How Deferred Sales Trusts and Installment Sales Work
Question askedExplain deferred sales trust
Quick answer: A "deferred sales trust" is a marketing name for a strategy that uses the tax rules governing installment sales to defer capital gains tax when you sell an appreciated asset. The documents provided don't use the term "deferred sales trust," but they do contain the installment-sale rules (IRC § 453 and § 453A, and IRS Publication 537) that actually govern this kind of arrangement. This answer assumes 2025 tax law.
Note: IRS publications don't use the term "deferred sales trust"; this explanation is built from the installment-sale rules that apply to it.
What it is
An installment sale, as defined in the Code, is a disposition of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs. A "deferred sales trust" typically layers a third-party trust into this structure: instead of selling directly to a buyer, the seller sells the asset to a trust in exchange for an installment note, and the trust then resells the asset to the ultimate buyer. The seller reports gain over time as note payments are received, rather than all at once in the year of sale.
How it works
Under the installment method, the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price. So each payment received carries a mix of return-of-basis and taxable gain, spreading the tax liability across the years payments are collected.
Two structural rules matter a lot for a trust-based version of this strategy:
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Related-party and dealer issues. The installment method is unavailable for certain categories. For instance, the term "installment sale" does not include any dealer disposition, or a disposition of personal property of a kind which is required to be included in the inventory of the taxpayer if on hand at the close of the taxable year. A "dealer disposition" includes any disposition of personal property by a person who regularly sells or otherwise disposes of personal property of the same type on the installment plan, and any disposition of real property which is held by the taxpayer for sale to customers in the ordinary course of the taxpayer's trade or business.
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The pledge rule. If the note is used as collateral, Publication 537 warns that if you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation — known as the pledge rule, and it applies if the selling price of the property is over $150,000. This matters because a seller who tries to borrow against the trust's note to get cash early can accidentally trigger immediate taxation, since the pledge rule accelerates the reporting of the installment obligation payments.
Risks and limits
- Large-obligation interest charge (§453A). If the face amount of installment obligations from sales over $150,000 held by a nondealer exceeds $5,000,000 in a year, § 453A imposes an additional interest charge on the deferred tax liability. The statute applies to an obligation... arising during a taxable year only if such obligation is outstanding as of the close of such taxable year, and the face amount of all such obligations held by the taxpayer which arose during, and are outstanding as of the close of, such taxable year exceeds $5,000,000. Publication 537 illustrates the mechanics: the interest due equals Deferred Tax Liability x Applicable Percentage x Underpayment Rate, using the § 6621(a)(2) underpayment rate.
- Payment characterization. Certain forms of consideration received don't count as "payment" for deferral purposes, but marketable securities and demand notes can be treated as payment even before cash changes hands, under Treas. Reg. § 1.453-3 (a regulation whose text here doesn't show a clear last-amended date, so confirm currency before relying on it).
- Death of the seller. If the seller dies holding the note, Publication 537 notes that if an installment obligation is canceled, becomes unenforceable, or is transferred to the buyer because of the death of the holder of the obligation, it's a disposition, and the estate must figure its gain or loss on the disposition.
In practice
This strategy defers — it does not eliminate — capital gains tax; gain is recognized as payments are received rather than all at once. Whether it works as intended depends heavily on facts: how the trust is structured, whether the seller retains impermissible control or security interests over the note (risking pledge-rule or constructive-receipt problems), and whether the size of the obligation triggers the § 453A interest charge. Given the complexity and the aggressive marketing around "deferred sales trusts," it's well worth having a CPA review the specific trust documents and sale structure before relying on this approach.
Sources relied upon
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Statute 26 U.S.C. § 453 — Installment method — (b) Installment sale defined › (2) Exceptions
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“The term “installment sale” means a disposition of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs.”
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Statute 26 U.S.C. § 453 — Installment method — (b) Installment sale defined › (2) Exceptions
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“(c) Installment method defined For purposes of this section, the term “installment method” means a method under which the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price.”
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Statute 26 U.S.C. § 453 — Installment method — (b) Installment sale defined › (2) Exceptions
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“(2) Exceptions The term “installment sale” does not include— (A) Dealer dispositions Any dealer disposition (as defined in subsection (l)). (B) Inventories of personal property A disposition of personal property of a kind which is required to be included in the inventory of the taxpayer if on hand at the close of the taxable year.”
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Statute 26 U.S.C. § 453 — Installment method — (l) Dealer dispositions › (1) In general
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“For purposes of subsection (b)(2)(A)— (1) In general The term “dealer disposition” means any of the following dispositions: (A) Personal property Any disposition of personal property by a person who regularly sells or otherwise disposes of personal property of the same type on the installment plan.”
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Statute 26 U.S.C. § 453 — Installment method — (l) Dealer dispositions › (1) In general
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“(B) Real property Any disposition of real property which is held by the taxpayer for sale to customers in the ordinary course of the taxpayer’s trade or business.”
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IRS publication IRS Publication 537 — Installment Sales — Payments Received or Considered Received › Installment Obligation Used as Security (Pledge Rule), p. 8
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“If you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation. This is known as the pledge rule, and it applies if the selling price of the property is over $150,000.”
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IRS publication IRS Publication 537 — Installment Sales — Payments Received or Considered Received › Installment Obligation Used as Security (Pledge Rule), p. 8
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“Installment payments. The pledge rule accelerates the reporting of the installment obligation payments.”
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Statute 26 U.S.C. § 453A — Special rules for nondealers — (b) Installment obligations to which section applies › (2) Special rule for interest payments
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“For purposes of subsection (a)(1), this section shall apply to an obligation described in paragraph (1) arising during a taxable year only if— (A) such obligation is outstanding as of the close of such taxable year, and (B) the face amount of all such obligations held by the taxpayer which arose during, and are outstanding as of the close of, such taxable year exceeds $5,000,000.”
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IRS publication IRS Publication 537 — Installment Sales — Other Rules › Interest on Deferred Tax, p. 22
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“Step 4: Compute the Interest Due (Additional Tax) on the Deferred Tax Liability = Deferred Tax Liability x Applicable Percentage x Underpayment Rate Deferred Tax Liability 2,842,010 x Applicable Percentage 64.2857% x Underpayment Rate 6.00% 2022 453A additional tax $109,620 2023 Deferred Tax Liability calculation: 2022 Deferred Obligation 14,000,000 – 2023 Payment received (5,000,000) 2023 Deferre…”
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IRS publication IRS Publication 537 — Installment Sales — Disposition of an Installment Obligation › No Disposition, p. 18
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“However, if an installment obligation is canceled, becomes unenforceable, or is transferred to the buyer because of the death of the holder of the obligation, it’s a disposition. The estate must figure its gain or loss on the disposition.”
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