Deferred Sales Trust vs 1031 Exchange

Both a Deferred Sales Trust (DST) and a 1031 exchange can help you defer capital gains taxes, but they work in very different ways. A 1031 exchange lets you reinvest the proceeds from a property sale into another like-kind property to delay paying taxes, while a DST uses an installment contract through a trust to spread out tax payments over time.

The differences between a DST and a 1031 exchange lie in key areas such as the types of assets they cover, their timelines, flexibility, complexity, and setup costs. Understanding these differences is crucial because the option you choose will affect your cash flow, flexibility, risk, tax exposure, and long-term financial plan.

At Universal Pacific 1031 Exchange, our experienced qualified intermediaries have 35+ years of experience helping investors facilitate smooth and IRS-compliant exchanges. We help you evaluate different tax-deferral options, handle deadlines, and structure your exchange to support available tax-deferral benefits. Contact us today to start an exchange with professional support you can trust.

In this blog, we’ll break down the key differences between a Deferred Sales Trust and a 1031 Exchange, their pros and cons, and how to choose the right option for your specific goals.

What Is a 1031 Exchange?

A 1031 Exchange is a tax deferral strategy that allows real estate investors to defer capital gains taxes when they sell one investment property and reinvest the proceeds into another similar property. It is covered by Section 31 of the Internal Revenue Code. By deferring taxes, you keep more of your capital working for you, thereby building wealth and growing a real estate portfolio over time.

The 1031 exchange process begins when an investor sells their property and transfers the proceeds to a Qualified Intermediary (QI). The QI is a neutral third party who holds the funds in escrow and manages the exchange to ensure it meets IRS rules. From the date of the sale, the investor has 45 days to identify potential replacement properties.

Once they identify the replacement properties, the investor has a total of 180 days from the sale of the original property to complete the purchase. The QI then transfers the funds directly into the new property, ensuring the investor does not handle the money. To defer capital gains taxes completely, you must reinvest all the proceeds into the new property.

To qualify for tax deferral, investors must follow strict IRS rules, including the timeline for 1031 exchanges. Both the relinquished and replacement properties must be like-kind, and must be used for business or investment, not personal residences. The same taxpayer who sold the original property must also purchase the new one, and the exchange must be structured through a Qualified Intermediary.

What Is a Deferred Sales Trust?

A Deferred Sales Trust (DST) is a financial strategy that allows individuals to sell appreciated assets, such as real estate or a business, while deferring capital gains taxes. It is a specialized form of installment sale. Instead of selling directly to the buyer, the exchanger sells the asset to a specially structured trust. This trust then sells the property to the end buyer. Because the seller receives payments from the trust over time rather than all at once, they can delay paying capital gains taxes and spread them out over future years.

The process begins when the seller transfers ownership of the asset to the Deferred Sales Trust before the sale takes place. The trust then sells the asset to the buyer and holds the sale proceeds from the sale. In return, the seller enters into an agreement with the trust to receive payments, usually structured as an installment contract or promissory note. These installment payments can be customized – monthly, yearly, or in a lump sum at a later date – depending on the seller’s financial needs and goals.

During this period, the money inside the trust can be invested in a variety of ways, such as stocks, bonds, or new real estate. This means the funds not only remain protected from immediate taxation but also have the potential to grow. The seller only pays taxes on the portion of the payments they receive each year, which can lead to significant tax savings and more cash control compared to paying a large tax bill upfront.

For a DST to work properly, it must be structured carefully to comply with IRS rules. The seller cannot have direct control over the trust or the funds. The agreement with the trust must be legally binding. It is also essential to work with experienced tax professionals and attorneys when setting up a DST, as mistakes could cause the IRS to treat the transaction as a regular sale.

Note that Deferred Sales Trust is NOT the same as Delaware Statutory Trusts, even though they’re both called DSTs and can both help defer capital gains taxes. For better clarity, you can check out our comprehensive blog on DST 1031 Exchange.

Key Differences Between a Deferred Sales Trust vs 1031 Exchange

While both a Deferred Sales Trust (DST) and a 1031 Exchange are designed to defer capital gains taxes, they work very differently. You need to understand these differences to be able to choose the right strategy that best fits their investment goals and circumstances.

