537 Installment Sale Trust vs. Delaware Statutory Trust: Key Differences in Tax Deferral Strategies

Introduction

When selling high-value assets like real estate or a business, minimizing capital gains tax liability is crucial. Two popular tools for tax deferral are the 537 Installment Sale Trust (537 IST) and the Delaware Statutory Trust (DST). Though they share the goal of tax deferral, their structures, benefits, and use cases differ significantly. This article explores these differences to help investors make informed decisions.

Understanding the 537 Installment Sale Trust (537 IST)

What is a 537 IST?

A 537 Installment Sale Trust is a special-purpose trust that uses the installment sale method defined in IRC Section 453 and IRS Publication 537. It allows sellers to defer capital gains taxes by receiving payments over time, rather than all at once.

Origin and History: Ernst & Ernst Legacy

The 537 IST was pioneered by Ernst & Ernst (now Ernst & Young) in the 1970s to help their partners defer taxes upon exiting business interests. Today, it's a proven strategy backed by decades of IRS-compliant usage.

IRS Compliance and Legal Structure

Fully compliant with IRS rules, the 537 IST uses an arms-length trustee and ensures there is no constructive receipt of funds, avoiding immediate taxable events. The 537 IST uses IRS Code 453 and Publication 537 for accounting and reporting.

Key Features of a 537 Installment Sale Trust

• Tax Deferral Mechanics: Proceeds from the sale enter the trust instead of the seller’s account. Taxes are deferred and only paid when income is distributed.

• Liquidity and Flexibility: Withdraw funds at any time, pay taxes only on what you withdraw.

• Security via Secured Notes: Assets are held in trust and secured via a promissory note.

• Investment Control: Sellers approve investment decisions.

• Multi-layered Compounding: Gain interest on principal, on interest, and on deferred taxes.

Use Cases and Applicability

• Ideal for: Business owners, real estate investors, appreciated asset holders selling/exiting.

• Backup for Failed 1031 Exchanges

• Estate Planning: Offers generational income and step-up in basis for heirs.

Understanding the Delaware Statutory Trust (DST)

What is a DST?

A Delaware Statutory Trust (DST) is a legally recognized trust established under Delaware law that allows multiple investors to hold fractional ownership interests in real estate assets. It is primarily used for 1031 exchange transactions, enabling real estate investors to defer capital gains taxes when selling one property and reinvesting in another.

IRS Recognition and Legal Framework

DSTs are explicitly recognized by the IRS as valid 1031 exchange vehicles under Revenue Ruling 2004-86. This ruling provides a “safe harbor” for investors using DSTs to ensure their tax deferral strategy complies with IRS guidelines. Unlike other fractional ownership structures, DSTs are structured to prevent investors from having control over day-to-day operations—making them compliant for tax purposes.

Structure and Operation

In a DST, a sponsor or trustee purchases institutional-grade real estate—such as multifamily apartments, medical offices, or industrial parks—and then offers ownership shares to investors. Investors become beneficial owners, not direct property owners. This means they are entitled to income and appreciation, but they do not participate in active management or decision-making.

Common Use Cases

DSTs are especially popular among:

• Retirees seeking passive income from real estate.

• Landlords exiting property ownership but wanting continued exposure to real estate.

• Investors performing a 1031 exchange who prefer hands-off management.

• Heirs of real estate investors who wish to continue tax deferral benefits.

Trust Administration and Oversight

All operations, from property management to asset sales, are conducted by the DST sponsor or trustee, who is typically a licensed real estate professional or firm. Investors receive scheduled income distributions and can track their investment performance, but they cannot influence decisions such as refinancing, leasing, or selling the property.

Key Features of DST

• Passive Income: Managed by sponsor/trustee.

• Fractional Ownership: Low minimum investment amounts.

• Limited Liquidity: Often 5-10 year hold.

• IRS Safe Harbor: Fully 1031-compliant.

Pros and Cons

Compliance Considerations

Unlike Deferred Sale Trusts or Monetized Installment Sales, the 537 IST is not on the IRS Dirty Dozen list. It uses independent trustees and requires no constructive receipt of proceeds to remain compliant.

Case Studies

Business Owner Uses IST:
A seller uses the IST to defer taxes from a $2M business sale, earning income and passing the trust to heirs.

Real Estate Investor Uses DST:
Investor exchanges into a DST for hands-free property ownership and monthly income.

Cost Structures

• 537 IST: Setup + annual admin fee. Includes audit defense and custom investment control.

• DST: Management and sponsor fees baked into investment cost (6–10%).

Choosing the Right Strategy

Ask yourself:

• Do you need liquidity?

• Do you want investment control?

• Are your assets only real estate?

• Is generational planning important?

Conclusion

Both 537 IST and DST serve distinct purposes. Use the 537 IST for control and flexibility with broad asset classes. Use the DST for hands-free, real estate-specific deferral through 1031 exchange. Consult your tax advisor to determine the best fit.

Want to compare selling your asset traditionally, with a 537 Installment Sale Trust, and using a 1031 exchange? Get a free Revenue Estimator Report HERE for a direct comparison.