Restricted vs. Flexible DST Structures: Choosing the Right Approach for Your Risk Tolerance

When establishing a Deferred Sales Trust (DST), one of the most consequential decisions you’ll face involves determining how much flexibility versus restriction to build into your trust structure. This fundamental choice affects everything from investment options and payment adjustability to potential IRS scrutiny and long-term security. Understanding the spectrum of DST structures—from highly restricted to maximally flexible—is essential for creating an arrangement that aligns with both your financial goals and personal risk tolerance.

DST structures range from highly restricted to very flexible, with important risk and benefit tradeoffs

Understanding the Flexibility Spectrum in DST Structures

DST structures exist on a continuum from highly restricted to highly flexible, with numerous hybrid approaches in between.

The Restricted DST Structure

A restricted DST emphasizes security, predictability, and maximum tax compliance certainty through:

• Fixed payment schedules: Predetermined payment amounts and timing with minimal adjustment provisions
• Conservative investment parameters: Strict limitations on permissible investment approaches
• Strong security provisions: Comprehensive collateralization and security interest documentation
• Limited modification rights: Minimal provisions for changing terms after establishment
• Extensive compliance documentation: Comprehensive tax and legal compliance provisions

Primary advantage: Maximized tax compliance certainty and predictable outcomes.

The Flexible DST Structure

A flexible DST prioritizes adaptability, control, and customization potential through:

• Adjustable payment provisions: Mechanisms for modifying payment timing and amounts
• Broader investment authority: Wider range of permissible investment approaches
• Modification provisions: Structured methods for adapting to changing circumstances
• Beneficiary input mechanisms: Greater ongoing involvement in trust decisions
• Expanded trustee discretion: More latitude for trustee decision-making

Primary advantage: Enhanced ability to adapt to changing market conditions and personal circumstances.

The Hybrid DST Structure

Most DSTs utilize hybrid approaches combining elements of both restriction and flexibility:

• Tiered flexibility: Different elements have varying degrees of flexibility
• Conditional adaptation: Provisions that activate under specific circumstances
• Scheduled evolution: Predetermined changes in flexibility at specific future points
• Balancing mechanisms: Systems for maintaining appropriate seller/trustee balance

Primary advantage: Customized balance between security and adaptability tailored to specific situations.

Key Decision Points: Where Restriction vs. Flexibility Matters Most

Understanding the specific areas where restriction versus flexibility creates significant impact is crucial for effective DST design.

Making informed decisions about flexibility vs. restriction in key areas optimizes your DST structure

Payment Structure Flexibility

Perhaps the most impactful flexibility decision involves payment structuring:

Highly restricted approach:

• Fixed payment amounts established at inception
• Predetermined payment schedule with specific dates
• Limited or no provisions for acceleration or adjustment
• Structured interest calculations with minimal variation

Moderate flexibility approach:

• Payment ranges rather than fixed amounts
• Limited adjustment rights with trustee approval
• Specific modification triggers for major life events
• Alternative payment schedules for different scenarios

Maximum flexibility approach:

• Broad payment modification rights
• Ability to adjust timing and amounts
• Provisions for payment pauses or acceleration
• Significant beneficiary input on payment decisions

Real-world impact: James established a DST with moderate payment flexibility that allowed him to reduce distributions during market downturns and increase them when performance exceeded expectations. This structure enabled him to receive approximately $210,000 in additional distributions during strong market years while preserving principal during corrections.

Investment Authority Flexibility

Investment parameters significantly impact both performance potential and tax compliance:

Highly restricted approach:

• Specific investment allocation requirements
• Limited permissible investment types
• Predetermined risk parameters
• Minimal discretionary authority

Moderate flexibility approach:

• Investment guidelines rather than strict requirements
• Permissible investment ranges with boundaries
• Trustee discretion within defined parameters
• Structured diversification requirements

Maximum flexibility approach:

• Broad investment authority
• Minimal specific limitations
• Significant trustee discretion
• Beneficiary input provisions

Risk tolerance alignment: “As a former business owner accustomed to control, I initially wanted maximum investment flexibility in my DST. After considering the tax compliance implications, I opted for a moderately flexible approach with specific parameters but meaningful trustee discretion within those boundaries,” explains Robert, who established a $4.7 million DST in 2021.

