A Deferred Sales Trust can defer a significant tax bill on the sale of a highly appreciated asset, but it is not the right fit for every seller. Before deciding whether to move forward, it helps to understand both what a Deferred Sales Trust offers and where its trade-offs lie. Below is a plain-language look at the pros and cons, with links to more detailed resources where they exist on this site.
Quick Recap: What a Deferred Sales Trust Does
A Deferred Sales Trust is a strategy that allows a seller to defer capital gains tax on the sale of a highly appreciated asset. The seller transfers ownership of the asset to an independent trust before the sale, the trust sells the asset to the buyer, and the seller receives payments over time under an installment sale agreement. Tax is generally owed only as payments are received, not all at once in the year of the sale. For the full explanation of the mechanics, see our guide, "What Is a Deferred Sales Trust?"
The Pros
- Deferred capital gains tax without a fixed reinvestment deadline. Unlike a 1031 exchange, a Deferred Sales Trust does not require identifying or closing on a replacement asset within 45 or 180 days.
- Works for any appreciated asset. A Deferred Sales Trust is not limited to real estate. It can be used for a business, publicly traded or closely held stock, or other capital assets.
- Investment diversification. Proceeds held in the trust can be invested across asset classes rather than remaining concentrated in a single property or business.
- Predictable income stream. Installment payments from the trust can be structured to provide steady income, including into retirement.
- Estate planning benefits. When combined with additional planning, a Deferred Sales Trust can support goals such as maintaining family wealth and avoiding a rushed liquidation of assets under less than ideal circumstances. See our full breakdown on our Benefits page.
- No requirement to remain with co-owners. When a partnership or ownership group sells an asset together, each individual owner can set up their own Deferred Sales Trust, managed to their own risk tolerance, rather than staying aligned on a single reinvestment decision.
The Trade-Offs
- Fees. Setting up and administering a Deferred Sales Trust involves a setup fee and ongoing trustee or administrative costs, typically calculated as a percentage of trust assets. For smaller gains, these costs can outweigh the benefit of deferral.
- Loss of direct control. Because an independent trustee manages the trust's assets, the seller does not retain the same day-to-day control over the assets that they would have had over the original asset.
- Structuring complexity. A Deferred Sales Trust must be set up precisely, before a binding sale agreement is in place, and administered correctly under Internal Revenue Code Section 453. This is not a do-it-yourself strategy; it requires experienced legal and tax professionals.
For a deeper look at the risks involved and how they are typically managed, see our article, "What Are the Risks of a Deferred Sales Trust?"
Cost Snapshot
Costs generally include a one-time setup fee and an ongoing annual fee tied to the value of the trust's assets. Because fee structures and payment terms vary by case, see our article on the Payment Structure of a Deferred Sales Trust for more detail, or speak with a case manager about the numbers for your specific situation.
Who a Deferred Sales Trust Makes Sense For
Business owners exiting a sale who do not plan to reinvest in another operating business, real estate investors who want to stop actively managing property rather than exchange into another one, and holders of a concentrated stock position who want to diversify without triggering a large, immediate gain tend to be the best fits for this strategy.
Common Misconceptions
A Deferred Sales Trust defers capital gains tax; it does not eliminate it permanently. Tax is still owed as installment payments are received.
A Deferred Sales Trust is not the same thing as a Delaware Statutory Trust, despite the similar name and acronym. A Delaware Statutory Trust is a real estate co-ownership structure sometimes used as replacement property in a 1031 exchange, while a Deferred Sales Trust is a tax deferral strategy under IRC 453. The two serve very different purposes and are easy to confuse in a quick search.