Inheriting a historic property can be both a gift and a financial challenge. These homes or buildings often have deep sentimental value and cultural significance, but they can also come with significant preservation costs and a heavy capital gains tax burden if you decide to sell.
If you’re thinking about selling and wondering how to avoid paying capital gains tax on inherited property and preserve your financial flexibility without getting blindsided by taxes. We have a solution for you. While there’s no legal way to skip paying taxes, a Deferred Sales Trust (DST) can help. It allows you to honor the historic property while making smart financial tax decisions.
The Unique Tax Situation of Historic Inherited Properties
When you inherit a property, the IRS typically allows a step-up in basis. This means you inherit the property without all the appreciation. The cost basis for the property reverts back to the fair market value it had when the previous owner passed away. That’s great news because it can wipe out years of unrealized gains for tax purposes. However, the story doesn’t always end there for historic properties.
Historic homes often appreciate in value dramatically due to location, scarcity, and protected status. If you’ve held the property for some time after inheriting it or invested in restorations, additional appreciation can occur. Selling that property (even just a few years later) may lead to significant capital gains.
Moreover, historic designations often come with restrictions on improvements or renovations, making it more challenging to increase value without navigating regulatory requirements. This can limit your flexibility while still exposing you to a sizable tax bill upon sale.
That’s where many heirs begin searching for creative, IRS-compliant strategies to unlock value without compromising their wealth.
What Is a DST and Why Does It Work?
A DST is a legal tool that allows you to sell high-value assets, such as historic properties, without immediately triggering capital gains tax. The strategy uses a well-established section of the tax code: IRC §453, which governs installment sales and trusts. Here’s how that process works:
- You sell the inherited property to a specially formed trust, not directly to a buyer.
- The trust sells the property to the buyer at fair market value.
- Since you didn’t receive the cash upfront, the IRS considers it an installment sale, and defers the capital gains tax on the transaction.
Instead of paying taxes on the entire gain all at once, you pay over time as you receive principal from the trust. This structure creates powerful opportunities for reinvestment and preserving generational wealth.
Why Historic Properties Are a Perfect Fit for the DST
Can a DST handle the complexity of a historically protected building? The answer is yes. In many ways, historic properties are especially well-suited to this strategy. These assets are often highly appreciated, particularly if they occupy a prime urban location or hold landmark status. At the same time, they can present ownership or maintenance challenges, making a carefully planned cash-out an attractive option.
Selling historic real estate quickly at fair value can also be difficult due to restoration regulations and preservation rules. This is where a DST provides significant flexibility. It gives you the breathing room to exit this unique, high-value asset without rushing the sale out of concern for taxes. You maintain control over both the structure of the sale and the reinvestment path for the proceeds, allowing you to maximize value while managing tax liability.
Turning a Burden Into a Financial Asset
Imagine you inherit a Victorian mansion in a historic San Francisco district. While beautiful, it’s also very outdated and requires city-approved contractors for any work. You hold onto it for a few years, during which time the value increases from $2.5 million to $3.2 million.
Now, you’re ready to sell, but the improvements you made and the appreciation since the inheritance result in a $700,000 taxable gain. In California, your tax bill on the full amount could exceed a third of your proceeds.
By using a DST, you could defer that gain and the taxes on it and reinvest the full $3.2 million through the trust. You can receive regular payments from the trust and pay taxes over time, or choose to receive interest only payments. You could also use the funds to purchase real estate that’s easier to manage or more aligned with your goals.
Rather than being penalized for preserving a part of history, you benefit from it.
Structuring a DST for Historic Real Estate
To use a DST effectively with historic real estate, you must set up the trust well in advance of any sale. If you wait until you line up a buyer or they sign the purchase agreement, the opportunity to defer taxes is past. Establishing the trust early allows you to coordinate all the moving parts and structure the sale in compliance with IRS tax codes.
Executing a DST correctly requires a specialized team familiar with both DST rules and the unique challenges of historic properties. This typically includes a DST-focused tax attorney to draft and oversee the trust documents, a third-party trustee to manage the sale and reinvestment of proceeds, and a financial advisor to align reinvestments with your long-term goals.
It’s equally important that your capital gains tax consultant understands the nuances of historic real estate. They should have knowledge of local and federal historic preservation tax credits, know how easements may affect property value, and understand landmark commission regulations.
By combining expertise in DSTs with an understanding of historic property laws, a DST professional can structure a transaction that maximizes value and provides long-term tax flexibility.
Benefits Beyond Tax Deferral
While tax deferral is the primary appeal, DSTs also offer:
- Estate Planning Flexibility: You can direct payments from the trust to your heirs over time, avoiding large tax hits.
- Asset Protection: The trust structure can protect proceeds from lawsuits or creditors.
- Portfolio Diversification: Reinvest across real estate, securities, private lending, or even business ventures.
For families inheriting multiple properties or passing down a generational portfolio, this strategy enables smoother, less emotionally fraught decisions about what to keep or sell, and how to maximize the legacy you’ve been given.
Honor the Past, Invest in Your Future
Inheriting a historic property places you at the crossroads of legacy and financial responsibility. You want to do right by your family, respect the property’s historical value, and still make a smart decision for your future. A DST can offer the tax-smart path to do just that.
By deferring the capital gains on your sale, you retain the full value of your inheritance and position yourself to reinvest in ways that honor your family’s vision.
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Selling an inherited historic property often presents both financial opportunities and tax complexities. A Deferred Sales Trust (DST) can assist you in preserving both flexibility and value. Learn about the ways a DST can facilitate the sale of a historic property in this infographic.
