold, allowing them to strategically manage their tax situation and financial needs in retirement.

5. Step-up in basis for heirs

For retirees focused on estate planning, zero-coupon DSTs offer an additional tax benefit through a step-up in basis. When a DST investment is passed on to heirs, the property’s basis is “stepped up” to its current market value at the time of the owner’s death. This step-up effectively eliminates any capital gains tax liability that would have been owed on the property’s appreciation during the original owner’s lifetime.

This tax benefit is particularly advantageous for high-income retirees who want to minimize tax burdens on their heirs. By reinvesting in a zero-coupon DST, retirees can defer capital gains taxes during their lifetime and transfer an appreciated asset to heirs without triggering a tax liability. For heirs, this means they receive the full value of the asset without the weight of capital gains tax, enabling a more seamless transfer of wealth.

Balancing risks and rewards

While zero-coupon DSTs offer substantial tax benefits, they’re not without risks:

Zero-coupon DSTs are illiquid, meaning investors typically cannot access their capital until the end of the DST’s term. Retirees considering this investment should ensure they have sufficient liquidity in other areas of their portfolio for emergency or lifestyle needs.
Additionally, real estate market conditions can affect the value of the DST property at maturity, so it’s essential to work with a trusted adviser who understands the complexities of DST investments and can help structure them to align with your long-term goals.

Why zero-coupon DSTs are well-suited for high-income retirees

For high-income retirees, zero-coupon DSTs offer a combination of tax deferral, estate planning advantages and the potential for appreciation without the downside of annual income taxation. Unlike traditional income-generating real estate investments, zero-coupon DSTs provide a unique way to accumulate wealth over time without triggering annual tax liabilities. This tax-efficient structure makes them ideal for retirees who want to preserve wealth, optimize taxes and secure assets for the next generation.

Zero-coupon DSTs are an innovative investment for high-income retirees seeking to maximize tax advantages and manage taxable income. By combining capital gains deferral, enhanced depreciation deductions and no taxable income during the investment term, zero-coupon DSTs deliver a tax-efficient way to participate in real estate. With added estate planning benefits such as a step-up in basis, zero-coupon DSTs enable retirees to preserve wealth and optimize tax outcomes for themselves and their heirs.

High-income retirees should work with knowledgeable financial and tax advisers to assess whether a zero-coupon DST aligns with their financial goals and risk tolerance. When structured correctly, zero-coupon DSTs offer a compelling blend of wealth accumulation, tax efficiency, and legacy planning — making them a valuable addition to the portfolios of tax-conscious, high-income retirees.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Derek Miser serves as Chief Managing Member at Miser Wealth Partners, LLC, located in Knoxville, Tenn., and Tellico Village, Tenn. Miser Wealth Partners delivers family office services to successful retirees and entrepreneurs nationwide and in Puerto Rico. He recently published his first book, "Golden Years, Greener Pockets." This guide to tax efficiency for retirees is an excellent read for anyone contemplating or already retired.