Which Assets Are Not Suitable for a Deferred Sales Trust?

A deferred sales trust (DST) under Internal Revenue Code §453 (IRC) can be a powerful tool for deferring capital gains taxes on selling highly appreciated assets. However, not all assets qualify for installment sale treatment under the IRC, and using a DST with an inappropriate asset can trigger adverse tax consequences.

What Makes an Asset Suitable for a Deferred Sales Trust?

To qualify for DST treatment, an asset must meet two primary requirements:

• It must be eligible for installment sale treatment under IRC §453.
• It must have substantial built-in gain that would otherwise trigger a large capital gains tax liability upon sale.

Commonly Used Assets in a DST Include:

• Highly appreciated real estate
• Privately held businesses (e.g., LLCs, S corps, C corps)
• Collectibles, artwork, or intellectual property
• Equipment and machinery with depreciated book values
• Certain private notes or promissory instruments

These assets are ideal because they are typically sold via private negotiation, and payments can be structured over time through a promissory note, satisfying §453 requirements.

Which Assets Are Not Suitable for a Deferred Sales Trust?

DSTs are not a one-size-fits-all solution. Several types of assets are generally unsuitable due to how they are transferred, taxed, or valued. These include:

Publicly Traded Securities (Under Normal Circumstances)

Publicly traded stocks and bonds are typically settled through brokers in T+2 (trade date plus two days) and are paid in full at the time of sale.

Because of this immediate cash realization, they fail the installment sale requirement under §453 and are considered to have a constructive receipt, disqualifying them from DST treatment.

Exception: They may be used if first contributed to a private entity that is later sold, but this raises economic substance and step transaction doctrine risks and must be reviewed carefully.

Assets with High Secured Debt Relative to Basis

If the property is encumbered by significant debt, particularly if debt exceeds basis, IRC §453(b)(2) and 453A can treat the debt as boot (cash equivalent), triggering immediate gain recognition.

Selling debt-encumbered real estate to a DST is possible, but it must be carefully structured to avoid accelerating taxes due to disguised sales or debt relief issues.

Dealer Property or Inventory

Property held primarily for resale (such as builder/developer inventory or car dealership stock) is excluded from installment method treatment under IRC §453(b)(2)(A).

These assets are considered ordinary income property, not capital assets, and are not eligible for DST deferral.

Services or Compensation Income

You cannot use a DST to defer earned income, including wages, bonuses, commissions, or self-employment income.

Attempting to assign service income to a trust would violate the assignment of income doctrine and likely trigger immediate tax, penalties, and interest.

Risks of Using Inappropriate Assets in a DST

Attempting to transfer non-qualifying assets into a DST structure exposes you to serious consequences:

• Immediate tax recognition – If the IRS deems the transaction as not qualifying under §453, the entire gain may be taxed in the year of sale.
• Penalties and interest—Misusing installment sales can lead to accuracy-related penalties and interest, especially if the IRS determines the structure lacks economic substance.
• Audit exposure – The IRS has specifically scrutinized improper use of installment sales in recent years, especially under schemes labeled “monetized installment sales” or where there is a pre-arranged sale with no real risk to the trust.

Consult a Qualified DST Attorney Before Proceeding

The deferred sales trust is a legitimate and IRS-sanctioned strategy when used correctly and with the right type of asset. Improper use, however, can backfire, leading to tax liability and regulatory trouble.

At 453 Trust Powered by Pennington Law, we provide advanced legal and tax structuring to help you defer taxes on the sale of qualifying assets. Contact us today to determine if your sale is DST-eligible and how to structure it for maximum benefit and compliance.