Deferred Sales Trust: What It Is, Examples, Pros and Cons

A deferred sales trust (DST) is an advanced tax strategy. It allows investors to delay capital gains taxes on the sale of assets that have significantly risen in value. Usually investors create them for assets such as real estate or businesses. By selling the asset to a trust, the seller can receive payments over time. This spreads out tax liabilities and allows any profits to grow tax-deferred. However, DSTs can be complex, and there are often fees involved in setting up and maintaining the trust.

A financial advisor can work with you to manage large investment gains.

How a Deferred Sales Trust Works

A DST is a tax-deferral entity designed to help individuals sell highly appreciated assets without facing immediate capital gains taxes. It works by transferring the ownership of the asset to a specially created trust before the sale. The trust then sells the asset and holds the proceeds. This allows the seller to avoid recognizing the capital gain at the time of the sale. Instead, the seller collects installment payments from the trust, deferring the tax obligation until they receive payment.

You can structure the installment payments in a variety of ways. The most common are fixed payments over a set period of time or interest-only payments and a final lump sum. The flexibility in the payment schedule allows the seller to spread out their income, potentially lowering their annual tax liability. During this time, the funds in the trust are invested, and the earnings can grow tax-deferred, providing additional financial benefits.

A DST requires careful planning and management, as it involves legal and financial complexities. Trust managers are responsible for the administration of the trust and investment of the proceeds. This makes selecting the right professionals especially critical.

Pros and Cons of a Deferred Sales Trust

A DST can be an appealing option for individuals looking to manage capital gains taxes from the sale of appreciated assets. It offers several benefits, including tax deferral and flexible payment structures, making it a useful tool for long-term financial planning. However, DSTs also come with certain drawbacks, such as complexity and ongoing management costs, which may not be suitable for everyone. 

Pros of a Deferred Sales Trust

• Tax deferral: The primary benefit of a DST is the ability to defer capital gains taxes. Rather than paying a hefty tax bill immediately upon sale, you can spread out payments over time, potentially reducing your overall tax burden.
• Flexible income stream: DSTs allow you to structure payments in a way that suits your financial needs, such as receiving fixed monthly payments or a lump sum at a future date. This flexibility provides greater control over your income and tax planning.
• Investment growth: The trust holds the proceeds from the sale and can invest them. This can enhance long-term wealth accumulation compared to receiving the proceeds and immediately paying taxes.

Cons of a Deferred Sales Trust

• Complexity: A DST involves legal and financial intricacies, requiring professional management to ensure compliance with IRS regulations. The setup process can be expensive and time-consuming, making it less suitable for smaller transactions.
• Ongoing management fees: Managing the trust involves regular administrative and investment fees. These costs can add up over time, potentially cutting into the overall benefit of the tax deferral.
• Potential for reduced liquidity: By deferring payments, you may have limited access to large sums of cash upfront. For individuals who need liquidity for other investments or immediate financial needs, this can be a disadvantage.

Whether the pros and cons of a Deferred Sales Trust balance in your favor depends on your specific financial situation, tax bracket and long-term objectives. This strategy works best for sellers with significant capital gains who don’t need immediate access to all sale proceeds and who prioritize tax efficiency over liquidity.

Before proceeding with this complex tax strategy, consultation with experienced tax professionals and financial advisors is essential to ensure it aligns with your overall financial plan and goals.

Deferred Sales Trust vs. 1031 Exchange 

A deferred sales trust and a 1031 exchange defer capital gains taxes, but they differ significantly in terms of their structure and application. 

A 1031 exchange is specific to real estate transactions and allows investors to defer taxes by reinvesting the proceeds from a property sale into another “like-kind” property. Replacement property must be of equal or greater value, and you must follow strict timelines for identifying and purchasing the new property.

In contrast, a deferred sales trust offers greater flexibility because it involves more than real estate. DSTs can manage various asset types, including businesses, stocks and other high-value holdings. Instead of reinvesting in another property or asset, the seller transfers ownership to the trust, which then sells the asset. 

