1031 vs Deferred Sales Trust and Monetized Installment Sales: The IRS View

One route has a statute behind it and the other has a proposed listing in front of it

Section 1031 is a Code section with deferred-exchange regulations, a body of case law and, for fractional trust interests, Rev. Rul. 2004-86, which classifies a qualifying Delaware statutory trust as an investment trust and lets an exchange into its beneficial interests proceed without recognition. You can hand your CPA the citations and they can read them.

The marketed alternatives are built on the general installment-sale rules in §453 plus a promoter's reading of them. That is not automatically improper, but it is a different evidentiary position, and on August 4, 2023 Treasury published proposed regulations that would identify monetized installment sale transactions, and substantially similar transactions, as listed transactions for purposes of §6011.

The proposal has not been finalized, and its own applicability date says the listing takes effect when a Treasury decision adopting it is published. Nothing about that delay is reassuring: the notice states plainly that the IRS will take the position in litigation that participants are not entitled to the claimed benefits, and it invites people who have already filed to consider amended returns.

What the transaction Treasury described actually does, step by step

Read the government's own description before the sales deck, because it is specific. The proposed §1.6011-13(b) transaction has seven elements, and a deal can be substantially similar without containing all of them.

• You have already found a buyer willing to pay cash for appreciated property.
• You agree to sell that property to an intermediary instead, in exchange for an installment obligation.
• The intermediary either never takes title or holds it only briefly.
• The intermediary transfers the property to your original buyer for cash.
• You take out a loan whose interest payments mirror the intermediary's interest payments to you, with balloon principal at the end of both instruments.
• The buyer's cash, less fees, funds or collateralises that loan, and the lender agrees to repay the intermediary over the note's term.
• Your return treats the whole thing as an installment sale under §453.

The three arguments Treasury says it will run, and the cases behind each one

The notice does not merely disapprove; it sets out the theories. First, the intermediary is not a bona fide purchaser. It is interposed after you and your buyer have already agreed price and terms, it neither enjoys the benefits nor bears the burdens of ownership, and the notice cites Commissioner v. Court Holding Co., Wrenn, Blueberry Land and Enbridge Energy for treating such a conduit as no sale at all.

Second, you are treated as already paid. A note issued by someone other than the person acquiring the property, or a note secured directly or indirectly by cash, is a payment under Reg. §15a.453-1(b)(3); the purported loan may not be a bona fide loan; and §453A(d) deems full payment where an installment obligation secures borrowing.

Third, the arrangement may be disregarded under the economic substance rules in §7701(o), under substance over form, or under the step transaction and conduit doctrines. Any one of those winning is enough to put the entire gain back into the year of the original sale.

What being wrong costs: 75%, 40%, 20% and a tax year that never closes

The penalties are not symmetrical with the fee you paid. A participant who fails to disclose a listed transaction on Form 8886 faces a §6707A penalty of 75% of the decrease in tax, with a $5,000 minimum and a $100,000 maximum for an individual, and disclosure is due within 90 days if a transaction you already reported becomes listed later.

On top of that, §6662A imposes a 20% accuracy-related penalty on an understatement from a disclosed reportable transaction and 30% where it was not adequately disclosed, and §6662(i) raises the ordinary 20% penalty to 40% for a nondisclosed transaction lacking economic substance. Section 6501(c)(10) keeps the assessment period open until one year after the transaction is disclosed.

Your promoter has exposure too, which is worth knowing because it shapes their advice: material advisors file Form 8918 and face a §6707 penalty of the greater of $200,000 or half their gross income from the deal, plus $10,000 a day under §6708 for not producing an investor list.

A deferred sales trust is not the DST that qualifies as replacement property

The acronym collision does real damage in this market. A Delaware statutory trust is a fractional ownership vehicle whose beneficial interests that ruling treats as fractional shares of the buildings themselves, which is why they can be identified and closed inside an ordinary exchange.

A deferred sales trust is a different animal entirely: a sale of your property to a third-party trust in return for an installment note, after which the trust invests the proceeds and pays you over time. It is not replacement property, it does not involve a qualified intermediary, and it rests on the general rules of §453 rather than on guidance written for it.

If a presentation uses the three letters without saying which one it means, stop and ask. Our traditional DST and cash out DST pages describe the first kind, and nothing on this site offers the second.

Nine questions that separate a structure from a sales pitch

Ask these in writing and keep the answers. A promoter who can answer all nine is worth a second meeting; one who deflects on the first has told you what you need to know.

• Which statute, regulation, revenue ruling or decided case supports this exact structure, by citation?
• Is the note I receive issued by the person acquiring my property, and is it secured, directly or indirectly, by the sale proceeds?
• Will any borrowing of mine be secured by that note, and have you modelled §453A(d) if so?
• Will I be required to attach Form 8886 to my return, and will you file Form 8918 as a material advisor?
• Is any part of your fee refundable or contingent on the tax result being sustained, which can itself make a transaction reportable?
• Who is the trustee, and what is their relationship to you, to the promoter and to the investment manager?
• Who bears the tax, interest and penalties if the IRS prevails, and what balance sheet stands behind that promise?
• Will my own CPA, who is not paid by you, sign the return that reports this?
• What happens to my money if the trust's investments fall in value, and who can I sue?

Where the money can go when a full exchange is genuinely not realistic

There are ordinary answers for a seller who cannot or will not exchange, and none of them require a novel structure. A plain seller-financed sale reported under §453 is unremarkable, well documented and compared in detail in 1031 versus installment sale.

A partial exchange lets you take a measured amount of cash and defer the rest; an opportunity zone fund defers eligible capital gain; and a bonus depreciation fund can offset passive gain in the same year. Our accelerated depreciation funds and opportunity zone pages set out how we use each one.

Breakwater Exchange is a 1031 exchange broker operating inside a regulated broker-dealer framework alongside vetted national sponsors, and none of the structures described in the proposed regulations are part of that. Take any of this to your own CPA or attorney, and retain independent tax counsel that you pay before signing anything a promoter has drafted.