Deferred Sales Trust vs. Charitable Remainder Trusts

When planning for retirement income while managing significant appreciated assets, sophisticated investors often consider trust structures that offer tax advantages. Two powerful options—Deferred Sales Trusts (DSTs) and Charitable Remainder Trusts (CRTs)—provide compelling benefits, yet serve different financial objectives. Understanding the key differences and similarities between these vehicles is crucial for optimizing your retirement income strategy.

Comparing tax-advantaged trust structures helps investors align vehicles with specific retirement goals

Understanding the Core Mechanics: How Each Trust Works

Deferred Sales Trust Fundamental Structure

A Deferred Sales Trust operates as an installment sale strategy:

1. You sell your appreciated asset to a third-party trust in exchange for a secured installment note
2. The trustee then sells the asset to the end buyer
3. Sale proceeds are invested within the trust
4. You receive payments according to predetermined terms
5. Capital gains taxes are paid gradually as you receive principal payments

Key DST mechanism: Capital gains tax deferral with flexible payment options and no charitable requirement.

Charitable Remainder Trust Fundamental Structure

A Charitable Remainder Trust follows a different approach:

1. You donate your appreciated asset to the charitable trust
2. The trust sells the asset with no immediate capital gains tax
3. You receive income payments for a specified term or lifetime
4. At the end of the term, the remaining trust assets go to your chosen charity(s)
5. You receive an immediate partial tax deduction based on the projected charitable remainder

Key CRT mechanism: Complete capital gains tax elimination with required charitable component and immediate tax deduction.

Side-by-Side Comparison: The Critical Differences

Key structural differences between DSTs and CRTs impact their suitability for different retirement objectives

Tax Treatment Comparison

Real-world impact: For a $2 million asset with $1.5 million in capital gains:

• DST scenario: Capital gains tax of $300,000 (assuming 20% rate) paid gradually over payment term
• CRT scenario: No capital gains tax, plus potential upfront tax deduction of $200,000-$600,000 depending on payout rate and term

Payment Structure Comparison

Practical example: Sarah, 65, wants to maximize early retirement income, then reduce payments later:

• DST option: Can structure $120,000 annual payments for 10 years, then $60,000 annually for 10 years
• CRT option: Must select either fixed percentage or fixed amount, with less customization potential

Asset Control and Remainder Comparison

Strategic implications: With a $3 million asset in a 15-year structure:

• DST outcome: Approximately $3.5-4.5 million in total payments to you, with remaining principal returning to your estate
• CRT outcome: Approximately $3.5-4.5 million in total payments to you, with remaining $1.5-2.5 million going to charity

Real-World Implementation: Case Studies Showing Different Outcomes

Case Study 1: Business Sale with Family Legacy Focus

Client profile: Richard, 68, selling manufacturing business for $5.2 million with $4.5 million capital gain. Primary objectives: income for life, maximize family wealth transfer.

DST implementation:

• 20-year installment note at 6%
• Monthly payments: $37,000 ($444,000 annually)
• Tax result: $18,750 in capital gains tax paid annually
• Family outcome: Approximately $4 million in wealth transfer to children after Richard’s expected lifetime

CRT alternative:

• 6% CRUT for lifetime
• Year 1 payment: $312,000 (declining in low-return years)
• Tax result: $450,000 immediate income tax deduction, no capital gains tax
• Family outcome: No direct wealth transfer, but $1.5 million life insurance policy funded with portion of tax savings could provide inheritance

Decision factor: Richard chose the DST because family wealth transfer was a higher priority than charitable impact, despite higher total tax liability.

Case Study 2: Real Estate Portfolio with Charitable Intent

Client profile: Margaret, 70, selling apartment buildings worth $3.8 million with $2.2 million capital gain. Primary objectives: reliable lifetime income, support favorite charities, simplify life.

CRT implementation:

• 5.5% CRUT for lifetime
• Year 1 payment: $209,000 (variable based on trust performance)
• Tax result: $380,000 immediate income tax deduction, no capital gains tax
• Charitable outcome: Projected $2.1 million to her chosen universities upon death

DST alternative:

• 20-year installment note at 5.5%
• Monthly payments: $26,000 ($312,000 annually)
• Tax result: $13,750 in capital gains tax paid annually
• Charitable outcome: No direct charitable benefit

Decision factor: Margaret chose the CRT because charitable intent was a significant motivation, and the immediate tax deduction helped offset other income in her high-earning years.

