How to Avoid Capital Gains Tax on the Sale of Your Home — Even If You’ve Maxed Out the $500K Exemption

If you’ve owned your home for 20 or 30 years here in the Bay Area, you might be sitting on a huge amount of equity. That’s great — until you go to sell and realize the capital gains tax could take a serious bite out of your nest egg. This is a common problem for long-time California homeowners, and is of particular concern for older adults in the Bay Area who are counting on their home equity to be the biggest chunk of their nest egg in their later years.

If you’re married and selling your primary residence, you can exclude up to $500,000 of capital gains from taxes. But in this market, it’s not unusual to see $2M+ in appreciation on a longtime home.  But what if you can’t claim that $500,000 tax exclusion because you’ve been renting the property out for some time?  Or if you’re a single person and can only exclude $250,000 in capital gains?  The amount of tax you’d be liable to pay just goes higher and higher.

Of course, if the property has been used as a rental, you could always do a 1031 tax-deferred exchange and buy another rental property, but that means you’d have to keep being a landlord – and many people grow tired of that business after years of dealing with tenants, maintenance issues, interruptions in cash flow from periodic vacancies, and all the other vagaries of owning income-producing properties.

Yet when homeowners and investors want out, they often stay in much longer than they’d prefer because they are reluctant to see so much of their earned equity get hoovered up by the tax man.  That’s when sellers come to me, wondering: Is there a legal way to avoid paying all that capital gains tax?

The answer might surprise you — yes, there is. And it’s called a Deferred Sales Trust, or DST for short.

What Is a Deferred Sales Trust?

I recently sat down with Ariocha Salas from Move Money Safely, who specializes in tax strategies like DSTs. Unlike a 1031 exchange (which only works for investment properties), a Deferred Sales Trust can be used on your primary residence.

Here’s the basic idea: the IRS has a section of the tax code — IRC 453 — that says if you don’t receive all of your sale proceeds up front, and instead get paid in installments, you can defer the capital gains taxes. That’s what the DST does.

You first sell your property to a specially-created trust, which then sells the property to the actual buyer. Since you didn’t directly receive the proceeds, you don’t have to pay capital gains tax right away. Instead, you hold a note (think of it like a promissory note) and receive payments over time — and only pay taxes as you receive those payments.

The trust, managed by licensed professionals, invests the funds on your behalf. It can even pay you a set interest rate (like 7%–8%) over time. You keep more of your equity working for you, instead of handing a huge chunk to the IRS.

Real-World Example

Ariocha shared a great case study. A woman had lived in her Bay Area home for 30 years. She bought it for around $600K, and today it’s worth about $3M. That’s a $2.4M gain, and after her $500K exemption, she was looking at possibly $800,000 in taxes.

She didn’t owe anything on the house and wanted to downsize and live closer to her grandkids — who lived in three different states. The capital gains tax was making that dream feel out of reach.

With a DST, she was able to defer those taxes, take out her original $600K basis tax-free, and use it to buy two smaller homes. The rest of her equity went into the DST, which now pays her income for life — and she didn’t lose that $800K to the IRS.

Your Neighbor Sold their House too Cheap!

Who Can Use a Deferred Sales Trust?

You don’t need to be ultra-wealthy or elderly to use one. If you’ve owned any kind of appreciated asset — a home, business, investment property, or even crypto or art — you may qualify. It’s especially helpful for longtime homeowners here in Silicon Valley and the Bay Area who are looking to cash out but don’t want to get hit with a massive tax bill.

What About Costs?

One of the best parts? DSTs are often less expensive than paying the tax. Ariocha broke it down like this: if you’re selling a $1M asset, the capital gains taxes could easily hit $370,000 or more in California. In contrast, the tax attorneys who set up the DST typically charge 1.5% of the trust amount — about $15,000 — plus a small annual trustee fee. That’s a massive difference.

As Ariocha put it: “Would you rather do business with the IRS or with someone who can help you keep most of your money working for you?”

How Long Does It Take to Set Up?

If you’re thinking about selling, timing is key. The DST has to be in place before your sale closes. Ideally, I’d connect you with Ariocha and his team right after we sign the listing agreement, so you have a few weeks to learn the structure, ask questions, and make sure it’s the right fit.

