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Deferred Sales Trust: Tax Deferral Strategy
If you own a business or real estate with a large amount of gain and are not selling your property because of capital gain taxes, or can't find suitable, qualified property exchanges, then you may want to consider a Deferred Sales Trust™ (DST).
The DST utilizes a legal and established method to allow the seller of the property to defer capital gain taxes due at the time of sale over a period of time that is selected by the Seller/Taxpayer in advance.
Deferring taxes, legally, is not new. Some commonly used tax deferral methods include 1031 exchanges, charitable trusts and traditional seller carry-back installment sale contracts.
Trust law predates the formation of the U.S. law and tax law. Various types of trusts are used by millions of Americans in order to protect and preserve their wealth for themselves and their heirs.
The Deferred Sales Trust can be used with any kind of entity, e.g. LLCs, S or C election corporations, as well as individuals who own real estate, rental properties, vacation homes, commercial properties, hotels, land, industrial complexes, retail developments, and raw land, to name a few.
Over the long run, the Deferred Sales Trust has the ability to generate substantially more wealth than a direct and taxed sale. It may be superior to the Charitable Remainder Trust , installment sale or like-kind property exchange in many respects. Consult your tax advisor to ascertain the potential benefits of this option.
Deferred Sales Trust Benefits
There are significant benefits in electing to use the Deferred Sales Trust when selling a property or capital asset. These include:
|Tax Deferral||When the appreciated property or capital assets are sold, capital gains tax on the sale is generally deferred until the Seller (Taxpayer) actually receives the payments.|
|Estate Tax Benefits||May accomplish an “estate tax freeze” for estate tax purposes.|
|Maintains Family Wealth||When properly structured, the principal inside the subject installment sales note can be preserved with “interest only” or partial principal payments creating the potential to pass on a large portion of the note principal to your legal heirs with proper estate planning.|
|Estate Liquidity||Converts a liquid asset into monthly payments.|
|Retirement Income||Provides a stream of income that can be used as retirement income.|
|Probate Avoidance||With proper estate planning.|
|Eliminates Risks Associated with Ownership||By utilizing the DST, the asset owner takes an asset that is otherwise "exposed" or liability prone and converted it to a "no-liability" asset.|
|Does Not compete with Charitable Remainder Trust||Nothing is required to be given away to charity, as happens with the competing strategy known as a Charitable Remainder Trust.|
|Portfolio diversification||The DST Trustee may invest in REIT’s, bonds, annuities, securities or other “prudent investments” that are suitable to help assure the Trustee’s performance in repaying the Seller/Taxpayer pursuant to the held installment sales note.|
How does the Deferred Sales Trust work?
- The process starts with initial due diligence and prospective marketing and market research. If the transaction is viable, the trust and property owner will negotiate to reach terms with regard to the asset(s). If the transaction is feasible, the property owner ("Seller/Taxpayer"), selling ownership of the property/capital asset to a dedicated trust (the "Trust") that is set up specifically for the Seller/Taxpayer and the contemplated transaction.
- The Trustee (must be DST Trained and Approved) of the trust pays the Seller/Taxpayer for the property/capital asset. The payment isn’t in cash, but with a special payment contract called an "installment sales contract". It is strictly a private arrangement between the trust and the Seller/Taxpayer. The term of payments is established in advance and pursuant to the sale contract negotiated by and between the Seller/Taxpayer and the Trustee.
The payments may begin immediately or they may be deferred for some period of months or years.
- The trust sells the property. There are generally minimal capital gains taxes due from the trust on the sale since the trust often purchases the property for a price and value similar to what it may get sold to a third-party Buyer.
The Seller/Taxpayer is not taxed on the sale since he has not yet received any cash for the sale. Often Seller/Taxpayers will choose deferral because they have other income and don’t need the payments right away. Of course, the payments may begin immediately.
Deferral is strictly an option. It is important to understand that payment of the capital gain tax to the IRS is done with an "easy installment plan" as the Seller/Taxpayer receives the payments. Part of the payment received is tax free return of basis, part is return of gain which is taxed at capital gain rates, and part is interest. On top of that, the tax payments will be made with depreciated dollars. The tax dollars will likely be worth less than they are today due to inflation. If invested properly, the money in the trust could potentially grow at a greater rate than that of inflation and even the distribution rate and ensures the necessary liquidity to pay back the note due to the Seller/Taxpayer. (The interest rate in the note to you is dictated by the IRS to be a fair and arm’s length or competitive rate, i.e. 6% to 8%.)
While we have primarily focused on capital gains tax, the amount of gain due to straight line depreciation is also deferred with a DST. But if you have taken accelerated depreciation in excess over straight line, this amount cannot be deferred.
Frequently Asked Questions
The payments are based on what you, the Seller/Taxpayer, arrange and pre-negotiate with the DST Trained and Approved Trustee. Depending on your income goals and other objectives, the amount and length of term of the installment sales note are your choice and subject to your 100% agreement.
With proper estate planning (i.e. by creating a living trust) scheduled installment note payments otherwise due to you can continue to pay to your legal heirs pursuant to the note term that you have chosen.
Yes. The DST Trained and Approved Trustee, in his/her absolute discretion, may allow you to refinance your installment sales note in order to extend or shorten the note term or to provide you with payments (or greater payments) of principal (and should you decide to take an "interest only" note initially).
If the DST Trained and Approved Trustee deems appropriate, they may elect to terminate the installment sales contract. However, you would immediately owe all the taxes, including all unpaid capital gains due from the original sale of the property/capital asset.
Politicians, from time to time, discuss changing capital gain rates. If that happens you would pay the new rate on the capital gains portion of your installment note payment. However, there is usually adequate notice to make a sound financial decision prior to any such change in taxation or tax rates.
Yes, please contact the Estate Planning Team or a duly qualified DST tax professional to discuss this option. We recommend that you work with Estate Planning Team's Professional Advisors who are experienced in trust law, trust asset management and tax law
Yes, in that case, you would pay taxes only on the capital gain portion of the money which you kept for yourself outside the trust.
For detailed technical information, have your CPA contact EPT for a full legal and tax cite package. The names Deferred Sale Trust™ and DST are common law trademarked names and are not found in the code. All of the legal and tax authority used in the DST are in the tax code, treasury regulations, cases, or rulings based upon the foundations found within the tax law.
A. The process is easy. Your next step is to complete a complimentary illustration request at: www.mydstplan.com/gregreese