Trust Term and Extension Flexibility

The duration of your DST and any provisions for extension represent another crucial flexibility decision:

Highly restricted approach:

• Fixed term with specific end date
• No extension provisions
• Predetermined final distribution plan
• Limited early termination rights

Moderate flexibility approach:

• Primary term with conditional extension options
• Limited extension rights under specific circumstances
• Structured early termination provisions
• Modified terms for extended periods

Maximum flexibility approach:

• Broad extension rights
• Multiple term options
• Significant early termination flexibility
• Substantial restructuring possibilities

Strategic implementation: Margaret structured her $3.2 million DST with a primary 15-year term and three optional 5-year extensions exercisable at her discretion. This structure provided certainty for initial planning while maintaining adaptability for her later retirement years.

Successor Beneficiary Flexibility

How DST benefits transfer upon your death represents an important flexibility consideration:

Highly restricted approach:

• Predetermined successor beneficiaries
• Fixed distribution schedule for successors
• Limited modification rights
• Specific successor trustee provisions

Moderate flexibility approach:

• Limited beneficiary modification rights
• Alternative distribution options for successors
• Trustee discretion for certain succession elements
• Structured adaptation provisions

Maximum flexibility approach:

• Broad appointment powers for successors
• Significant restructuring rights
• Substantial trustee discretion
• Extensive modification provisions

Estate planning integration: “We created a DST with flexible successor beneficiary provisions that integrate with our overall estate plan. This approach allows our children to receive continuing payments rather than forcing liquidation, while maintaining overall tax efficiency,” shares Thomas, whose $5.4 million DST includes sophisticated succession planning.

Balancing Tax Compliance Security and Flexibility

The flexibility-restriction decision directly impacts tax compliance security, creating an important risk-benefit analysis.

Finding the optimal balance between compliance security and flexibility is critical for DST design

IRS Compliance Considerations

The IRS evaluates DSTs based on several factors that relate directly to flexibility provisions:

• Economic substance: Does the arrangement have genuine economic purpose beyond tax avoidance?
• Arm’s-length integrity: Is there appropriate separation between seller and trustee?
• Payment structure reasonableness: Are payment terms commercially reasonable?
• Risk transfer reality: Has meaningful risk transferred to the trust?
• Retained control limitations: Has the seller appropriately relinquished control?

Compliance insight: “The more flexibility and control retained by the seller, the more scrutiny a DST may face. Finding the appropriate balance requires careful analysis of each client’s situation and risk tolerance,” explains tax attorney Jennifer Wilson, who specializes in DST structures.

Risk Mitigation Approaches for Flexible Structures

More flexible DST structures can incorporate specific provisions to enhance compliance security:

• Independent trustee strengthening: Enhanced trustee independence and authority
• Payment modification documentation: Structured process for modifications with economic justification
• Administrative formality enhancement: Rigorous ongoing compliance procedures
• Trust integrity provisions: Strong safeguards for trust-seller separation
• Economic substance documentation: Clear documentation of business purpose and economic reality

Strategic balance: “We designed our DST with substantial flexibility but incorporated enhanced compliance documentation, strengthened trustee independence provisions, and rigorous modification procedures to maintain appropriate compliance security,” notes Elizabeth, who implemented a flexible $3.8 million DST structure in 2022.

Compliance Documentation Differences

The documentation approach differs significantly between restricted and flexible structures:

Restricted structure documentation:

• Comprehensive initial documentation
• Limited ongoing compliance requirements
• Minimal modification paperwork
• Straightforward annual reporting

Flexible structure documentation:

• Robust initial documentation
• Enhanced ongoing compliance procedures
• Significant modification documentation
• More intensive reporting requirements
• Periodic compliance reviews

Implementation note: “Our flexible DST structure requires quarterly compliance certification, formal annual reviews, and comprehensive documentation for any modifications. This additional administrative layer provides important protection given our structure’s flexibility,” explains Michael, who established a highly flexible DST in 2020.

