Deferred Sales Trusts
A warning about the initials. Two completely different structures are both marketed as “DST.” This section covers the Deferred Sales Trust — a promoter-designed installment sale with no direct IRS blessing. section “Delaware Statutory Trusts (DSTs)” covers the Delaware Statutory Trust — a statutory entity the IRS explicitly approved for 1031 exchanges in Rev. Rul. 2004-86. They share three letters and nothing else. Throughout this book, “Deferred Sales Trust” is always spelled out and “DST” always means the Delaware entity. When a salesperson says “DST,” make them say which one, because one of them is a well-trodden path and the other is an audit posture.
A Deferred Sales Trust is pitched as an alternative to the 1031 exchange for deferring capital gains on appreciated assets. Instead of exchanging property, it uses an “installment sale” under IRC §453, “Installment method”, spreading the gain — and the tax — across the years in which you actually receive payments.
The distinction from an exchange matters. In a 1031 exchange, a IRC §1033, “Involuntary conversions” conversion, or a IRC §721 contribution, you have not cashed out; you have swapped one investment for another and the tax code lets your basis ride along. In an installment sale you have sold. Congress simply agreed, in §453, that you should not owe tax on money you have not yet been paid.
The process: you transfer the asset to a trust run by a third-party trustee, the trustee sells it, and the trustee agrees to pay you out of the proceeds over future installments. Because you receive nothing at closing, you recognize no gain at closing. Gain is recognized as each installment arrives.
Where the promoters overreach. The pitch often continues: structure the note as interest-only, roll it perpetually, and defer principal — and therefore gain — indefinitely. Be clear-eyed about what that is. It is not a strategy the IRS has blessed; it is a position you would be defending. Three doctrines sit directly on top of it:
- Constructive receipt and economic benefit.
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If you retain enough control over the trust — you picked the trustee, you direct the investments, you can accelerate payments — the IRS position is that the trustee is your agent and you constructively received the sale proceeds at closing. The whole deferral collapses into a fully taxable sale in year one, with penalties and interest.
- No governing authority.
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There is no revenue ruling, regulation, or published guidance approving the Deferred Sales Trust. “Deferred Sales Trust” is a marketed brand, not a statutory Code term. Contrast Rev. Rul. 2004-86, which gives the Delaware structure an explicit, citable holding. Promoter opinion letters are not authority and do not protect you from penalties the way a substantial-authority position does.
- The adjacent structure is already under attack.
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The closely related monetized installment sale — same installment note, plus a non-recourse “loan” that hands you the cash immediately — was rejected by the IRS in CCA 202118016, has appeared repeatedly on the IRS “Dirty Dozen” list, and was proposed for listed transaction status in REG-109348-22. Listed-transaction status brings mandatory disclosure on Form 8886 and penalties for failing to file it. If your Deferred Sales Trust has a monetization leg attached, you are in that neighborhood.
The realistic framing: an installment sale is a legitimate, statutory tool for spreading gain across tax years to manage brackets. It is not a tool for eliminating gain. If the pitch you are hearing promises permanent deferral, the promoter is selling the aggressive version and you are the one who signs the return.
The process begins with you, a property or business owner, transferring an asset to a trust managed by a third party on your behalf. The third party, acting as a trustee, sells your asset and agrees to pay you from the proceeds (or interest from the proceeds) over multiple future installments.
Initially, since no payments are made in this transfer, you realize no capital gain and owe nothing in capital gains taxes when the trustee sells the transferred asset. It is only as the trustee makes payments to you in installments that you may come to realize gain.
The gross profit ratio. Each installment you receive is split into three parts: return of basis (tax-free), gain (taxable), and stated interest (ordinary income, reported separately). The gross profit ratio determines the split. Under Treas. Reg. §15a.453-1(b)(2):
where SP is the selling price, AB the adjusted basis, SE the selling expenses, and QD the qualifying indebtedness the buyer assumes. Two subtleties hide in that . Debt the buyer assumes reduces the contract price, which raises the ratio — you are being paid less cash for the same gain, so more of each dollar is taxable. But debt in excess of your basis is treated as a payment received in the year of sale and is added back to the contract price, which is how a heavily mortgaged property can generate a tax bill in year one on an installment sale that pays you nothing. The gain recognized on a payment of is then .
Worked example. You transfer a rental property to the trust. Selling price $500,000; original cost $150,000; depreciation taken over the hold $50,000, so adjusted basis is $100,000; selling expenses $30,000; no debt assumed. The trustee sells for cash and agrees to pay you $50,000 every six months.
First, gross profit and the ratio:
Each $50,000 payment therefore carries of gain and $13,000 of tax-free basis recovery. Two payments a year gives $74,000 of annual gain.
