If you live in California, you’re no stranger to the Golden State’s heavy tax burden, especially when it comes to capital gains. Whether you’re selling real estate, a business, or even a highly appreciated stock portfolio, California’s combined state and federal capital gains taxes can take a significant portion out of your profits.
If you want to sell your high-value assets, you need a tax-deferral strategy that fits your specific landscape.
Here’s what you should know about using a Deferred Sales Trust (DST) in California, and how you can use it to legally defer your tax exposure while creating investment flexibility and long-term income.
Why California Sellers Need to Think Strategically
California imposes one of the highest state income tax rates in the country, topping out at 12.30% for high earners.1 And unlike many states, California doesn’t distinguish between regular income and capital gains. That means your sale proceeds are taxed just like wages.
Combine that with the federal capital gains rate (up to 20% for long-term capital gains), the Net Investment Income Tax (3.8%), and other possible surtaxes, and you’re potentially looking at 35–37% in total tax liability.
Here’s a quick scenario:
- You sell a commercial building in Los Angeles for $5 million
- Your cost basis is $1 million
- Capital gain: $4 million
- Approximate tax bill: $1.4–$1.5 million
A DST could help you defer that entire amount, giving you more capital to reinvest and grow.
How a Deferred Sales Trust Works in California
A DST is a legal, IRS-compliant tax strategy that allows you to defer capital gains taxes by placing the proceeds from a sale into a trust in exchange for an installment contract. Here’s what happens.
Step 1: You sell your asset to a DST before the buyer steps in. Establishing your DST before the sale, ensures you do not realize any gains from the sale.
Step 2: The DST then sells the asset to the buyer. Because you don’t own the asset or receive any payment, the sale does not trigger capital gains taxes for you.
Step 3: You receive installment payments as previously established. You only owe taxes as you receive principal payments from the trust.
This structure offers flexibility and control. It also means you have the potential to invest tax-deferred capital in a variety of vehicles, such as real estate, securities, or business ventures, without the pressure of a deadline (like with a 1031 exchange).
For California residents, it also means that you’re not hit with the full tax bill in the year of sale, which can be even more financially appealing.
California’s Special Considerations for DSTs
State Tax Rates Make Deferral Especially Valuable
California taxes all capital gains as ordinary income, with no special “long-term capital gains” rate. That means that if you defer gains through a DST, you’re potentially avoiding or delaying a state tax hit that could be as high as 12.3%, depending on your income.1
Installment Sale Execution Must Align with State and Federal Law
California generally conforms to federal installment-sale rules (IRC § 453), but there can be important differences in how income is reported. Working with California‑aware tax professionals ensures the structure aligns with both federal and California tax law.
Withholding Requirements on California Property Sales
If you are selling California real estate via an installment sale, the buyer (or withholding agent) may need to withhold a portion of the payment for state taxes. This means your DST planning needs to take into account not just when and how you’ll receive payments, but also the cash flow impacts of state withholding.
Sourcing Income for Residents vs. Nonresidents
If you’re a California resident, all installment payments you receive from a DST are generally subject to California income tax. For nonresidents, California will tax the portion of installment income that is sourced to California (for example, income from property located in California). Be sure you know how tax law will apply to your installment payments.
Community Property Law May Affect How Gains Are Treated
Because California is a community property state, how much of the deferred income from a DST is considered your separate property versus community property matters. This distinction can change how you report gains and how spouses divide income. Plan with a tax advisor who understands California community property rules.
Deferred Sales Trust vs. 1031 Exchange in California
If you’re a real estate investor, you’ve probably used or considered a 1031 exchange to defer taxes. But California complicates the picture. Not all 1031 exchanges fully defer the California state tax liability, especially if you relocate out of state or your investments change asset classes.
Here are ways a DST offers more flexibility than a 1031 when you want to defer capital gains tax on real estate in California:
- You’re not locked into real estate reinvestment.
- There’s no 45-day identification window.
- You can reinvest in passive income-producing assets or even diversify into stocks.
While a 1031 is advantageous for “like-kind” real estate, you can use a DST to defer gains on stock sales, business exits, cryptocurrency, and more. This makes it especially powerful for California entrepreneurs or investors who want to transition out of active ownership roles.
Real Estate Seller in San Diego
Say you’re a longtime real estate owner in San Diego. You want to retire and sell a $4 million multifamily property. You’ve depreciated the asset, and your cost basis is only $800,000.
You’re staring down a $3.2 million capital gain, with a tax bill approaching $1.2 million when factoring in California’s state taxes.
You don’t want to reinvest in another active property (ruling out a 1031 exchange), but you still want access to your capital for future income.
Using a DST, you can:
- Defer the full $1.2 million in taxes
- Receive payments over time, thus spreading out your tax liability
- Invest the capital into a mix of stocks, bonds, or private real estate funds
- Retain flexibility, reduce stress, and maximize wealth transfer to your heirs
Is a DST Right for You in California?
A DST is not a one-size-fits-all solution. It works best if:
- You’re facing $1 million or more in capital gains tax
- You want to diversify out of real estate or a business
- You want to transition into a more passive income model
- You care about wealth preservation and estate planning
That said, California’s aggressive tax policies make the DST an especially compelling solution. Whether you’re in the Bay Area, Sacramento, Orange County, or anywhere in between, the tax relief alone could justify the strategy.
Key Benefits of a DST for California Sellers
For sellers in California, a DST can provide several meaningful advantages.
First, it helps preserve capital by deferring large tax bills, allowing you to reinvest more of your wealth instead of losing a substantial portion to high state and federal taxes. DSTs also support estate planning, giving you the ability to coordinate the trust with a living trust or broader family office strategy to ensure your wealth transfers smoothly and efficiently.
Additionally, a DST offers asset diversification. If you’ve built wealth in a single concentrated investment, a DST allows you to reallocate those assets across a broader portfolio, reducing risk while maintaining growth potential.
Finally, the trust provides flexible timing to control when and how much you receive from the sale, which allows you to manage your tax exposure and align distributions with your financial goals.
For Californians navigating high taxes, volatile markets, and complex estates, a DST offers freedom and peace of mind, making it a powerful tool for long-term wealth management.
Don’t Let Taxes Control Your Next Move
California may be known for sunshine and startups, but it’s also notorious for heavy taxes, especially when it comes to selling highly appreciated assets.
With a DST, you don’t have to let that tax burden dictate your investment choices or retirement timeline. Instead, you can regain control and build a lasting legacy.
1https://www.hrblock.com/tax-center/filing/states/california-tax-rates/?srsltid=AfmBOoq5o3mUvE2KaKNQFrpfcsUAxCzPEzOHBANZ4fALLE-Gp-IO5A-v