Selling a business, real estate, or another highly appreciated asset can create significant tax-planning considerations. When a seller receives the full proceeds from a taxable sale immediately, the transaction may result in substantial taxable income in the year of the sale. This is one reason some sellers explore structures designed to defer recognition of gain.
A Deferred Sales Trust (DST) is a private tax-planning structure that is generally designed around the concept of a trust acquiring an asset and providing the seller with a payment obligation rather than an immediate lump-sum payment. The tax treatment of any particular structure depends on how the transaction is designed and implemented and on applicable federal and state tax law.
It is important to distinguish a Deferred Sales Trust from the statutory installment-sale rules. The IRS describes an installment sale as a sale in which the seller receives at least one payment after the tax year of the sale, and qualifying installment sales may allow gain to be reported as payments are received.
Because DST arrangements can involve complex legal, tax, and investment considerations, sellers should evaluate the structure before completing a transaction and obtain advice from qualified professionals.
What Is a Deferred Sales Trust?
A Deferred Sales Trust is generally presented as a transaction structure intended to spread the seller’s receipt of sale proceeds over time rather than providing the seller with the full purchase price immediately.
The basic concept involves the seller transferring an appreciated asset to an independent trust in a transaction structured before the ultimate buyer acquires the asset. Asset Protection Planning may also be considered alongside the trust structure as part of a broader approach to managing and protecting wealth, depending on the individual’s circumstances and applicable legal requirements.
The exact legal and tax mechanics matter. Simply placing an asset into a trust does not automatically create tax deferral. The transaction needs to be analysed under applicable tax principles and the specific facts.
How Does a Deferred Sales Trust Work?
A typical DST structure may involve several stages. First, the seller works with advisors to determine whether the proposed transaction is appropriate and whether the asset can be transferred under the intended structure.
The trust then becomes part of the transaction before the sale to the ultimate purchaser. Following the sale, the trust may hold or invest proceeds and make payments to the seller according to the terms of the arrangement.
One of the central planning concepts is that the seller may receive an obligation to receive future payments instead of receiving all sale proceeds immediately. This can resemble other forms of deferred-payment transactions, but a DST has its own structure and should not automatically be treated as identical to a conventional installment sale.
The IRS’s installment-sale rules provide that qualifying gain is generally reported as payments are received, with the taxable portion of each payment determined under the applicable installment-sale rules.
Who May Consider a Deferred Sales Trust?
A DST may be considered by owners or investors who are contemplating the sale of substantially appreciated assets and want to investigate alternatives to receiving the full proceeds immediately.
Potential situations may include the sale of a privately held business, certain real estate transactions, or other assets for which a structured payment arrangement may be worth evaluating.
However, not every asset or transaction will fit. The asset’s tax characteristics, ownership structure, buyer requirements, timing, financing, and applicable tax rules all need to be considered.
How Does a Deferred Sales Trust Defer Taxes?
Tax deferral depends on the legal and tax treatment of the specific transaction rather than simply on using the word “trust.” In a qualifying installment sale, for example, the IRS generally permits the seller to report the gain over the period in which qualifying payments are received rather than reporting the entire gain in the year of sale.
A DST may seek a similar economic objective through its own trust and payment structure, but the tax consequences depend on the transaction’s actual substance and structure.
Is Tax Eliminated or Only Deferred?
Tax deferral and tax elimination are very different concepts. Deferral means that taxable gain may be recognised at a later time rather than immediately, where the law permits that treatment.
It does not necessarily mean that the underlying tax liability disappears. Future payments, subsequent transactions, changes in tax law, and other events may affect when and how tax becomes due.
The IRS confirms that qualifying installment-sale treatment generally involves reporting gain as payments are received. It also notes that taxpayers can elect out of the installment method and report the full gain in the year of sale.
When Can Taxes Become Due?
The timing depends on the structure and the applicable tax rules. Under the conventional installment method, each payment generally contains a combination of return of basis, gain, and potentially interest. Interest is generally treated separately as ordinary income.
For a DST, the tax treatment needs to be specifically reviewed rather than assumed to follow exactly the same rules as a standard installment contract.
This makes advance tax planning important. Sellers should model the transaction before closing and understand potential tax consequences associated with future payments, withdrawals, investment income, and any changes to the trust arrangement.
What Assets Can Be Used With a Deferred Sales Trust?
The suitability of a DST depends heavily on the asset and transaction. Not every type of property will have the same tax treatment, and certain property may not qualify for installment treatment under the Internal Revenue Code.
