What is a Deferred Sales Trust for Real Estate?

When it comes to selling appreciated real estate, the capital gains tax can be brutal. Naturally, investors seek ways to ease the tax burden, and one option that gets thrown around is the Deferred Sales Trust, or DST.

But what exactly is a DST? And more importantly, does it live up to the hype? Let’s take a closer, more objective look.

So, What Is a Deferred Sales Trust (DST)?

A Deferred Sales Trust is a tax deferral mechanism based on the IRS’s installment sale rules (Section 453).

The basic idea is this: Instead of selling your real estate directly and taking the hit on taxes, you transfer it to a third-party trust. That trust sells the asset, and you receive payments over time instead of in a lump sum.

Because you’re not taking the full sale proceeds immediately, the logic goes, you don’t owe the full capital gains tax right away either. The tax liability is triggered only as the installment payments are made.

Sounds interesting, right? But this is where the story starts to get complicated.

How It Works: A Simplified Breakdown

Here’s a high-level look at the DST process:

1. You agree to sell your property, but first transfer it to a trust.
2. The trust sells the property and receives the funds.
3. You get a promissory note from the trust, outlining how you’ll be paid over time.
4. Taxes are deferred and paid gradually as you receive your payments.

This installment-based deferral is legally allowed under IRS guidelines, but—as always—the devil is in the details.

The Sales Pitch vs. The Reality

DSTs are often pitched as a flexible alternative to a 1031 Exchange. Proponents highlight benefits like:

• No like-kind property requirement
• No strict timelines
• Ability to diversify into other assets
• Estate planning opportunities
• Custom payment terms

But hold on: before you buy in, it’s worth looking at the fine print. DSTs aren’t backed by the IRS through any formal ruling specific to this exact structure. They’re legal in theory, but they walk a fine line and rely heavily on how well the setup is executed.

Concerns to Keep in Mind

Now here’s where that healthy skepticism comes in handy. Below are a few points that often get glossed over:

1. Complexity and Cost

Setting up a DST isn’t cheap. You’ll need to hire a trustee, legal team, and financial advisors who specialize in these arrangements. The upfront fees alone can make it impractical for deals under $500K in capital gains.

2. Lack of IRS Endorsement

While DSTs are structured around the installment sale rule, the IRS has never issued a public ruling explicitly approving this strategy. If something goes sideways or appears too aggressive, you could be looking at a costly audit or penalty.

3. Limited Oversight

Unlike 1031 Exchanges, which are widely used, DSTs live in a bit of a gray zone. You’re relying on a trustee and team to manage your assets properly. If they make poor investment choices—or worse—your money could be at risk.

4. Access to Funds

Don’t expect full access to your money after the sale. Once the trust sells your property, the funds go into investments managed by the trust. You’re locked into whatever installment plan you agreed to, which limits your liquidity and control.

DST vs. 1031 Exchange: A Comparison

Who Might Consider a DST?