How Does a Deferred Sales Trust Work?
A Deferred Sales Trust is a tax deferral strategy that allows an owner of highly appreciated property to sell that property, defer the resulting capital gains tax, and receive the sale proceeds over time as structured installment payments. Instead of paying a large capital gains tax bill in the year of sale, the seller recognizes gain gradually as payments are received, spreading the tax liability across years or decades.
The strategy is not new. It is built on the installment sale rules of Internal Revenue Code § 453, which have been part of the tax code since 1980. What the Deferred Sales Trust structure adds is a trust intermediary and a professional trustee who manages the sale proceeds and makes distributions to the seller according to an agreed payment schedule.
However, the typical "Deferred Sales Trust" arrangement that has become popular has drawn active IRS scrutiny in recent years for structural reasons that are worth understanding. Cutler Riley's approach eliminates those risks by structuring the transaction differently from the ground up.
The Problem With the Standard Deferred Sales Trust
In the typical Deferred Sales Trust arrangement, the transaction works like this: the seller transfers the appreciated asset to a newly created trust before the sale. The trust then sells the asset to the ultimate buyer and holds the proceeds. The seller receives an installment note from the trust — a promise of payments over time. Because the seller does not receive all the proceeds at once, the theory is that gain is recognized only as installment payments are received under IRC § 453.
The IRS has challenged this structure on two grounds. First, the seller-to-trust-to-buyer sequence looks like a step transaction — two steps that should be collapsed into one direct sale from seller to buyer, triggering full gain recognition in the year of sale. Second, when the trust receives the full purchase price from the buyer, the IRS argues that the seller constructively received those proceeds at that moment, because the seller is the economic beneficiary of a trust they created and effectively control.
Neither concern is frivolous. The IRS's Chief Counsel Memorandum AM 2023-006 reflects active scrutiny of these arrangements, and enforcement actions have followed. The problem is not installment sales — IRC § 453 is not under attack. The problem is the two-step architecture specific to the standard DST, and the constructive receipt exposure it creates.
How Cutler Riley Structures It Differently
Cutler Riley's structure eliminates the two-step problem by never having the trust buy the asset.
The seller negotiates and enters into a purchase agreement directly with the buyer, exactly as in any ordinary sale. Before closing, the purchase contract is amended by agreement of both parties to convert some or all of the purchase price from a lump-sum payment to an installment obligation. The buyer agrees to pay the deferred portion over time according to a specified schedule rather than all at once at closing.
At that point, the buyer's installment payment obligation — not the asset, and not the proceeds — is assigned to an independent irrevocable trust. The buyer pays the trust. The trust makes the scheduled installment payments to the seller.
The seller never sold to the trust. The trust never bought the asset. The trust never held the sale proceeds. There was one transaction: a direct sale from seller to buyer, with installment terms negotiated into the purchase contract itself. The trust's role is limited to holding and servicing the buyer's payment obligation after the sale is complete.
Why This Structure Is More Defensible
The constructive receipt doctrine under Treasury Regulation § 1.451-2 applies when a taxpayer has an unqualified, vested right to receive income and simply chooses not to receive it. In the standard DST, the argument is that the seller had an unobstructed right to the full proceeds the moment the trust sold the asset to the buyer.
In Cutler Riley's structure, that argument has no purchase. The seller never had an unobstructed right to receive the full purchase price in cash. The installment terms were negotiated into the original purchase contract before any right to a lump sum crystallized. There is no moment at which the seller held — or could have demanded — the full proceeds. The deferred obligation was built into the sale itself.
The step transaction argument fails for the same reason. There is only one transaction: a direct sale from seller to buyer under an installment contract. The trust's later assumption of the buyer's payment obligation is a post-sale administrative arrangement, not a step in a multi-step sale.
This is also why Cutler Riley's structure is categorically different from a monetized installment sale, which involves pledging the installment note as collateral for a loan to obtain immediate liquidity. The IRS has designated monetized installment sales a listed transaction. Cutler Riley's structure involves no pledge, no loan, and no access to the full proceeds. The seller accepts genuine illiquidity as the price of deferral.
The IRC § 453 Foundation
Installment sale reporting under IRC § 453 allows a seller to recognize gain ratably as payments are received rather than entirely in the year of sale. For each payment, the seller reports the gross profit percentage of that payment as capital gain, with the remainder representing return of basis and, where applicable, interest income.
