Comparing 1031 Exchanges vs. Deferred Sales Trusts

A liquidity event—such as selling a business or real estate—can generate $1M+ in capital gains, but taxes threaten to erode 30–50% of proceeds. Federal capital gains taxes (20%), the 3.8% Net Investment Income Tax (NIIT), and state levies (e.g., 13.3% in California) loom large, making tax deferral strategies like 1031 exchanges and deferred sales trusts (DSTs) critical tools for wealth preservation.

Each offers unique advantages, but missteps can trigger massive tax bills or limit reinvestment options. With over 40 years of fiduciary mastery, navigating market chaos from Black Monday to 2008, the Freedom Capital Playbook demands precision: choose the right tax deferral strategy to dominate your financial future. This article compares 1031 exchanges and DSTs, unveiling five elite tactics for entrepreneurs to maximize wealth in liquidity events.

Understanding 1031 Exchanges and Deferred Sales Trusts

A 1031 exchange, under IRS Section 1031, allows deferral of capital gains taxes by reinvesting proceeds from a sold property into a like-kind property within 180 days. Requirements include using a qualified intermediary, identifying replacements within 45 days, and matching or exceeding the original property’s value and debt.

A 2024 Deloitte report estimates 1031 exchanges save $500K–$2M in taxes for $5M+ real estate sales. However, strict timelines and property-type restrictions limit flexibility.

A deferred sales trust (DST), a structured installment sale under IRS Section 453, defers taxes by transferring assets to a trust, which sells them and pays the seller over time (e.g., 5–20 years). The trust reinvests proceeds in diversified assets (stocks, bonds), offering flexibility beyond real estate.


DSTs can save 20–30% in taxes but involve higher setup costs ($10K–$50K) and trust management fees (1–2% annually). These fiduciary strategies weigh tax deferral, liquidity, and reinvestment to optimize $1M+ exits.

Case Study: The $12M Real Estate Exit Dilemma

A 62-year-old real estate investor sold a $12M commercial property in 2023, with a $4M basis, facing $8M in taxable gains. A lump-sum sale would trigger $1.6M in federal capital gains taxes (20%), $304K in NIIT (3.8%), and $1M in California state taxes (13.3%), totaling $2.9M.

The investor, nearing retirement, sought tax deferral and diversified reinvestment. A fiduciary advisor presented two options. A 1031 exchange reinvested $12M into a like-kind retail complex, deferring all taxes but locking funds in real estate with $50K annual management costs.

Alternatively, a DST spread $8M in gains over 10 years ($800K annually), deferring $2.5M in taxes and reinvesting $7M into a municipal bond portfolio (3.5% yield) and growth ETF (VOO, 8% return). The DST saved $600K more than the 1031 exchange, yielding $250K annual income. By 2025, the DST portfolio grew to $8.2M, balancing flexibility and preservation.

Five Elite Tactics for Choosing Between 1031 Exchanges and DSTs

Entrepreneurs must select tax deferral strategies with precision to maximize wealth. Here are five tactics to optimize your liquidity event:

1. Assess Reinvestment Goals: Use a 1031 exchange for continued real estate exposure, ensuring like-kind properties match or exceed value to defer 100% of gains. Choose a DST for diversified reinvestment (stocks, bonds) to reduce sector risk.
   
   
2. Leverage DST Flexibility: Structure DST payouts (5–20 years) to keep AGI below $553,850 (15% capital gains) or $250,000 (NIIT threshold), deferring 20–30% more taxes than lump-sum sales.
3. Minimize Setup Costs: Negotiate DST fees (1–2% AUM) with trust companies like Midland Trust, or use low-cost 1031 intermediaries ($1K–$5K) for smaller exchanges ($1M–$5M).
   
   
4. Pair with Tax Deductions: Offset DST taxable payouts with deductions (e.g., $100K DAF contributions) or 1031 exchange costs (e.g., intermediary fees) to lower AGI and NIIT exposure.
   
   
5. Model Long-Term Outcomes: Use RightCapital or TurboTax to project tax deferral, reinvestment returns, and liquidity needs, comparing 1031’s real estate lock-in versus DST’s portfolio flexibility.

Actionable Tips for Entrepreneurs

• Audit Asset Basis Early: Calculate your property’s tax basis using CapIQ or a CPA to estimate gains and deferral potential. The advisor warns: “No basis, no strategy—know your numbers.”
  
  
• Engage a 1031/DST Specialist: Partner with a qualified intermediary (e.g., IPX1031) or DST trust attorney to ensure IRS Section 1031 or 453 compliance, avoiding audit risks.
  
  
• Automate Reinvestment Plans: Set up auto-transfers ($50K–$200K monthly) to DST portfolios or 1031 properties via Fidelity, ensuring disciplined wealth allocation.
  
  
• Monitor Market Conditions: Track real estate trends via CBRE or ETF performance via Morningstar to time exchanges or DST investments, avoiding 15% market dips (Morningstar, 2024).
  
  
• Reinvest for Income: Channel DST yields or 1031 rental income into dividend aristocrats ($100K–$300K annually), as a 2024 entrepreneur achieved, for compounding.

Challenges and Considerations

Choosing between 1031 exchanges and DSTs is complex. Tax deferral limits—1031 exchanges require strict like-kind reinvestment, while DSTs face taxable payouts over time (37% ordinary income if mismanaged). Setup costs—DSTs ($10K–$50K plus 1–2% fees) versus 1031 intermediaries ($1K–$5K)—impact net returns (Deloitte, 2024).

Market risk—real estate dropped 10% in 2023, affecting 1031 properties, while DST portfolios face stock volatility (Morningstar, 2024). Liquidity needs—$315K average for retiree health costs—require buffers (Fidelity, 2024).

Regulatory scrutiny—IRS audits 20% of 1031 exchanges for non-compliance (IRS, 2025). These strategies counter with diversified DSTs, low-cost intermediaries, and tax modeling. Behavioral traps—rushing exchanges or overpaying fees—threaten efficiency. The advisor’s antidote: “Defer taxes smart, or pay the IRS’s price.”

Conclusion

A $1M+ liquidity event demands elite tax deferral strategies, and choosing between 1031 exchanges and DSTs shapes your wealth’s future. With 40+ years of fiduciary mastery, these tactics—outsmarting taxes and scams—prove it’s about precision, not chance.

The real estate investor’s $600K tax savings highlight DST flexibility over 1031 rigidity. By assessing goals, minimizing costs, and modeling outcomes, you can dominate your exit. Don’t let taxes or rigidity erode your empire. Book a free Strategy Call at freedomcapitaladvisors.com to craft your deferral plan. As the advisor says, “Your wealth is your fortress—build it to last.”

Sources

1. Deloitte. (2024). Tax Deferral Strategies for Real Estate Sales. https://www2.deloitte.com/us/en/pages/tax/articles/tax-deferral-real-estate.html
2. IRS. (2025). Publication 544: Sales and Other Dispositions of Assets. https://www.irs.gov/publications/p544
3. Morningstar. (2024). 2023 Market Volatility and Investment Strategies. https://www.morningstar.com
4. Fidelity Investments. (2024). Retiree Health Care Cost Estimate. https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/press-release/2024-retiree-healthcare-costs-05012024.pdf