Deferred Sales Trust vs 1031 Exchange

For years, investment asset owners have used various legal strategies to manage or mitigate capital gains taxes from selling their property. These include utilizing deferred sales trusts (DSTs) and 1031 exchanges. Each strategy has advantages and disadvantages that may suit a person’s particular financial needs and goals. Working with an experienced attorney can help you understand how DSTs and 1031 exchanges work and identify which strategy best serves your objectives.

Let the legal team at 453 Deferred Sales Trust Powered by Pennington Law walk you through your legal options. Our national practice of seasoned legal professionals advises clients across a wide range of matters, including:

• Tax law
• Asset protection
• Financial advisory services
• Estate and trust planning
• Wealth and fiduciary matters
• Irrevocable trusts
• Professional third-party trustee duties
• Financial reinvestment
• Insurance

Our firm’s focus on assisting clients with structuring a deferred sales trust – “The Tax Tool You Didn’t Know You Had” – has earned us recognition as the Best Deferred Sales Trust Law Firm in the U.S. of 2024.

Contact 453 Deferred Sales Trust Powered by Pennington Law today for an initial case evaluation. We can review your situation and advise on whether using a deferred sales trust or 1031 exchange would best help you manage the tax implications of an investment asset sale.

What Is a DST?

So, what is a DST? It’s a tool that takes advantage of the taxation method under Internal Revenue Code §453, which governs the installment sales method of taxation.

A deferred sales trust allows a property seller to defer capital gains taxes by conducting the sale through the DST. When a property owner conducts a sale through a deferred sales trust, the owner must establish the trust and transfer to the trust the property they want to sell before a sale of the property to the ultimate third-party purchaser occurs. A deferred sales trust must have a bona fide third-party trustee free from the property owner’s control or influence.

In exchange for transferring their property to the trust, the property owner receives an installment payment contract that governs how the DST will pay the sale proceeds to the owner. After receiving the property, the trust will sell it to a bona fide third-party purchaser and take legal and equitable title to the proceeds. The trust may reinvest the proceeds to generate income. However, the trust must pay principal and income from the sale proceeds as directed by the installment payment contract.

By conducting the sale through a DST, the former property owner pays capital gains taxes on the property sale only when they receive distributions of principal from the sale proceeds.

What Are the Advantages of a DST?

Deferred sales trusts offer asset owners various financial benefits when conducting an asset sale through the trust. Some of the advantages of DSTs include the following:

• Deferring Capital Gains – A deferred sales trust allows an asset owner to defer capital gains tax from selling the asset indefinitely as long as the principal from the sale proceeds remains in the trust.
• Flexibility in Reinvestment – DSTs allow asset owners to reinvest sale proceeds in a wide range of other types of investments, enabling owners to diversify their wealth.
• Preservation of Family Wealth – An asset owner can use a deferred sales trust to create a retirement or family wealth fund by having the trust reinvest the sale proceeds and distribute only income from the investments.

What Are the Disadvantages of a DST?

However, a deferred sales trust has a few drawbacks. Disadvantages of DSTs include:

• Strict Requirements – To gain tax benefits from a sale through a deferred sales trust, a property owner must meet all the requirements. Any mistake in conducting the sale may jeopardize these benefits, potentially exposing the owner to unexpected capital gains taxes, penalties, fees, and interest.
• High Formation Costs – Ensuring that a DST meets the strict formation requirements means that a property owner may incur legal expenses to hire legal counsel with specific experience in establishing deferred sales trusts.
• Ongoing Operational Expenses – A deferred sales trust requires a property owner to retain a third-party trustee to manage it, which means the trust may incur expenses in the form of trustee fees. Furthermore, when the trust reinvests sale proceeds, it may incur operational costs such as financial advisor fees or brokerage commissions.

What Is a 1031 Exchange?

On the other side, what is a 1031 exchange? A 1031 exchange allows an owner of business or investment real estate to defer capital gains taxes from selling the property by “exchanging” it with another “like-kind” property in an integrated transaction.