For example, the IRS states that the installment method generally cannot be used for inventory, dealer property, or stocks and securities traded on an established securities market. A proposed DST therefore needs asset-specific analysis.
Can You Use a Deferred Sales Trust When Selling a Business?
A business sale can involve multiple categories of assets, and the tax treatment can differ depending on what is being sold. The IRS explains that a business sale is generally treated as the sale of individual assets rather than one single asset. Those assets may include capital assets, depreciable property, real property, inventory, and intangible assets, each of which can have different tax treatment.
This makes business-sale planning particularly important. A seller and buyer may also need to allocate the purchase price among the business’s assets, and the IRS generally requires the buyer and seller to report the allocation for applicable business-asset transactions using Form 8594.
Before attempting to use a DST in a business sale, the seller should evaluate the transaction structure, asset allocation, buyer requirements, financing terms, and tax consequences.
Can Real Estate Be Used in a Deferred Sales Trust?
Real estate may present opportunities for structured transactions, but eligibility and tax treatment depend on the property and transaction. The IRS recognises qualifying real estate installment sales and explains that sellers may generally report part of the gain as installment payments are received.
However, special rules can apply to depreciation recapture, property held for sale to customers, dealer property, and other categories. The IRS specifically states that depreciation recapture income must generally be recognised in the year of sale even when the transaction otherwise qualifies for installment treatment.
A real estate seller should therefore review the property’s basis, depreciation history, use, ownership structure, and proposed transaction before relying on any tax-deferral strategy.
What Are the Potential Benefits of a Deferred Sales Trust?
A properly structured deferred-payment arrangement may offer several planning considerations for qualifying sellers.
One potential benefit is the opportunity to spread receipts over time rather than receiving the entire proceeds immediately. This may provide greater control over cash flow and may allow the seller to plan around future liquidity needs.
A DST may also be considered alongside broader investment, estate, and wealth-planning objectives.
Potential considerations can include:
- Managing the timing of cash receipts
- Planning around a concentrated appreciated asset
- Creating a structured payment schedule
- Coordinating liquidity needs with future financial goals
- Integrating the transaction with broader wealth planning
These are planning considerations rather than guaranteed outcomes. The actual tax and financial results depend on the specific transaction, documentation, investment performance, and applicable law.
What Are the Risks and Limitations of a Deferred Sales Trust?
A DST is not a simple tax-saving arrangement. It can involve significant legal, tax, administrative, and investment complexity.
The seller must understand who controls the trust, how proceeds are held or invested, what contractual rights the seller receives, what fees apply, and what happens if circumstances change.
What Risks Should Sellers Understand Before Using a DST?
One important consideration is that tax deferral depends on the actual legal and economic substance of the transaction. A seller should not assume that transferring an asset to a trust automatically creates deferred tax treatment.
Investment risk is another consideration. If proceeds are invested after a sale, investment performance can affect the value of assets available to satisfy future obligations. Market losses can therefore affect the overall financial outcome.
There may also be administrative costs, trustee arrangements, legal expenses, accounting fees, and other transaction costs.
Sellers should also evaluate counterparty and contractual risks, including the terms governing future payments and the parties responsible for administering the trust.
Why Does Proper Structuring Matter?
Timing and transaction design can be critical. A strategy introduced after a binding sale transaction is already established may not produce the intended tax result.
The seller, buyer, trustee, attorney, tax advisor, and financial professionals should understand the transaction before closing. Documentation should accurately reflect the intended arrangement.
Professional advice should also consider federal and state tax rules, because state treatment may differ from federal treatment.
How Does a Deferred Sales Trust Compare With Other Tax Strategies?
A DST is one possible planning approach among several. Depending on the asset and circumstances, a seller may also consider a conventional installment sale or other transaction-specific strategies.
Deferred Sales Trust vs. Installment Sale
An installment sale is specifically recognised by the Internal Revenue Code and IRS guidance. The IRS defines an installment sale as a disposition in which at least one payment is received after the tax year of sale. For qualifying transactions, gain is generally reported as payments are received.
A DST may involve a more complex trust structure and should not simply be described as an installment sale without analysing the actual transaction.
Installment sales also have limitations. For example, the IRS states that the installment method generally does not apply to inventory or publicly traded stocks and securities, and certain depreciation recapture must be recognised in the year of sale.
Deferred Sales Trust vs. Immediate Sale
With a conventional immediate sale, the seller generally receives the purchase price according to the transaction documents and recognises the applicable taxable gain under the relevant tax rules.