Case Study 3: Hybrid Approach for Stock Portfolio Diversification

Client profile: James and Patricia, both 65, selling concentrated stock position worth $4.5 million with $3.9 million capital gain. Primary objectives: diversification, retirement income, balanced estate planning.

Hybrid implementation:

• $2.5 million to CRT: 7% CRUT for joint lives
• $2 million to DST: 15-year installment note at 6%
• Combined first-year income: $295,000
• Tax result: $275,000 immediate deduction plus partial capital gains deferral
• Estate outcome: Charitable impact plus partial wealth preservation

Decision factor: The couple chose a hybrid approach to balance multiple objectives: immediate tax deduction, partial family transfer, charitable intent, and income diversification.

Key Factors Driving the DST vs. CRT Decision

1. Charitable Intent Assessment

The single most significant factor in choosing between these vehicles is your charitable intent:

Strong charitable intent → CRT advantage

• You already donate regularly to charity
• Specific charitable organizations are important to you
• Your estate plan already includes charitable bequests
• You value the community recognition of substantial charitable giving

Limited or no charitable intent → DST advantage

• Primary focus is personal and family financial security
• Charitable giving is not a significant priority
• You prefer maintaining family control of assets

Quantifying the difference: On a $3 million asset, a CRT ultimately directs $1+ million to charity, while a DST keeps all remaining principal in the family.

2. Tax Deduction Value Assessment

The immediate tax deduction available with CRTs can be significantly valuable in certain situations:

High tax deduction value → CRT advantage

• You’re in peak earning years with high income tax rates
• You have substantial other income to offset with deductions
• You face Alternative Minimum Tax (AMT) issues
• You have carryforward deduction capacity if needed

Limited tax deduction value → DST potentially preferred

• You’re already in lower tax brackets
• You have limited other income to offset
• You have other substantial deductions already
• The CRT deduction would be partially wasted

Real numbers: A 65-year-old establishing a CRT with $2 million might receive a $400,000-$800,000 tax deduction, saving $148,000-$296,000 in taxes at 37% marginal rate, but much less at lower tax rates.

3. Payment Flexibility Requirements

The flexibility of payment structures varies dramatically between these vehicles:

High flexibility needs → DST advantage

• You need varying payment amounts throughout retirement
• You want to start with interest-only payments
• You anticipate changing financial needs over time
• You may need occasional larger distributions

Standard income needs → CRT potentially sufficient

• You’re comfortable with either fixed payments or fixed percentage
• Your income needs are expected to remain relatively consistent
• You understand and accept potential payment variability with CRUTs
• Standard CRT structures align with your cashflow needs

Practical impact: With a DST, you could structure payments at 3% initially, increasing to 7% later in retirement, with occasional larger distributions—flexibility unavailable with CRTs.

4. Asset Control Considerations

The level of ongoing asset control differs significantly:

Higher control priorities → DST advantage

• You want some input on investment management
• You may want to restructure terms in the future
• You value the potential for principal access if truly needed
• You prefer keeping wealth within family control

Comfort with relinquishing control → CRT acceptable

• You’re comfortable with irrevocable charitable commitment
• You accept limited or no access to principal
• You’re satisfied with standard CRT investment approaches
• You’ve completed comprehensive retirement needs analysis

Control implication: With a $4 million CRT, you’re irrevocably committing $1.5-2.5 million to charity with no ability to change this decision.

5. Estate Planning Integration

How each vehicle affects your broader estate plan is a critical consideration:

Family wealth transfer priority → DST advantage

• Keeping assets within family is high priority
• You have specific heirs you want to benefit
• Estate tax planning is a significant concern
• You want to preserve maximum financial legacy

Balanced family/charity approach → CRT with planning

• Charitable impact is meaningful to you
• You’ve addressed family needs through other means
• You’re comfortable with wealth flowing to both family and charity
• Tax efficiency is higher priority than maximum family transfer

Estate planning strategy: Many CRT users implement “wealth replacement” life insurance strategies, using tax savings to fund policies that replace the charitable portion for heirs.

