If given the choice, would you rather pay capital gains taxes on a large transaction all at once, or put it on layaway and make tax payments over time? If there’s no interest accruing while the tax payments are being delayed and you can invest that money, it would make sense to delay paying taxes, right?

This is precisely what a deferred sales trust can do.

Imagine you just sold your business, realizing a $1,000,000 gain. Now, you have a choice: take the full amount now and pay $149,492.50 in taxes immediately, or use a Deferred Sales Trust (DST) to spread the payments over five years and reduce your total tax bill to $54,975—a potential tax savings of $94,517.50.

This isn’t tax evasion—it’s smart tax planning. By structuring your sale strategically, you can take advantage of lower tax brackets and defer payments, keeping more money invested and working for you.

These estimates use the 2025 IRS capital gains tax brackets for married couples filing jointly and assume no other income sources. Actual tax outcomes may vary based on your financial situation and changing tax laws.

A common concern when selling a property or other appreciated assets is the tax bill, but with a deferred sales trust, capital gains can be deferred over time through an installment sale.

We break down how the trust works, and who can benefit most.

What Is a Deferred Sales Trust?

A deferred sales trust (DST) allows for the deferral of capital gains tax when selling real estate or other qualified assets. Rather than a typical transaction where the seller would receive funds from the buyer and capital gains would be realized and taxes would be owed, the funds are redirected to a trust.

The trust agreement is set up by the seller to receive funds on any schedule they choose. The trust manages the entire proceeds of the sale, pre-tax. This means that a larger dollar amount can be invested, left to grow, and then taxes are to be paid at a later date. This not only allows for the potential for maximum appreciation, it provides flexibility in managing an income stream and the ability to fine-tune a portfolio for tax-efficiency.

How Does It Work?

Deferred sales trusts start with the owner transferring a property or other asset to a trust, and then that asset is held by a third party (trustee) on their behalf. The trustee then sells the asset, completes the transaction, and agrees to pay the original seller over multiple installments. The asset value is determined before it is put into the trust and the sale happens immediately, so there is no increase in value and the trust does not owe capital gains on the sale. Since no payments are received by the seller in the initial transaction, no capital gains tax would be due.

The only time the seller would owe capital gains tax is when the trust makes an installment payment after the sale.

Determining the Taxes

The IRS has a straightforward calculation that determines how much of the realized gain is due when the installment payments are distributed:

Gross Profit Ratio = Gross profit / Sale price

A basic example would be if someone bought a property for $200,000 and they sold it after its value increased to $1,000,000. In this scenario, the gross profit would be $800,000 and since it sold for $1,000,000, the gross profit ratio would be 0.80.

Now, let’s say the installment agreement stated that a $100,000 lump sum payment would be distributed annually. On the $100,000 the original seller receives each year, they would only owe capital gains on $80,000 because the gross profit ratio was 0.80 and the tax rate would vary depending on their personal situation.

Remember, this strategy doesn’t allow sellers to avoid capital gains; it just defers them until payments are being received from the trust.

Deferred Sales Trusts Can Offer Flexibility Across Several Dimensions

The proceeds of the sale are managed inside the trust like any other investment portfolio. This can allow for flexibility in managing an income stream, creating tax-efficiency and ensuring adequate portfolio diversification. A DST can also provide a tax-efficient exit scenario to a real estate investment when an investor is selling a property after previously utilizing a 1031 exchange.

For a business owner that is selling a business, the DST can provide a similar income stream to what the owner was taking out of business, but while leaving the balance of the principal to grow tax-free inside the trust.

This can be beneficial when devising a retirement income strategy, as the trust can be set up with all other sources of income in mind. This can ensure payments from the trust are low enough to create an income stream that, when added to Social Security benefits, pension benefits, or other investment income, will not trigger additional taxes or the Medicare Part B surcharge.

Keeping the Details in Mind

While they can provide a lot of advantages, it can get complicated when making sure all the right actions are being taken, tax advantages are being maximized, and the transaction qualifies for the full benefits. It’s also important to consider the upfront and investment management fees of setting up and maintaining a deferred sales trust. Since DSTs are fairly complex, the IRS lays out rules that must be carefully followed with one of them being that the trustee must be independent from the seller, meaning you can’t appoint a family member, trusted business partner, or a similar relation to manage the trust.

Alternative Tax-Deferral Strategies

While a Deferred Sales Trust is a powerful tool for deferring capital gains taxes, it's not the only option available. Here are some alternative strategies:

Installment Sale (Seller Financing) – Section 453

How It Works: Instead of receiving the full sale price upfront, the seller agrees to receive payments over time, deferring capital gains taxes as payments are received.

Advantages: Provides a steady income stream and defers tax liability.

Disadvantages: Risk of buyer default and potential complexities in managing installment agreements.

Opportunity Zone Investment

How It Works: Reinvest capital gains into Qualified Opportunity Funds that invest in designated low-income communities, deferring taxes until 2026 and potentially reducing the tax burden.

Advantages: Potential for tax-free growth if held for 10 years and promotes community development.

Disadvantages: Investments are subject to market risks and require long-term commitment.

Source

Employee Stock Ownership Plan (ESOP) – Section 1042

How It Works: Sell your business to an ESOP and reinvest the proceeds into qualified replacement property to defer capital gains taxes.

Advantages: Provides tax deferral and benefits employees through ownership.

Disadvantages: Complex to establish and may not be suitable for all business structures.

Source

Charitable Remainder Trust (CRT)

How It Works: Transfer appreciated assets into a CRT, receive a charitable deduction, and defer capital gains taxes while receiving income from the trust.

Advantages: Provides income stream, charitable deduction, and defers taxes.

Disadvantages: Irrevocable trust and remainder goes to charity, not heirs.

Each of these strategies has its own set of benefits and considerations. It's essential to consult with a tax professional or financial advisor to determine the best approach for your specific situation.

The Takeaway

If you’re like most people, discovering a way to lower your tax bill, especially on highly appreciated assets, is worth having a conversation about. Setting up and maintaining a deferred sales trust can be complicated, but it can provide unique tax advantages that other strategies aren’t able to. And like most strategies involving a trust, it’s recommended to talk with a tax professional or your financial advisor before implementing to ensure the rules are being followed and you get the most value possible out the transaction.

The information contained herein is intended to be used for educational purposes only and is not exhaustive.  Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return.  If applicable, historical discussions and/or opinions are not predictive of future events.  The content is presented in good faith and has been drawn from sources believed to be reliable.  The content is not intended to be legal, tax or financial advice.  Please consult a legal, tax or financial professional for information specific to your individual situation.

This content not reviewed by FINRA

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