A Deferred Sales Trust (DST) is an estate planning tool that allows you to defer capital gains taxes when selling highly appreciated assets—such as real estate, businesses, or stocks. By transferring the asset to an irrevocable trust in exchange for a promissory note, you shift the tax liability and spread tax payments out over installment periods.
Benefits of a Deferred Sales Trust
- Sell Real Estate Tax Deferred: Keep your full sale proceeds working for you rather than paying immediate taxes.
- Retire with Lifetime Income Stream: Convert your illiquid assets into a steady, reliable stream of retirement cash flow.
- Avoid Capital Gains and Depreciation Taxes: Defer costly federal capital gains taxes and expensive depreciation recapture liabilities.
- Defer 3.8% Excess Tax: Shield your transaction profits from the 3.8% Net Investment Income Tax (NIIT).
- End-to-End Control of Transaction: Maintain full authority over how the trust structures the payment terms and installment timeline.
- Inheritance Tax Advantage: Pass a significantly larger financial legacy to your heirs by reducing your taxable estate.
- 1031 Alternative: Pivot away from strict real estate rules and rigid replacement properties into a flexible tax shelter.
- No Worries of Defaults or Foreclosure: Eliminate the operational risks and property management burdens of traditional buyer financing.
How a Deferred Sales Trust Works
- Transfer: You transfer your asset to an irrevocable trust and receive a promissory note outlining the payment terms.
- Sale: The trustee sells the asset to a third-party buyer. Because you receive the proceeds via the promissory note rather than a direct cash lump sum, you only pay capital gains taxes on the specific installment amounts you receive each year.
- Reinvestment: The trustee can reinvest the proceeds into income-generating assets, allowing the trust’s value to grow.
DST vs. 1031 Exchange
While both strategies defer capital gains taxes, they operate differently:
- 1031 Exchange: Limited exclusively to real estate. You must identify a “like-kind” replacement property within 45 days and close the purchase within 180 days.
- Deferred Sales Trust: Can be used for real estate, businesses, stocks, collectibles, and other high-value assets. There is no strict timeline to buy another property, offering more flexible payout control.
Tax Advantages & Estate Planning
Selling a highly appreciated asset triggers significant federal and state taxes. A DST serves as a powerful wealth preservation tool for you and your heirs through several key mechanisms:
- Wealth Maximization: It passes more money to your heirs by keeping your wealth intact rather than depleting it upfront with immediate capital gains taxes.
- Compound Growth: The trustee can invest the money from the asset sale into new investments, generating income and growing the trust’s total valuation over time.
- Leveraged Capital: By deferring taxes, you keep the money that would have gone to the IRS working for you, maximizing the size of your income-generating portfolio.
- Generational Income: It provides your beneficiaries with a steady, reliable stream of payments over time from the trust’s ongoing investment earnings.
- Higher Legacy Value: Once the initial promissory note pays out in full, the remaining accumulated growth leaves a significantly larger financial legacy for succeeding generations.
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DST Example: Real Estate Sale
Suppose Mr. and Mrs. Jones own a property with a sale price of $5,000,000\) and a depreciated cost basis. By comparing a standard taxed sale to a Deferred Sales Trust, the DST preserves your net investment and significantly increases your payout:
| Feature | Taxed Sale | Deferred Sales Trust |
| Selling Price | $5,000,000 | $5,000,000 |
| Capital Gains Tax | $800,000 | $0 |
| CA State Tax | $83,700 | $0 |
| Ordinary Income Tax | $333,700 | $0 |
| Net Investment | $3,782,600 | $5,000,000 |
| 5% Annual Income | $189,130 | $250,000 |
| 25-Year Payout | $4,728,250 | $6,250,000 |
| Total Advantage | – | $1,521,750 gained |
Benefits of Deferred Sales Trust
- Sell Real Estate Tax Deferred
- Retire with Lifetime Income Stream
- Avoid Capital Gains and Depreciation Taxes
- Defer 3.8% Excess Tax
- End to End Control of Transaction
- Inheritance Tax Advantage
- 1031 Alternative
- No Worries of Defaults or Foreclosure
Basic Rules
- There cannot be a pre-existing Buy/Sell Agreement
- The seller cannot have entered into escrow in a pre-existing agreement
Assets Suitable for Legacy Trust
- Real Estate
- Business Ownership Interest
- Stocks
- Bonds
- Mutual Funds
Jeff Reed can be reached at (949) 444-8570 or email [email protected]. The accompanying information regarding the Deferred Sales Trust is provided for informational and educational purposes only. No representations or guarantees are given or implied as to the legality or tax implications of a transaction such as this. The services of an attorney and/or appropriate tax professional must be sought and used before attempting this trust transaction.