The tax benefit is real. Spreading recognition over multiple years can keep the seller in lower capital gains brackets, reduce or eliminate the 3.8% net investment income tax that would otherwise apply, and avoid phaseouts that compound the cost of a single large recognition event. The deferral does not eliminate the tax — it controls when it is paid and at what rates.
IRC § 453A imposes an interest charge on deferred gain from installment obligations exceeding $5 million from the sale of non-dealer property. That charge represents the government's cost of the deferral and is a real factor in evaluating the net benefit for large transactions.
IRC § 453 does not apply to dealer sales, sales of publicly traded securities, or the recapture income portions of gains on depreciable property under IRC §§ 1245 and 1250. Your CPA must confirm eligibility before the structure is implemented.
Who This Structure Is For
This approach is most useful for sellers who have a large embedded gain, do not need all the proceeds immediately, and want to convert a significant taxable event into a structured income stream over time.
The most common situations are a business owner selling a closely held company who wants retirement income rather than a single lump sum taxed at the highest rates, a real estate investor selling appreciated rental property where a 1031 exchange is not practical or desired, and a seller who values controlling the timing and bracket exposure of gain recognition over the next several years.
This structure is not suitable for sellers who need the full purchase price at closing, sellers whose assets do not qualify for § 453 installment treatment, or sellers with significant debt encumbering the asset being sold, where the debt-relief component may be treated as a payment received at closing regardless of the installment structure.
Cutler Riley's Role
Cutler Riley drafts the trust agreement, the purchase contract amendment converting the sale to installment terms, and the assignment of the buyer's payment obligation to the trust. Depending on the structure and the parties involved, Cutler Riley serves as trustee or coordinates appointment of an independent third-party trustee.
This is a collaborative engagement. Your CPA must be involved from the beginning to confirm § 453 eligibility, model the gain recognition schedule, and advise on the interaction with § 453A interest charges. The legal structure and the tax analysis are both essential, and neither replaces the other.
Frequently Asked Questions
How is this different from a typical Deferred Sales Trust?
In a typical DST, the seller transfers the asset to the trust, which then sells to the buyer and holds the proceeds. That two-step structure exposes the arrangement to step transaction and constructive receipt arguments from the IRS. In Cutler Riley's structure, the seller sells directly to the buyer in a single transaction. The trust assumes the buyer's installment payment obligation after the sale — it never buys the asset or holds the sale proceeds. The seller never had an unobstructed right to a lump sum, so the constructive receipt argument does not apply.
Does the trust hold the sale proceeds?
No. The buyer pays the deferred portion of the purchase price to the trust in satisfaction of the installment obligation the buyer agreed to in the purchase contract. The trust services that payment obligation — it does not receive and reinvest a lump sum of sale proceeds on the seller's behalf. That distinction is central to how this structure avoids the IRS's concerns about standard DST arrangements.
Can I take some proceeds at closing and defer the rest?
Yes. Many sellers take a portion of the purchase price at closing — fully taxable in the year of sale — and structure the remainder as an installment obligation assigned to the trust. The hybrid approach allows some immediate liquidity while deferring the majority of the gain recognition.
What assets qualify for installment sale treatment?
Most sales of appreciated real property and closely held business interests qualify. Exceptions include dealer property held primarily for sale to customers, publicly traded securities, and the recapture income portions of gains on depreciable property under IRC §§ 1245 and 1250. Your CPA must confirm eligibility for your specific asset and transaction.
Is a 1031 exchange a better option for real estate?
It depends on your goals. A 1031 exchange defers gain indefinitely as long as you continue reinvesting in qualifying replacement property, and the deferred gain is eliminated at death through stepped-up basis. It is generally the better tool for sellers who want to remain in real estate. The installment sale structure is most useful for sellers who want to exit real estate entirely, sell a business rather than real property, or have more flexibility in how proceeds are managed after the sale.
If you are approaching a sale of a business or appreciated real estate and want to understand whether a structured installment sale fits your transaction, Cutler Riley, PLLC offers a free consultation. We will walk through the structure, explain how it differs from standard DST arrangements, and work with your CPA to assess whether § 453 installment treatment is available for your specific situation. Schedule your free consultation here.