A deferred-payment strategy instead focuses on receiving proceeds over time, where permitted. This can change the timing of cash flow and potentially the timing of tax recognition, but it also introduces additional contractual and administrative considerations. The choice should be based on the seller’s circumstances rather than on the name of the strategy.
What Should You Know Before Setting Up a Deferred Sales Trust?
Planning should begin before the sale is completed. Sellers should gather information about the asset, tax basis, expected sale price, ownership structure, current tax position, liquidity needs, and long-term objectives.
The transaction should then be reviewed by qualified professionals who understand both the proposed trust structure and the underlying tax rules.
When Should You Start Planning a Deferred Sales Trust?
Planning should begin well before a transaction closes. This provides enough time to review the asset, evaluate alternatives, structure the transaction, prepare documentation, and coordinate the buyer and other parties.
Waiting until the last moment can limit the ability to change the transaction structure. For a business sale, early planning is particularly important because negotiations may already establish important economic terms before tax advisors have fully evaluated the structure.
Which Professionals Should Be Involved?
Depending on the transaction, a seller may need to coordinate with:
- A tax attorney
- A CPA or tax professional
- An estate planning attorney
- A financial advisor
- A trustee or trust administrator
- Other transaction professionals
Each professional may address a different part of the transaction. Coordination is important because changing one component can affect the legal, tax, or financial treatment of another.
FAQs About Deferred Sales Trusts
What Is a Deferred Sales Trust?
A Deferred Sales Trust is generally described as a trust-based transaction structure intended to provide for deferred receipt of proceeds from the sale of an appreciated asset. The legal and tax treatment depends on the specific transaction, documentation, and applicable law.
How Does a Deferred Sales Trust Defer Capital Gains Tax?
The intended objective is generally to defer recognition of gain by structuring the transaction so that the seller receives payments over time instead of receiving the entire sale proceeds immediately. However, tax deferral is not automatic simply because a trust is involved. The specific structure must be evaluated under applicable tax law.
Can a Deferred Sales Trust Be Used for the Sale of a Business?
A business transaction may potentially be considered, but a business sale can involve many different asset categories with different tax treatments. The IRS notes that the sale of a business generally involves the separate sale of its assets for tax purposes.
Can You Use a Deferred Sales Trust for Real Estate?
Real estate transactions may involve installment-sale treatment when applicable. The IRS states that qualifying real estate installment sales can generally allow sellers to report part of the gain as payments are received.
Is a Deferred Sales Trust the Same as an Installment Sale?
No. An installment sale is a specific tax concept recognised under federal tax law. A Deferred Sales Trust is a particular trust-based transaction structure that may seek deferred recognition of gain. The two should not automatically be treated as identical.
Are There Risks Involved With a Deferred Sales Trust?
Yes. Potential considerations include tax uncertainty, transaction complexity, administrative costs, investment risk, trustee and contractual considerations, and changing tax laws. The intended tax treatment should be reviewed by qualified professionals before the transaction is completed.
How Long Can Taxes Be Deferred With a Deferred Sales Trust?
There is no universal DST deferral period that applies to every transaction. The timing depends on the structure, payment terms, asset, applicable tax rules, and other circumstances.
For a standard installment sale, tax recognition generally follows qualifying payments under the installment method rather than a single universal time period.
When Should You Set Up a Deferred Sales Trust?
Planning should begin before the sale is completed. Because transaction structure and timing can affect tax treatment, sellers should discuss the strategy with qualified legal and tax advisors before signing final sale documents.
Do You Need a Tax Attorney for a Deferred Sales Trust?
Because a DST can involve complex tax and legal questions, consulting a qualified tax attorney can be appropriate. A tax attorney can review the proposed structure, applicable tax rules, documentation, and potential risks in coordination with other advisors.
Conclusion: Understanding Your Deferred Sales Trust Options
A Deferred Sales Trust may be considered by sellers seeking to explore ways of receiving proceeds over time after the sale of an appreciated asset. However, the term itself does not guarantee tax deferral, and a trust-based structure should not be assumed to receive the same treatment as a conventional installment sale.
The IRS provides specific rules for qualifying installment sales, including rules that generally allow gain to be reported as qualifying payments are received. Those rules also contain important limitations and special provisions for certain assets and transactions.
Contact us today to discuss your tax planning needs and learn how professional guidance can help you evaluate a Deferred Sales Trust and other potential strategies in the context of your specific circumstances.