1. Type of Assets Covered – A 1031 Exchange applies only to real estate used for business or investment purposes. This includes properties such as rental homes, apartment complexes, commercial buildings, or raw land. However, personal residences, vacation homes used primarily for personal enjoyment, or properties intended for quick resale do not meet the requirements.In contrast, a Deferred Sales Trust can be used with a much wider variety of assets. Beyond real estate, it can apply to the sale of a business, certain highly appreciated personal property, or even investments outside of real estate. This makes the DST a more flexible option for individuals who want to defer taxes on assets that fall outside the narrow scope of a 1031 Exchange.
2. Tax Deferral Method – With a 1031 exchange, you achieve capital gains tax deferral by reinvesting all the sale proceeds into a like-kind replacement property. Any portion of the proceeds that is not reinvested, known as boot in a 1031 exchange, becomes taxable.The DST works differently. Instead of reinvesting all the money immediately, you set up an installment agreement with the trust. The trust handles the asset sale and holds the proceeds, then makes payments to you over time. With this, you can spread out your tax liability over many years rather than paying it all at once. You only owe capital gains taxes when you receive payments.
3. Timelines and Deadlines – The IRS sets strict deadlines for a 1031 exchange. From the date of the sale, you have 45 days to identify possible replacement properties in writing. Then, you must complete the purchase of one or more of those properties within 180 days. These deadlines are non-negotiable, and failure to meet them means losing the tax deferral benefit.A DST, on the other hand, does not impose such rigid deadlines. Once the trust is established and the sale happens, the seller has flexibility in deciding how the payments will be structured and when they will be received.
4. Control and Flexibility – In a 1031 Exchange, investors must follow detailed IRS rules. The property acquired must qualify as like-kind, and the replacement must be equal to or greater in fair market value to achieve full tax deferral. The reinvestment is also limited to real estate, which can restrict diversification.By contrast, a DST offers much greater flexibility. You can invest the sale proceeds in a variety of ways, such as stocks, bonds, or even opportunities in the real estate market. You can also decide how to structure the payments, whether you want steady income over many years, a lump sum at a later date, or a mix of both.
5. Complexity and Costs – In terms of setup, a 1031 exchange costs less and is generally simpler. It requires working with a Qualified Intermediary to manage the process. But as long as you follow the deadlines and rules, the transaction is fairly straightforward.A Deferred Sales Trust, however, is more complex. It requires careful legal and tax planning, often involving specialized attorneys and financial advisors. The setup fees and ongoing management costs are typically higher than those of a 1031 Exchange.

Deferred Sales Trust vs 1031 Exchange: Summary of the Differences

Pros and Cons of a 1031 Exchange

The main benefit of a 1031 exchange is the ability to defer capital gains taxes. With this, you get to preserve more equity, enabling you to purchase larger or more profitable properties without losing funds to taxes. It also offers opportunities to grow and diversify a real estate portfolio, relocate investments to stronger markets, and consolidate or expand holdings.

On the other hand, following the strict IRS rules and timelines for a 1031 exchange can be challenging for some investors. You have only 45 days to identify replacement properties and 180 days to complete the purchase, which can create pressure and limit flexibility. The strategy is also limited to real estate only, which means you cannot use it for other appreciated assets like businesses. Additionally, if you fail to reinvest all the proceeds into a qualifying property of equal or greater value, you’ll owe taxes on the boot.

Pros and Cons of a Deferred Sales Trust

A Deferred Sales Trust provides greater flexibility than a 1031 exchange. It can be used for real estate, businesses, or other assets. In addition, the payout schedule can be tailored to fit the seller’s financial goals. The funds inside the trust can also be invested in a wide range of assets, from stocks and bonds to diversified real estate. This flexibility allows sellers to spread out tax payments, manage cash flow, and keep more control over how their wealth grows.

On the downside, setting up a DST requires experienced attorneys and advisors, which makes it more expensive than a 1031 exchange. The seller also gives up direct control, as the trust must be managed by a third party trustee under a legally binding agreement. If structured incorrectly, the IRS may deny the tax benefits. For these reasons, a DST is often better suited for larger transactions where the potential savings justify the setup costs.

When to Consider Each Strategy?