Another major difference between a 1031 exchange and a DST is liquidity. In a 1031 exchange, investors must reinvest all of their sale proceeds into another property. This can limit cash availability. With a DST, there is more control over when and how the seller receives payments, offering more liquidity and financial flexibility. However, DSTs involve ongoing management, whereas 1031 exchanges are typically more straightforward for real estate investors focused on building portfolios.

Both strategies offer valuable tax deferral benefits. Choosing between them depends on the type of assets involved in the sale, the investor’s goals, and their need for flexibility. Working with a financial advisor can help determine which option best suits your financial situation.

How a Deferred Sales Trust Is Set Up and What It Costs

You do not set up a deferred sales trust on your own. It requires a specialized attorney to draft the trust documents, a trustee to manage the trust and its investments, and often a tax advisor to model the tax consequences before and after the transaction. Getting all of those pieces in place before the asset sale closes is a requirement, not a suggestion. You cannot create a DST cannot retroactively after a sale has already occurred.

You begin the process before finalizing the sale. The asset owner works with a DST attorney to establish the trust structure and transfer ownership of the asset into the trust before the sale closes. The trust then sells the asset to the buyer, and the proceeds stay inside the trust rather than passing directly to the seller. From that point forward, the trust holds and invests the proceeds and makes installment payments to the seller according to the terms established in the trust agreement.

The legal setup alone typically runs between $10,000 and $30,000 depending on the complexity of the transaction and the professionals involved. More complex situations involving business interests, multiple asset types or significant estate planning considerations can push that figure higher. These upfront costs are paid regardless of how the trust performs afterward.

Taxes and Fees

On top of the setup costs, the trustee charges ongoing management fees for administering the trust and overseeing its investments. These fees typically run between 0.5% and 1.5% of the trust’s assets per year. On a $2 million trust, that is $10,000 to $30,000 annually, every year the trust remains in place. Over a 10-year period, the cumulative management costs can reach $100,000 to $300,000 or more before factoring in investment returns. ¹

Those numbers matter because they set a practical floor. For a transaction generating a modest capital gain, the combined setup and ongoing costs can easily exceed the tax savings from deferral, leaving the seller worse off than if they had simply paid the capital gains tax upfront. Most tax professionals who work with DSTs suggest the structure generally becomes viable for transactions generating at least $500,000 in capital gains, and it tends to produce the clearest benefit at $1 million or above.

The investment returns generated inside the trust also affect the overall outcome. The trustee manages a diversified portfolio for proceeds held in the trust. The growth on those investments compounds tax-deferred until beneficiaries receive their payments. This is a meaningful benefit for sellers who do not need immediate access to the full proceeds. However, the investment strategy largely falls to the trustee. This is why they matter as much as the legal structure itself.

Before committing to a DST, ask the professionals involved for a full cost illustration. It should show setup fees, annual management fees and projected after-tax outcomes under different return assumptions. Compare that to the alternative of simply paying the capital gains tax and reinvesting the net proceeds. This will give you a concrete basis for the decision rather than relying on the general promise of tax deferral.

Bottom Line

A deferred sales trust (DST) can be a useful tool. It defers capital gains taxes on the sale of highly appreciated assets. It offers flexibility in managing income streams and allows the proceeds to grow tax-deferred over time. However, it also comes with complexities. You must navigate setup costs and the need for professional management. Still, for individuals looking to minimize immediate tax liabilities while maintaining control over their financial future, a DST may be an attractive option.

Tips for Managing Capital Gains

• A financial advisor can help you plan and manage your capital gains. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Tax-loss harvesting, the practice of selling underperforming investments to offset capital gains, involves selling assets at a loss to lower your tax liability from profitable investments. These losses are initially applied to your capital gains for the year, decreasing the taxable amount. If your losses surpass your gains, you can deduct up to $3,000 ($1,500 for those married filing separately) against other income types, including wages or interest.

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