Shane Styne is CEO & Founder of Top Notch CPAs.
For decades, savvy investors, business owners and high-net-worth individuals have sought strategies to legally defer capital gains taxes on the sale of highly appreciated assets. One powerful tool many have turned to for this purpose is a deferred sales trust (DST), structured under the provisions of Internal Revenue Code (IRC) Section 453.
The concept of tax deferral through installment sales has been around for a while. Installment sale tax treatment allows sellers to recognize capital gains incrementally over time rather than in a single tax year. This tax provision remains a foundational mechanism for structuring the sale of appreciated assets in a tax-efficient manner.
How A Deferred Sales Trust Works
At its core, a deferred sales trust is an advanced estate planning and tax deferral strategy that allows an asset owner to sell highly appreciated property without immediately incurring capital gains tax.
Instead of selling the asset outright, the owner transfers it to a dedicated third-party trust before the sale occurs. The trust then sells the asset to a buyer and receives the proceeds. Because the seller does not take direct receipt of the funds, the gain is not immediately recognized for tax purposes.
Instead of a lump sum taxable event, the seller receives installment payments over time, spreading out capital gains tax liability across multiple years. This structure is aligned with IRC Section 453, which governs installment sales and allows for tax deferral based on when payments are received.
Benefits Of A Deferred Sales Trust
1. Capital Gains Tax Deferral
By deferring tax liability, sellers can reduce their immediate tax burden, often preserving 15%-28% more of their proceeds that would otherwise be lost to taxation.
2. Flexibility And Versatility
A DST offers flexibility both in terms of which assets can be sold through the structure and how proceeds can be reinvested. Unlike a traditional 1031 exchange (which is limited to real estate reinvestment), a DST allows sellers to defer capital gains on diverse asset types—including businesses, cryptocurrency, commercial real estate and stocks—while gaining the freedom to reinvest proceeds across a broad portfolio of investments such as real estate, stocks, bonds, cash value life insurance and annuities.
3. Protection Against Market Volatility
Sellers can structure payments to align with their financial needs while allowing the trust to invest in assets that provide stable income and long-term growth.
4. Estate Planning And Wealth Transfer Advantages
A DST can be integrated into a broader estate plan, allowing beneficiaries to receive structured distributions while reducing estate tax exposure.
The Drawbacks
1. Complexity And Setup Costs
Setting up a DST requires legal structuring, coordination with a qualified trustee and compliance with IRS regulations. This often involves legal and financial advisory fees, making it less practical for smaller transactions.
The upfront costs and ongoing administrative fees may not be justified unless the asset being sold has a substantial capital gain.
2. Loss Of Direct Control Over Proceeds
Once the asset is sold through the trust, the seller does not receive immediate access to the full proceeds. Instead, they receive installment payments as structured in the trust agreement.
The trustee manages the funds and investments, which means the seller must work with the trustee rather than making direct investment decisions. While this can provide professional oversight, some investors may prefer more direct control over their assets.
Selling A Business With A DST
Consider a business owner who built a company over 25 years, growing its value to $10 million. A direct sale would likely trigger approximately $2 million to $3 million in federal and state capital gains taxes.
By implementing DST, the business owner holds on to the $2 million to $3 million to boost investment growth by transferring the company into the trust before selling it to a buyer. The DST then sells the business and receives the proceeds, allowing the seller to receive payments over many years instead of incurring immediate taxation.
Conclusion
The deferred sales trust can be a powerful tool for investors and business owners seeking to maximize their wealth while reducing tax burdens. When leveraging the tax deferral provisions of IRC Section 453, sellers can optimize their cash flow, retain more control over their investment choices and create long-term financial stability.
DST requires proper structuring, so it is important to seek the assistance of experienced professionals. Given the increasing scrutiny on capital gains tax rates, the deferred sales trust remains a strategic advantage that high-net-worth individuals may want to seriously consider before selling their assets.
For those seeking to preserve their wealth and invest wisely post-sale, DST could represent not just a tax strategy—but a long-term financial planning solution.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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