Now the part the sales presentation omits: §453(i). Depreciation does not spread evenly across the note, and on a cost-segregated property a large slice of it does not spread at all. Two different rules govern two different pieces of your accumulated depreciation, and the promoter’s spreadsheet almost always collapses them into one:
- §1245 recapture –- accelerated, in full, in year one
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Under IRC §453(i), “Recognition of recapture income in year of disposition”, “recapture income” — the amount that would be ordinary income under IRC §1245 or IRC §1250 — is recognized in the year of disposition regardless of how little cash you received, and is added to basis for computing the remaining installment gain. On a building depreciated straight-line there is no §1250 ordinary recapture to speak of, so this looks harmless. It is not harmless if you ran a cost segregation study (section “The Magic of Cost Segregation”): every 5-, 7-, and 15-year component you carved out is §1245 property, and all of its accumulated depreciation accelerates into year one as ordinary income at 37%. The strategy that manufactured your front-loaded deduction is the same strategy that manufactures a year-one tax bill on the way out.
- Unrecaptured §1250 gain –- spread, but front-loaded
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The 25%-rate gain attributable to straight-line depreciation on the building is capital gain under IRC §1(h), not ordinary recapture, so §453(i) does not touch it and it rides the installment method. Treas. Reg. §1.453-12 then dictates the ordering: unrecaptured §1250 gain is taken into account before any adjusted net capital gain. Your early payments are taxed at 25% and your later ones at 20%, which is precisely backwards from what you want out of a deferral structure.
Run it on the example. The $50,000 of depreciation was straight-line on the building, so nothing accelerates and the 0.74 ratio stands — but the first $50,000 of recognized gain is unrecaptured §1250. Payment one carries $37,000 of gain, all of it at 25%; payment two carries $37,000 of which $13,000 is the remainder of the 25% bucket and $24,000 finally reaches the 20% rate. You have front-loaded the expensive rate into the years you receive the least cash.
Now run it with a cost segregation study behind you. Suppose $30,000 of that $50,000 sat in §1245 components. That $30,000 is ordinary income in year one:
in a year the trust paid you $100,000, before a dollar of state tax. The recapture is added to basis, so gross profit falls to and the ratio to ; every later payment recognizes less gain — cold comfort against a check you must write now. Scale that to a $5 million property where a study carved out $1.2 million of short-life components and claimed 100% bonus depreciation on all of it, and the year-one ordinary-income bill approaches half a million dollars on an installment sale that pays you a fraction of that. Anyone selling you deferral without separating §1245 from unrecaptured §1250 either does not know the statute or is counting on you not to.
And §453A, if the note is large. For non-dealer dispositions of property over $150,000, once your aggregate outstanding installment obligations from the year exceed $5 million, IRC §453A, “Special rules for nondealers” imposes an interest charge on the deferred tax — computed at the underpayment rate on the tax you have deferred, payable annually with your return. Deferral stops being free at $5 million. Since the readers most attracted to this structure are selling assets well above that line, this is the norm, not the exception. IRC §453A(d) adds a second trap: pledging the installment note as collateral for a loan is treated as receiving payment, which is precisely why the monetization structures described above draw fire.
The rest of the fine print. IRC §453(e) accelerates the whole gain if a related party resells the property within two years. IRC §453(k) bars the installment method for publicly traded securities entirely. IRC §453(b)(2)(A) bars it for dealer dispositions. And IRC §1038, “Certain reacquisitions of real property” governs what happens if the buyer defaults and you take the property back.
The unsecured-note problem. Step back from the tax mechanics and look at what you now own. You traded a building — a hard asset you could see, insure, and foreclose on — for an unsecured promissory note from a trust whose investments you do not control. If those investments perform badly, you owe tax on payments as they arrive while the principal behind them erodes. You cannot secure the note without triggering §453A(d). You cannot accelerate it without inviting the constructive-receipt argument. The credit risk is real, concentrated, and structurally unhedgeable.
When it genuinely works. The legitimate use is bracket management, and the arithmetic is worth doing. Recognizing $370,000 of gain at once likely puts you in the 20% long-term bracket plus the 3.8% NIIT — call it 23.8%, or $88,060. Spread across ten years at $37,000 a year, much of it may land in the 15% bracket and stay under the NIIT threshold — call it 15%, or $55,500. The $32,560 of bracket arbitrage is real money, and it does not require any aggressive position at all: a plain installment note from a real third-party buyer gets you there.
Against that, weigh the deferral’s time value. If your alternative is investing the tax dollars at return for years, deferring tax is worth — but only if the trust’s own return net of its fees beats what you would have earned yourself. Promoter fees on these structures commonly run 1.5% of the sale price up front plus ongoing trustee and management fees. On $500,000 that front-end load is $7,500 before the first dollar of deferral benefit arrives.
Installment sales do have one genuine advantage over a 1031 exchange: since the TCJA limited §1031 to real property, installment treatment remains available on business sales, and other non-real-property assets. That flexibility is real. It is also available through an ordinary installment sale to an ordinary buyer, with none of the trust structure’s exposure. Read IRS Pub. 537, “Installment Sales” and Form 6252 before you pay anyone a fee to complicate it.