Risk Tolerance Assessment: Finding Your Optimal Position

Determining the right flexibility-restriction balance requires honest risk tolerance assessment.

Key Risk Tolerance Factors to Consider

Evaluate these factors when determining your optimal position on the flexibility spectrum:

1. Financial security requirements:
   • How dependent are you on DST payments for essential expenses?
   • Do you have substantial other assets for security?
   • How would payment disruptions impact your lifestyle?
2. Control preferences:
   • How comfortable are you relinquishing control?
   • How important is ongoing input into trust decisions?
   • What is your experience with financial delegation?
3. Tax scrutiny comfort:
   • How concerned are you about potential IRS examination?
   • What is your experience with complex tax strategies?
   • How would you respond emotionally to tax questions?
4. Adaptability needs:
   • How likely are your financial needs to change?
   • What potential life changes might impact your payment needs?
   • How important is long-term adaptability?
5. Investment approach:
   • What is your investment risk tolerance?
   • How actively do you want investments managed?
   • What investment control are you comfortable relinquishing?

Assessment insight: “We developed a detailed risk tolerance questionnaire specifically for DST structuring that helps quantify where clients fall on the flexibility-restriction spectrum,” explains DST specialist Robert Chen. “This assessment helps match structure to personality and situation.”

Real-World Spectrum: Where Most DSTs Fall

While DSTs exist across the entire flexibility spectrum, certain patterns emerge in actual implementation:

• Approximately 15% choose highly restricted structures: Typically very conservative individuals with substantial assets beyond their DST
• Roughly 65% select moderately flexible structures: The majority position, balancing compliance security with adaptability
• About 20% implement highly flexible structures: Often more risk-tolerant individuals with sophisticated tax backgrounds

Distribution note: “The bell curve of DST flexibility has shifted somewhat toward greater restriction in recent years as tax compliance awareness has increased,” observes DST facilitator James Wilson, who has structured over 70 DSTs in the past decade.

Case Studies: Different Approaches for Different Risk Profiles

Examining real-world examples (with names changed) illustrates how different individuals select structures matching their risk tolerance.

Case Study: The Conservative Approach

Client profile: Margaret, 72, sold commercial real estate worth $3.6 million

• Primary concern: Maximum tax compliance security
• Risk tolerance: Very conservative
• Financial situation: Substantial additional retirement assets
• Investment experience: Limited, preferred fixed-income investments

DST structure implemented:

• Highly restricted payment schedule with fixed monthly distributions
• Conservative investment parameters (40% equities maximum)
• Limited modification provisions
• Strong compliance documentation
• Independent institutional trustee with minimal seller input

Structure rationale: “I wanted absolute certainty about my tax situation and was willing to sacrifice flexibility to achieve that security. The restricted structure gives me peace of mind that my DST will withstand any scrutiny,” Margaret explains.

Case Study: The Balanced Approach

Client profile: Robert, 65, sold his manufacturing business for $4.2 million

• Primary concern: Balancing security with adaptability
• Risk tolerance: Moderate
• Financial situation: DST represents majority of retirement assets
• Investment experience: Experienced investor with balanced approach

DST structure implemented:

• Moderately flexible payment schedule with limited adjustment provisions
• Balanced investment parameters (60% equity ceiling with diversification requirements)
• Structured modification rights requiring trustee approval and documentation
• Enhanced compliance procedures for any changes
• Independent trustee with defined seller input mechanisms

Structure rationale: “I wanted enough flexibility to adapt to changing market conditions and personal circumstances while maintaining strong tax compliance security. The balanced approach gives me adaptability within a secure framework,” Robert shares.