In a pinch, though, they can get a DST up and running in as little as 7–10 days.

When Renting Out a Home Doesn’t Make Sense

One more example that hit home for me: Ariocha helped a family friend who needed to move into an assisted living facility. Her house could rent for around $5,000/month, but the care home cost $12,000/month — and she had over $2M in equity tied up in the home.

Rather than rent and lose money each month, they sold using a DST. Now that equity is invested and paying her a monthly income stream, giving her financial stability for years to come — without handing over hundreds of thousands to the IRS.

Point. Click. Offer. Sell.

Are Deferred Sales Trusts Legal and Legitimate?

In Episode 25 of the “Practical Tax” podcast by well-known law firm Moskowitz LLP, host Steve Moskowitz discusses Deferred Sales Trusts with Brett Swarts, founder of Capital Gains Tax Solutions. Swarts explains that DSTs are designed to help individuals defer capital gains taxes on the sale of highly appreciated assets by utilizing installment sale principles under IRC Section 453. The strategy involves selling the asset to a trust, which then sells it to a buyer, allowing the seller to receive payments over time and defer taxes accordingly.

While the concept is grounded in existing tax code, the podcast emphasizes the importance of proper structuring and compliance with IRS regulations. Moskowitz and Swarts highlight that DSTs are not a one-size-fits-all solution and should be tailored to individual circumstances. They also note that the IRS has not provided specific rulings on DSTs, so it’s crucial to work with experienced tax professionals to ensure the strategy is implemented correctly and to mitigate potential risks.

In summary, Deferred Sales Trusts can be a viable option for deferring capital gains taxes when selling appreciated assets, but they require careful planning and adherence to tax laws. Due to the lack of explicit IRS guidance, it’s essential to consult with qualified tax advisors to determine if a DST is appropriate for your situation and to ensure compliance with all applicable regulations.

Deferred Sales Trusts, Life Insurance, and Annuities

Life insurance and annuities can play a strategic role when paired with a Deferred Sales Trust (DST), helping to enhance estate planning, tax deferral, and wealth transfer. After the sale of an appreciated asset is deferred through a DST, the proceeds can be invested into various vehicles, including life insurance policies or annuity contracts. These instruments offer the potential for tax-deferred growth, and in the case of life insurance, a tax-free death benefit that can pass to heirs outside of the taxable estate. This allows the seller to not only delay capital gains taxes but also to leverage the DST to create long-term financial security for themselves and their beneficiaries.

Annuities, meanwhile, can provide a predictable income stream for retirement, offering stability while the deferred taxes remain under control. When structured carefully, this combination can help meet legacy goals, enhance liquidity, and manage tax exposure, but it’s essential to work with professionals experienced in DST compliance and IRS regulations to ensure everything is set up properly.

Disadvantages of a Deferred Sales Trust

One significant disadvantage of Deferred Sales Trusts (DSTs) is the loss of the stepped-up cost basis at death, which can have meaningful tax implications for heirs. In a traditional estate scenario, if you hold appreciated assets until your death, your beneficiaries typically receive a step-up in basis to the asset’s fair market value at the time of your passing, effectively wiping out any capital gains tax liability.

However, with a DST, the asset has already been sold and the sale proceeds are held in trust, so your heirs inherit your interest in the trust—not the asset itself—and the original deferred capital gains tax liability remains. This means the heirs continue to receive installment payments taxed based on the original gain, potentially resulting in a greater overall tax burden compared to receiving assets with a stepped-up basis.

Additionally, DSTs are complex, often require specialized legal and tax expertise, and have upfront costs and ongoing administrative fees that can erode returns. The structure also involves some degree of IRS scrutiny, particularly if the transaction isn’t executed precisely within legal parameters. For these reasons, DSTs should be carefully evaluated alongside other tax-deferral or estate planning strategies to determine if they’re the right fit.

Final Thoughts

If you’re sitting on a lot of equity and thinking of selling — but the idea of a huge tax bill is keeping you stuck — let’s talk. A Deferred Sales Trust isn’t for everyone, but in the right situation, it’s a powerful way to unlock your equity, preserve your wealth, and live the lifestyle you want.

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