Deferred Sales Trust vs. 1031 Exchange: Which Tax Deferral Strategy Is Right for You?
By Michael J. Holmes, Attorney at Law
High-net-worth investors and business owners seeking to defer capital gains tax on appreciated real estate, businesses, or highly valued assets have historically relied on the 1031 Exchange under Internal Revenue Code §1031. But in recent years, another powerful strategy has gained traction—one that offers far greater flexibility: the Deferred Sales Trust (DST).
Both are legal tax deferral strategies, but they differ significantly in structure, flexibility, asset eligibility, and timing requirements. Choosing the wrong strategy can cost millions in avoidable taxes—so it’s critical to understand how each works.
What Is a 1031 Exchange?
A 1031 Exchange allows investors to defer capital gains taxes by reinvesting proceeds from the sale of investment property into another “like-kind” investment property. It’s a popular strategy for real estate investors but comes with strict IRS rules.
Key Requirements of a 1031 Exchange
- Must involve investment or business-use real estate.
- 45-day deadline to identify replacement property.
- 180-day deadline to complete the purchase.
- Funds must be held by a Qualified Intermediary (QI).
- To fully defer taxes, you must:
- Reinvest 100% of equity
- Purchase equal or greater value
- Replace debt paid off in the sale
Limitations of a 1031 Exchange
- Real estate only – no businesses, stocks, crypto, or cash.
- No liquidity – cannot receive cash without tax.
- Risk of paying “boot tax” on partial withdrawals.
- Relies on strict timelines—no extensions.
- Often forces investors to overpay for replacement property under the deadline pressure.
What Is a Deferred Sales Trust (DST)?
A Deferred Sales Trust is a tax strategy based on IRS Section 453, also known as the installment sale method. Unlike a 1031 Exchange, a DST works with many types of assets—including real estate and businesses.
How a DST Works
- You sell your asset to a trust in exchange for a promissory note.
- The trust sells the asset to the end buyer.
- The sale proceeds are invested tax-deferred within the trust.
- You receive customized installment payments over time.
Advantages of a DST
- No 45 or 180-day deadlines.
- Works for businesses, crypto, and real estate.
- Provides liquidity (cash flow without all taxes due now).
- Invest in anything: property, notes, index funds, private lending, etc.
- Can be used as a 1031 rescue option if deadlines fail.
- Reduces estate tax exposure and improves legacy planning.
Limitations of a DST
- Requires an IRS-compliant structure.
- Must use an independent, licensed trustee.
- Legal fees are higher than 1031 exchange costs.
Deferred Sales Trust vs. 1031 Exchange Comparison
| Feature | 1031 Exchange | Deferred Sales Trust (DST) |
|---|---|---|
| IRS Code | §1031 | §453 |
| Asset Types | Real estate only | Real estate & business assets |
| Deadlines | Yes – strict | No |
| Diversification | No | Yes |
| Liquidity | No | Yes |
| 1031 Rescue Option | No | Yes |
| Investment Choices | Like-kind real estate | Any approved investment |
| Estate Planning Benefits | Limited | Strong |
Which Strategy Is Right for You?
- Use a 1031 Exchange if: You plan to stay in real estate long-term.
- Use a DST if: You want passive income or to exit real estate.
- Use both: Combine them as a 1031 Exit Strategy.
Serving Clients in California, Idaho, Texas & Washington
Tax deferral rules vary by state—especially in California and Washington where extra capital gains taxes may apply. Strategic planning is essential before selling:
- California: FTB closely scrutinizes 1031 and DSTs—compliance matters.
- Idaho: DST-friendly and ideal for reinvestment.
- Texas: No state income tax makes DST strategies highly effective.
- Washington: Capital Gains Tax applies—DSTs can help mitigate exposure.
📞 Speak With Attorney Michael J. Holmes
If you’re selling real estate or a business and want to defer taxes legally, schedule a strategy consultation today.
Law Offices of Michael J. Holmes, APC
Website: www.askholmes.com
Email: michael@askholmes.com
Phone: (714) 464-5188
Licensed in California, Idaho, Texas & Washington
⚠️ Legal Disclaimer
This article is for educational purposes only and does not constitute legal or tax advice. Tax strategies such as 1031 Exchanges and Deferred Sales Trusts must be reviewed by qualified advisors. Results vary. Consult a licensed attorney before taking action.