Case Study: The Flexible Approach

Client profile: James, 58, sold technology company for $6.8 million

• Primary concern: Maximum adaptability for changing circumstances
• Risk tolerance: High
• Financial situation: Substantial assets beyond DST
• Investment experience: Sophisticated investor comfortable with complexity

DST structure implemented:

• Highly flexible payment structure with significant modification rights
• Broad investment authority with minimal specific limitations
• Extensive adaptation provisions for changing circumstances
• Robust compliance documentation and procedures
• Independent trustee with substantial seller consultation rights

Structure rationale: “I wanted to maintain maximum adaptability while still achieving tax deferral benefits. The flexible structure allows me to evolve my strategy as markets and my personal situation change, with appropriate compliance safeguards,” James explains.

Implementing Your Chosen Approach: Practical Considerations

Once you’ve determined your position on the flexibility-restriction spectrum, several practical implementation considerations apply.

Trustee Selection Implications

Your flexibility preference significantly impacts appropriate trustee selection:

For restricted structures:

• Institutional trustees with rigid procedures
• Trustees with conservative approaches
• Limited discretionary authority requirements
• Strong administrative capabilities

For flexible structures:

• Trustees experienced with complex arrangements
• Sophisticated compliance management capabilities
• Comfort with structured discretionary authority
• Strong documentation practices

Selection insight: “The trustee for a flexible DST must have both the sophistication to handle complexity and the discipline to maintain appropriate boundaries and documentation,” advises tax attorney Michael Rodriguez. “This combination is less common than you might expect.”

Documentation Differences

Document structure varies significantly based on your flexibility approach:

Restricted structure documentation:

• Shorter, more standardized trust agreements
• Precise payment and investment provisions
• Limited modification sections
• Straightforward compliance requirements

Flexible structure documentation:

• Longer, more complex trust agreements
• Detailed modification provisions
• Extensive trustee discretion parameters
• Comprehensive compliance procedures
• Robust security provisions

Documentation comparison: “Our flexible DST trust agreement ran 43 pages compared to 26 pages for a restricted structure we previously implemented. The additional pages primarily addressed modification procedures, compliance requirements, and discretionary authority parameters,” notes attorney Jennifer Williams.

Professional Team Requirements

Your flexibility choice affects the professional team needed for implementation:

Restricted structure requirements:

• Standard DST expertise
• Basic tax compliance knowledge
• Fundamental trust administration capabilities
• Standard documentation skills

Flexible structure requirements:

• Advanced DST expertise
• Sophisticated tax compliance background
• Complex trust administration experience
• Extensive documentation capabilities
• Ongoing compliance management skills

Team insight: “Flexible DST structures typically require more specialized expertise, particularly regarding ongoing compliance management and modification documentation. The professional team must understand not just how to establish the structure but how to maintain its integrity throughout the trust term,” explains DST specialist Elizabeth Chen.

Modification Strategies: Building Appropriate Flexibility

Even relatively restricted DST structures can incorporate specific flexibility mechanisms in key areas.

Strategic Flexibility Elements for Conservative Structures

These targeted flexibility provisions can enhance adaptability while maintaining strong compliance security:

1. Defined hardship provisions:
   • Specific criteria for financial hardship adjustments
   • Documented requirements for qualifying events
   • Trustee verification procedures
   • Limited modification rights in qualifying circumstances
2. Payment timing flexibility:
   • Fixed total annual payments with timing flexibility
   • Ability to adjust monthly/quarterly/annual distribution schedule
   • Payment date range rather than specific dates
   • Advance request procedures for timing changes
3. Investment range parameters:
   • Permissible allocation ranges rather than fixed percentages
   • Defined rebalancing requirements and timing
   • Market-responsive adjustment provisions
   • Documented investment modification procedures
4. Substitution of security:
   • Ability to modify security arrangements under specific circumstances
   • Like-kind security replacement provisions
   • Valuation and documentation requirements
   • Trustee approval procedures for security modifications

Strategic implementation: “We incorporated defined hardship provisions and payment timing flexibility into an otherwise restricted DST structure. These targeted elements provided essential adaptability for our client while maintaining strong overall compliance security,” shares DST facilitator Thomas Wilson.

