If you’re preparing to sell a highly appreciated asset, like your privately held company, one of your biggest concerns is probably the looming capital gains tax bill. After years (or decades) of building value in your business, you could be facing a seven-figure tax liability when it’s time to cash out.
I know I did! I even looked at the possibility of moving to another state to escape California taxes, but that’s for another post.
But here is a more realistic solution: a Deferred Sales Trust (DST), which allows you to defer capital gains, maintain investment control, and receive a steady stream of income over time.
Let’s take a closer look at how it works and whether it’s a fit for you.*
What Is a Deferred Sales Trust?
A Deferred Sales Trust is a legal, IRS-compliant strategy that helps defer the recognition of capital gains tax on the sale of appreciated assets such as real estate, stock portfolios, or your IT business.
Rather than selling the asset directly to the buyer (and triggering immediate taxes), the seller first transfers ownership to a specially created trust. The trust then sells the asset to the buyer and, in return, the seller receives an installment note, allowing them to collect payments over time and spread out their taxable income.
This structure opens the door to potential investment growth, more control over timing of income, and, in some cases, a reduced overall tax burden.
How Does a Deferred Sales Trust Work?
Here’s a simplified step-by-step breakdown of what happens:
- Asset Transfer to the Trust
You, the seller, transfer ownership of your business (or other asset) into a legally structured Deferred Sales Trust before a binding agreement is signed with a buyer. This step is key! And it takes time. You have to let the buyer know in advance of generating the purchase agreement. - Trust Sells the Asset
The DST sells the business to the buyer at fair market value, completing the transaction on your behalf. - You Receive an Installment Note
Instead of receiving a lump sum from the sale, you receive an installment note from the trust. This note outlines how and when you’ll be paid: monthly, quarterly, annually, or even interest-only with a balloon payment at a future date. - Tax Deferral & Investment Growth
Capital gains tax is only due as payments are received. In the meantime, the funds within the DST can be invested, potentially earning tax-deferred returns.
Why Sellers Consider a Deferred Sales Trust
For sellers of privately held businesses (especially those exiting during peak valuation windows), a DST offers several compelling benefits:
- Capital Gains Tax Deferral
By spreading income over time, you defer the bulk of the tax burden. This can be especially advantageous if it allows you to stay within a lower tax bracket year-to-year. - Customizable Income
Want to receive steady income during retirement? Prefer a lump sum in 5 years? The installment note can be tailored to your needs and lifestyle goals. - Ongoing Investment Control
While the funds are held in the trust, they can be professionally invested to grow (on a tax-deferred basis) until distributed to you. - Estate Planning Flexibility
In some cases, DSTs can be combined with other strategies for wealth transfer and estate planning, especially if you want to pass future payments to your heirs.
But a Deferred Sales Trust is Not for Everyone…
As with any advanced tax strategy, DSTs come with important caveats:
- Complex Structure
This is not a DIY solution. You’ll need a qualified team to execute it properly, typically including a tax attorney, financial advisor, and trust administrator. And do not wait until the last minute to try and find someone. Not many people know how to do this, and you also need time to shop the fees associated with setting this up. - Ongoing Costs
There are legal, trustee, and advisory fees to consider, which may eat into returns if not managed wisely. - Limited Liquidity
Since you’re deferring proceeds over time, you won’t have immediate access to the full sale price. Make sure the payout schedule aligns with your liquidity needs.
A Real-World Scenario
Let’s say you’re selling your managed service provider (MSP) business for $10 million, with a $7 million capital gain. A direct sale could result in a $1.5M–$2M+ tax hit in the year of sale, depending on your state and tax bracket.
With a DST, you might structure the proceeds over 10–15 years while still taking some money upfront. Again, you only pay taxes on what you actually receive each year, while the balance stays invested. Depending on market performance and your spending needs, this could lead to more money in your pocket long-term – and more flexibility in how you use it.
Is a Deferred Sales Trust Right for You?
A DST isn’t a fit for everyone. But for business owners with significant unrealized gains, long-term financial goals, and a preference for income over lump-sum payouts, it can be a powerful tool.
Whether you’re in the early stages of preparing for a sale or currently negotiating a deal, it’s worth talking to your M&A advisor and tax counsel before signing anything. DSTs must be set up prior to a binding sale agreement to be effective.
Final Thoughts
I found out about this great tax strategy from one of my sellers (in California) because he was appalled at the amount of taxes that would be taken out between federal and state. He, however, only brought it up a few weeks before the close, which made the buyer very unhappy and created additional work. Still, it is your option to do this; just be sensitive to the extra work that needs to be done to accomplish it. That said, I probably wouldn’t mention it before signing the LOI, but certainly right afterwards to give everyone the heads up.
Whether you’re selling this year or just beginning to explore your exit options, it’s smart to evaluate strategies like a Deferred Sales Trust early in the planning process.
* As always, you know I am not giving you tax advice, so check with a professional.
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