In a 1031 exchange, a property owner sells their property through a qualified intermediary. The intermediary holds the funds from the sale while the property owner identifies a new, eligible property to buy with the funds.

1031 exchange rules impose deadlines for a property owner to identify and complete the purchase of a new property to take advantage of deferring capital gains taxes. Furthermore, a property owner must purchase a “like-kind” property with the sale proceeds, which usually refers to other real estate of equal
or a greater value than the property they sold.

What Are the Advantages of a 1031 Exchange?

A 1031 exchange can offer various tax and financial benefits when selling real estate. Examples of the Advantages of a 1031 exchange include the following:

• Deferring Capital Gains Tax on a Property Sale – Conducting a property sale and purchase of a new parcel of real estate through a 1031 exchange allows a property owner to avoid paying capital gains taxes on the sale.
• Preserving Wealth Growth – Not paying capital gains taxes when selling property allows owners to keep the value growth they’ve earned during their property ownership.
• Facilitating Reinvestment Into Properties with Better Growth Opportunities – A 1031 exchange may allow property owners to reinvest the value they’ve built in one property into another with more significant growth potential.

What Are the Disadvantages of a 1031 Exchange?

However, the limitations of 1031 exchanges can make them unsuitable for many property owners. Some of the disadvantages of a 1031 exchange compared to a deferred sales trust include the following:

• Timing Rules – After selling their property, an owner must identify the new property they wish to purchase. They then must complete the purchase of that property or a substantially similar property within a certain timeframe, or lose the tax benefits of a 1031 exchange.
• Like-Kind Requirement – 1031 exchange rules limit real estate owners to reinvesting their sale proceeds in other real estate of equal or greater value.
• Additional Transaction Costs – In most cases, a property seller must use a qualified intermediary to put a 1031 exchange into effect, with their services imposing an additional cost on the real estate transaction.

What Flexibility Would I Have with Investment Choices with Each Strategy?

Deferred sales trusts offer greater flexibility with investment choices compared to 1031 exchanges. A
DST allows an asset owner to reinvest their wealth in different kinds of assets or to diversify their
investment portfolio. Furthermore, DSTs do not have the strict timing requirements of 1031 exchanges.
Conversely, a 1031 exchange requires a property owner to reinvest the proceeds from their property
sale into a like-kind replacement property, usually another piece of real estate or real estate interest of equal or
greater value.

How Can I Determine Which One Is Right for Me?

Some of the factors you should consider when deciding between a deferred sales trust and a 1031 exchange for your property sale include the following:

• Type of Asset You Wish to Sell – A 1031 exchange only allows exchanges of real estate ownership or interests, whereas a deferred sales trust will enable owners to defer capital gains taxes for a broader range of assets.
• Timing on Reinvestment Opportunities – A 1031 exchange may not work as well for a property owner who wants more time to identify their reinvestment opportunity after a sale, whereas a DST does not have strict deadlines on reinvestment.
• Willingness to Incur Expenses – Although both DSTs and 1031 exchanges have upfront costs, a deferred sales trust will have ongoing operational expenses during the life of the trust.

How Can a Lawyer from 453 Deferred Sales Trust Powered by Pennington Law Help?

Choosing between a deferred sales trust and a 1031 exchange, and structuring either option to meet your financial needs and goals, will require experienced legal counsel. A lawyer from 453 Deferred Sales Trust Powered by Pennington Law can help you choose a suitable legal option and structure your strategy
by:

• Reviewing the terms of your proposed asset sale
• Sitting down with you to discuss your financial needs and goals
• Evaluating your legal options and explaining the pros and cons of deferred sales trusts to help you make an informed decision about which strategy to use
• Structuring your DST or 1031 exchange to meet your specific objectives

Contact Our 453 Deferred Sales Trust Lawyers Today

When you have property to sell, conducting the sale through a deferred sales trust or 1031 exchange can help you manage or mitigate capital gains taxes from the sale. Contact 453 Deferred Sales Trust Powered by Pennington Law today for a free initial consultation with our attorneys. We can assess your options and advise you on whether a DST or a 1031 exchange would be best for you.