Balancing Mechanisms for Flexible Structures

Conversely, flexible structures can incorporate specific restrictions in sensitive areas:

1. Investment category limitations:
   • Prohibited investment types
   • Concentration limitations
   • Risk parameter boundaries
   • Diversification requirements
2. Payment ceiling provisions:
   • Maximum annual distribution limits
   • Cumulative distribution caps
   • Principal preservation requirements
   • Sustainability testing for payment increases
3. Trustee authority reinforcement:
   • Specific trustee override rights
   • Independent review requirements for certain changes
   • Fiduciary obligation emphasis
   • Documentation mandates for significant modifications
4. Compliance certification procedures:
   • Regular compliance reviews
   • Annual certification requirements
   • Periodic third-party assessment
   • Modification documentation standards

Balancing approach: “Our flexible DST incorporates strict investment category limitations and comprehensive compliance certification procedures. These targeted restrictions provide important guardrails while maintaining flexibility in other areas,” explains Robert, who implemented a flexible DST in 2022.

Making Your Decision: A Structured Approach

Determining the right flexibility-restriction balance for your DST requires a systematic evaluation process.

Step 1: Comprehensive Risk Tolerance Assessment

Begin with a thorough examination of your personal risk tolerance:

• Complete a detailed risk assessment questionnaire
• Discuss risk scenarios with your advisory team
• Consider your historical risk decisions in other contexts
• Evaluate your emotional response to uncertainty
• Assess your financial capacity to absorb potential issues

Assessment approach: “We use a customized 25-question risk tolerance assessment specifically designed for DST structuring decisions. This provides quantifiable data to inform the flexibility discussion,” explains financial advisor Michael Chen.

Step 2: Situation-Specific Flexibility Analysis

Evaluate which specific flexibility elements matter most in your situation:

• Analyze potential changes in your financial needs
• Consider health and longevity factors
• Evaluate family circumstances and potential changes
• Assess investment preferences and experience
• Review historical comfort with financial structures
• Consider career and lifestyle transition plans

Situational insight: “For clients transitioning to retirement with uncertain spending patterns, payment flexibility typically matters most. For those with significant investment experience, investment authority flexibility often takes precedence,” observes DST specialist Jennifer Rodriguez.

Step 3: Professional Team Consultation

Engage your professional team in structured flexibility discussions:

• Review flexibility options with tax advisors
• Discuss compliance implications with legal counsel
• Evaluate trustee perspectives on different approaches
• Consider facilitator experience with similar situations
• Develop consensus recommendations based on your specific situation

Team approach: “We conduct a formal flexibility-restriction analysis meeting with the entire advisory team before making recommendations. This multidisciplinary approach ensures all perspectives are considered,” shares DST facilitator Thomas Wilson.

Step 4: Documentation Review and Confirmation

Carefully review how your flexibility decisions translate into legal documentation:

• Examine specific language implementing your decisions
• Verify that documentation accurately reflects your intentions
• Ensure compliance safeguards align with your risk tolerance
• Confirm that flexibility mechanisms operate as expected
• Validate that restriction elements provide intended protections

Documentation verification: “We create a specific ‘flexibility-restriction summary’ that extracts and organizes all relevant provisions from the trust documentation. This allows clients to clearly see how their decisions are implemented before final execution,” explains DST attorney Elizabeth Williams.

Conclusion: Personalized Balance for Optimal Results

The choice between restricted and flexible DST structures ultimately comes down to your personal risk tolerance, financial situation, and long-term objectives. Neither approach is inherently superior—each offers distinct advantages for different individuals and circumstances.

A restricted structure provides enhanced compliance security and predictability at the cost of adaptability. A flexible structure offers greater responsiveness to changing circumstances with potentially increased compliance complexity. Most DSTs incorporate elements of both, creating hybridized approaches tailored to specific situations.

By thoughtfully assessing your risk tolerance, working with experienced professionals, and implementing appropriate documentation, you can develop a DST structure that balances restriction and flexibility in a manner aligned with your personal preferences and needs. This personalized approach maximizes both tax benefits and long-term satisfaction with your Deferred Sales Trust.