A 1031 exchange is often the better choice if you want to keep growing your real property portfolios while deferring taxes. It works well when the goal is to trade into a larger property, move investments to a stronger market, or consolidate multiple holdings into one. Because the process is relatively straightforward and less costly, it is especially useful for investors who are comfortable with strict IRS timelines and who plan to stay focused on real estate as their main investment vehicle.

On the other hand, a Deferred Sales Trust might be a better choice when the relinquished asset is not limited to real estate. It also comes in handy when you need greater flexibility. Moreover, the DST is a strong option for business owners selling their companies or individuals with highly appreciated assets outside of real estate. It is also appealing for those seeking to diversify into different types of investments rather than rolling everything back into real estate.

How to Decide Between a Deferred Sales Trust and a 1031 Exchange

Before choosing between a Deferred Sales Trust and a 1031 exchange, you should carefully evaluate your financial situation and long-term goals.

• Start by reviewing the type of asset you are selling, since a 1031 exchange only applies to real estate while a DST can be used for other appreciated assets like businesses or investments.
• Consider the size of the transaction. While a 1031 may be more practical for straightforward property sales, a DST might be better suited for larger or more complex deals where flexibility and diversification matter.
• You should also consider your investment timeline, cash flow needs, and tolerance for IRS restrictions. Ask yourself whether you want to stay invested in real estate or diversify into other assets, whether you need immediate income or prefer to delay payments, and how comfortable you are with strict deadlines. Understanding these points will help you narrow down the strategy that aligns with your goals.
• It’s also important to involve a tax advisor or attorney early in the process. Key questions to ask include: What are the tax implications if I choose one option over the other? How do the setup costs compare with the potential tax savings? What risks should I be aware of if the structure is not handled correctly? Getting clear answers to these questions helps avoid costly mistakes.
• Ultimately, you need professional guidance since both strategies require strict compliance with tax rules. An experienced advisor can review your unique situation, explain the trade-offs, and guide you through the legal and financial details. By working with the right professionals, you can make a confident decision that not only guarantees asset protection, but also supports your long-term financial plans.

Need Help With a 1031 Exchange?

You can successfully defer taxes with either a DST or a 1031 exchange. The strategy that is best for you depends largely on your investment goals and priorities in terms of asset control, cost, time, etc. Because each strategy has its own rules and risks, you should work with experienced tax and legal professionals to choose the option that best fits your goals and to avoid costly mistakes.

As the best Qualified Intermediary in Los Angeles, our experienced team at Universal Pacific 1031 Exchange have all the experience and expertise you need to facilitate a smooth 1031 exchange. Whether you’re upgrading to larger properties, diversifying into new markets, or seeking more passive income, we make sure you achieve maximum tax deferral while protecting your investments. Book a free consultation with us today to start an exchange.

FAQs

With 35+ years of experience as trusted 1031 exchange accommodators, our licensed CPA professionals have provided comprehensive answers to common questions most investors have about deferred sales trust and 1031 exchange investments.

What Are the Disadvantages of a Deferred Sales Trust?

The main disadvantages are its complexity and higher setup costs compared to other strategies. It also requires the seller to give up direct control of the proceeds, since the funds must remain in the trust to stay compliant with IRS rules. If the trust is not structured properly, the IRS could disallow the tax benefits.

How Much Does a Deferred Sales Trust Cost?

The cost of setting up a Deferred Sales Trust varies depending on the size of the transaction and the professionals involved. Typically, there are legal and administrative fees that can range from several thousand dollars to a percentage of the transaction. Because of these costs, a DST is usually more practical for larger sales where the tax savings outweigh the expenses.

What Is the IRS’s Position on a Deferred Sales Trust?

The IRS does not have a specific ruling that directly approves or disapproves of Deferred Sales Trusts. However, when properly structured to follow installment sale rules under Section 453 of the Internal Revenue Code, a DST can be a valid strategy. This is why careful legal structuring and compliance are critical.

How Do I Defer Capital Gains Without a 1031 Exchange?

If you are not using a 1031 Exchange, a Deferred Sales Trust is one option to defer capital gains by spreading out payments over time. Other possibilities include Opportunity Zone investments or structured installment sales, depending on the asset and your financial goals. The best approach should always be discussed with a qualified tax advisor.