Most investors choose a deferred sales tax trust for its benefits. Tax deferral, estate planning flexibility, and the ability to reinvest on your terms are all appealing. But before you jump in with both feet, there’s a fundamental requirement that you can’t overlook. Your Deferred Sales Trust (DST 2.0) must be irrevocable.
That one word—irrevocable—may sound limiting. After all, who wants to give up control? The truth is irrevocably is necessary for DST 2.0 to eliminate estate, which is the primary benefit for DST 2.0.
What Does “Irrevocable” Mean in the Context of a DST 2.0?
An irrevocable trust is one that cannot be altered, amended, or revoked by you as the seller after it’s established and funded. Once you sell your asset to the trust and the sales proceeds are held within it, you no longer legally own or control those assets directly, however, your heir or heirs can be the beneficiary(s) of the DST 2.0. (When I refer to trust in the context of this article I will be referring to DST 2.0. There is a DST 1.0 that is a business trust and not an irrevocable trust.)
You still retain a deferred payment agreement from the trust that entitles you to receive scheduled payments over your lifetime and if you are married your spouse’s lifetime. These payments are not flexible and need to be paid starting the frist few years the trust is established. The exact amount is determined by your age if you are married, your spouse’s age and IRS tables. However, the trust legally holds and controls the underlying assets under the direction of a third-party trustee and according to the terms laid out for the trust.
While this may seem like a loss of control, it’s actually a powerful compliance safeguard.
Why the Irrevocable Structure Matters to the IRS
The IRS tax code allows the use of certarin tax structures and if properly executed and compliance recognized DSTs as a compliant method of deferring capital gains taxes as long as they abide by strict rules. Central to that compliance is the requirement that the sale is complete and genuine.
If you were able to revoke or alter the trust, the IRS could argue that you never really gave up control of the asset, and therefore, the sale wasn’t valid. It could trigger immediate capital gains taxation on the entire sale, potentially eliminating the entire purpose of using the DST.
In other words, the irrevocable nature of the trust for DST 2.0 is what makes the tax deferral legitimate. It proves to the IRS that:
- The trust, not you, now owns the proceeds from the sale.
- You’ve exchanged your appreciated asset for a promissory note, not cash.
- You are no longer in control of how the principal is invested or distributed beyond the agreed-upon payment structure.
If the trust were revocable or if you owned the trust yourself, the IRS likley would treat it as if you were still in control of the proceeds. That would undermine the transaction and likely result in full taxation in the year of sale.
Misconceptions About Losing Control
Now, you may feel hesitant about placing your wealth into an irrevocable structure. You might think: “What if I need access to all of it later?” or “What if the trustee doesn’t act in my best interest?” While valid concerns, they’re often based on misunderstandings about how DSTs actually work.
First, while you no longer control the trust’s assets directly, your heirs are entitled to the remainder of the trust assets after you and/or your spouse dies + you and if you are married your spouse are entitled to payments over your lifetime.
Second, the trustee is not a stranger or outsider who makes decisions on a whim. In a properly structured DST, your trustee is an experienced third-party fiduciary who manages the trust under a clearly defined legal agreement. The trustee also can choose to have an investment advisor who helps guide how the trust’s funds are invested.
Finally, irrevocable doesn’t mean “irreversible.” You’re not locked into a rigid setup with no escape hatch. You’re simply placing the assets in a legally compliant structure that protects your tax strategy while still allowing strategic flexibility of the trust being shut down with trustee approval. If you’re unhappy with the way your trust is set up or managed, talk to your trustee about legal changes that can be made.
Key Benefits Tied to Irrevocability
By accepting the irrevocable nature of a DST 2.0, you unlock a range of benefits that wouldn’t be possible in a revocable or loosely structured trust. For instance, you:
1. Defer Capital Gains Taxes
Because you defer capital gains tax, you keep more of your sale proceeds working for you instead of handing a large chunk over to the IRS right away. This allows for greater reinvestment potential and compound growth.
2. Gain Lawsuit Protection and Estate Planning Advantages
Assets held within an irrevocable DST are generally shielded from personal creditors. Additionally, you can integrate your DST with your broader estate strategy to pass wealth on efficiently to heirs or charitable causes.
3. Force Compliance and Discipline
Irrevocability ensures that your tax strategy is legally sound and helps you avoid pitfalls that could arise from over-managing or prematurely accessing the principal. This structure is particularly valuable for high-net-worth individuals who want to preserve capital and reduce risk.
Irrevocability Is a Legal Necessity
If you’re serious about using a DST 2.0 to defer capital gains taxes and reinvest strategically, you must embrace the irrevocable structure as a feature, not a flaw. It’s what protects your deferral, your compliance, and ultimately, your wealth.
You don’t have to sacrifice flexibility or financial security when using a DST 2.0. You just need to work within the rules and with reputable capital gains tax consultants who understand the ins and outs of DST 2.0 irrevocability.