Potential Hybrid Strategies: Getting the Best of Both Worlds

For many sophisticated investors, combining DSTs and CRTs can create optimized outcomes:

Asset-Split Approach

Divide assets between DST and CRT structures based on objectives:

• Higher-basis assets to DST (less tax advantage from CRT)
• Highest-gain assets to CRT (maximum tax advantage)
• Family legacy assets to DST
• Assets aligned with charitable interests to CRT

Implementation example: Margaret owned multiple properties worth $7.2 million. She placed $4.5 million of highly-appreciated properties into a CRT and $2.7 million of lower-gain properties into a DST, optimizing both tax treatment and wealth distribution.

Sequential Strategy

Use CRT for immediate tax advantages, then DST for later transactions:

• Establish CRT with initial asset sale
• Utilize tax deduction to offset other income
• As CRT income flows, invest in new appreciated assets
• Use DST for later asset sales when charitable capacity is fulfilled

Implementation example: Robert established a $3.5 million CRT when selling his business at age 60. At 68, when selling investment real estate, he utilized a DST for that $2.1 million transaction, having already fulfilled his charitable objectives.

Complementary Payment Structures

Design complementary payment patterns between vehicles:

• CRT providing stable baseline retirement income
• DST structured for supplemental or variable needs
• CRT with standard unitrust or annuity provisions
• DST with customized timing for specific future objectives

Implementation example: The Williams family receives consistent income from their $2.8 million CRUT, while their $1.9 million DST is structured to provide larger distributions at five-year intervals for major travel plans and family gifts.

Practical Implementation Considerations

Setup and Ongoing Costs Comparison

Cost implication: While DSTs typically have somewhat higher setup and administration costs, this difference is minimal in the context of multi-million dollar transactions.

Professional Expertise Requirements

Both structures require specialized expertise, but with different focus areas:

DST expertise needed:

• Installment sale structuring
• IRC §453 compliance
• Independent trustee with tax expertise
• Security interest documentation

CRT expertise needed:

• Charitable tax planning
• IRS compliance for exempt organizations
• CMFC (Chartered Mutual Fund Counselor) for investment management
• Trust administration specific to CRTs

Advisor selection tip: Look for professionals with experience in both vehicles who can provide objective guidance based on your specific situation rather than promoting only one solution.

Implementation Timeline Comparison

Planning note: Both structures require advance planning before asset sale. Neither can be implemented retroactively after a sale is completed.

Common Questions About DST vs. CRT Selection

“Which structure provides better lifetime income?”

The answer depends on specific structuring, but generally:

• DST advantage: More flexible payment patterns, potentially higher initial payments
• CRT advantage: Elimination (not just deferral) of capital gains tax, leaving more principal for investment
• Outcome difference: Often within 10-15% of each other over a lifetime, with specific structuring determining which provides more

“Can I change my mind after establishing these trusts?”

The flexibility differs significantly:

• DST: Limited modification potential through restructuring with trustee agreement
• CRT: Virtually no ability to change fundamental structure once established, though some CRTs allow limited changes to charitable beneficiaries
• Practical implication: Both require careful upfront planning, but DSTs offer slightly more downstream flexibility

“Which is better for reducing estate taxes?”

Both have estate planning implications:

• CRT advantage: Assets removed from taxable estate
• DST consideration: Unpaid note balance included in taxable estate
• Planning solution: Life insurance often used with either structure to address estate tax concerns

“What happens if tax laws change?”

Both structures have tax law change risks:

• DST consideration: Future tax rate changes would apply to future payments
• CRT consideration: Generally grandfathered, but future tax changes could affect ongoing income taxation
• Risk management: Impossibility of predicting future tax law makes diversification of strategies prudent

Conclusion: Making Your Optimal Selection

The choice between a Deferred Sales Trust and a Charitable Remainder Trust ultimately depends on your unique priorities:

Choose a DST if:

• Family wealth transfer is a primary objective
• Payment flexibility is highly important
• You want to maintain potential access to principal
• Charitable intent is limited or addressed through other means

Choose a CRT if:

• Charitable giving is a significant personal value
• The immediate tax deduction provides substantial benefit
• You’re comfortable with irrevocable charitable commitment
• Standard payment structures meet your retirement needs

Consider a hybrid approach if:

• You have substantial appreciated assets in different forms
• Both family legacy and charitable intent are important
• Tax diversification is a priority in your planning
• You want to optimize different advantages for different assets

Before implementing either strategy, work with experienced advisors who understand both options and can provide objective analysis based on your specific financial situation, tax position, and long-term objectives. With proper planning, either structure—or a thoughtful combination—can provide significant tax advantages while supporting your retirement income needs.