For deferring capital gains taxes on appreciated assets, deferred sales trusts are an alternative to 1031 exchanges. Deferred Sales Trusts, unlike exchange-based tax-deferment methods, are an example of a special type of sale known as an “installment sale,” which can be used to defer capital gains taxes by spreading payments on the sale over multiple installments. Unlike other installment sales, the Deferred Sales Trust arrangement can be used to reinvest your capital while deferring your capital gains tax obligation indefinitely by utilizing a third-party trust. So, what exactly is a deferred sales trust, its problems, fees, attorney, and its pros and cons?
What is Deferred Sales Trust?
A deferred sales trust is a legal agreement between an investor and a third-party trust in which the investor’s real estate is sold to the trust in exchange for predetermined future payments, known as installments, made over an agreed-upon time period. Investors can defer capital gains taxes over time by using a “Deferred Sales Trust.”
How Does a Deferred Sales Trust Work?
A deferred sales trust is established by appointing a third-party company to serve as a trustee. Once you have sold your investment property to the trust, you will get a promissory note or deferred installment contract in exchange. This has already been planned and signed.
You will be the trust’s beneficiary, with a third party acting as trustee. The trust sells the investment property and keeps the proceeds; which are distributed to you in accordance with the terms of the promissory note or installment contract. Furthermore, you have the option of receiving installment payments right away or deferring them. The trust either keeps the undistributed proceeds as cash or invests them. Even though you can put off paying capital gains taxes on the sale of your investment property; any principal payments made by the trust will be subject to capital gains taxes.
Deferred Sales Trust Problems
A Deferred Sales Trust can be an excellent tool for reducing your tax obligations and investing the savings to increase your wealth. However, any method of making money has problems, and a deferred sales trust is no exception.
Nonetheless, aside from the obvious risk of unforeseen market events causing your trust investments to lose money; the most significant pitfall is a lack of awareness of the potential stumbling blocks you may face. Fortunately, due diligence and a competent deferred sales trust team can assist you in avoiding these problems.
#1. DST has a complicated structure and a set of criteria.
Tax deferral strategies adhere to the rules established by the government agency tasked with collecting those taxes; the Internal Revenue Service. Making the most of tax-saving benefits is often complicated and not always easy.
#2. Some aspects of a sale may not qualify for installment treatment.
Aside from the fundamental rules, deferred sales trusts have many moving parts and necessitate a complex legal structure to ensure; that you are not held liable in the future for taxes that you thought were deferred. IRC 453 is a federal law that all states must follow; but not all parts of your sale may be eligible for installment method reporting.
#3. Entities have the option to refuse to recognize DSTs.
If you are using a DST to save a failed 1031 exchange; you must ensure that your Qualified Intermediary (QI) recognizes a Deferred Sales Trust as a valid exchange option. A QI who is unfamiliar with the strategy may refuse to release funds to your trustee; or there may not be enough time left in your exchange for your QI to complete their education and internal vetting.
#4. Your tax liabilities will not vanish.
As with any tax reduction or deferral strategy, there is no argument that an in-depth review of the procedure with your independent accountant is essential. Every situation is unique, and you don’t want to be surprised with a tax bill you didn’t expect.
Deferred Sales Trust Pros and Cons
Let us conclude by discussing some of the pros and cons of deferred sales trusts.
The primary benefit of deferred sales trusts is the ability to postpone capital gains taxes. Other potential benefits include:
- In the event of a failed exchange, there is a fallback option. If you were attempting to complete a 1031 exchange but missed a deadline, the exchange is not complete; your Qualified Intermediary (QI) may return the funds to you, leaving you liable for capital gains and depreciation recapture taxes. However, with a deferred sales trust, the QI sends money to the trust instead of you; which means you don’t have to pay taxes on a lump-sum payment right away.
- Increased investment options. A DST can be an effective estate planning and portfolio diversification tool. Sellers have more investment options with a deferred sales trust than with a 1031 exchange; because a 1031 exchange limits sellers to like-kind properties. You can use a deferred sales trust to buy stocks, bonds, mutual funds, angel investments, crowdfunding; cryptocurrency, and other financial instruments that are not permitted under 1031 exchange rules. Also, if you can’t find real estate assets that meet your investment criteria; creating your own is a good thing to do.
Deferred sales trusts are also accompanied by a number of caveats that have the potential to exacerbate investment problems.
Among the potential pitfalls of deferred sales trusts are:
- It is difficult. It can be difficult to establish and manage a DST. Set-up and maintenance fees can also be exorbitant.
- The recapture of deferred depreciation does not apply to all depreciation. You’ll need solid advice from your tax professional in this situation. When using a deferred sales trust, depreciation is taken on the relinquished property using accelerated depreciation methods; resulting in greater depreciation deductions than the straight-line method, although the property may still be subject to depreciation recapture taxes.
- Taxes are postponed rather than eliminated. Capital gains taxes are only postponed when a DST is used. When you begin receiving cash from the trust, you’ll have to pay capital gains taxes on the principal payments.
Other problems that could arise with the Deferred Sales Trust
Besides the risks that were already mentioned; there are some operational deferred sales trust problems that could cause some sleepless nights.
- Mismanagement is a possibility. There is little oversight of deferred sales trusts. If the trustee mismanages the trust, the IRS may declare it a tax evasion scheme; in which case any profits from the initial sale will be taxed at your full capital gain tax rate.
- Deferred sales trusts are not recognized in all states. These types of installment sale agreements, for example, are not recognized in California. Due diligence with your accountant and the selection of a good third-party trust agent is especially important to ensure the validity of the trust.
- Certain qualified intermediaries will refuse to release funds. Some qualified intermediaries may refuse to release funds from the trust because they do not recognize deferred sales. This action is similar to the stance taken by some states previously mentioned. Make sure you understand your QI’s position on deferred sales trusts.
Deferred Sales Trust Fees
Occasionally, a seller of an appreciated business or property who is interested in the Deferred Sales Trust will comment that the legal fees associated with establishing the DST are prohibitively expensive. But, do they?
Take, for example, the Deferred Sales Trust, which takes fees of about 1.5 percent of the first $1,000,000 in selling price and 1.25 percent of the sales price above $1,000,000 for setting up the legal structure and closing the deal.
Consider a hypothetical $1,000,000 sale in which the seller/taxpayer would have to pay $250,000 in capital gains and other taxes in a pure direct and taxed sale with no tax deferral, like when you sell something.
The legal and setup fees for establishing the Deferred Sales Trust would be approximately $15,000. Assume that the seller/taxpayer wanted to invest his or her money so that he or she could make 5% a year.
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If he or she had paid all of his or her taxes in the year of the sale, he or she would have earned $750,000 x 5% = $37,500 in annual income from the invested proceeds. Instead, if the seller/taxpayer could postpone the capital gains taxes for many years, he or she would earn $1,000,000 x 5% = $50,000 in annual income.
If the legal and setup fees of the deferred sales trust were each $15,000, the seller/taxpayer would be in the black by the end of the first year. They would continue to earn an extra $15,000 per year in future years if they had paid all of their taxes upfront.
Over a ten-year period, that equates to $150,000 more in the seller’s pocket than a direct and immediately taxed transaction. Another thing to note is that getting your sales proceeds in installments over time (plus interest) can help you lower your tax brackets, which means more money in your pocket.
Deferred Sales Trust Attorney
The Deferred Sales Trust is a legal agreement between you and a third-party trust in which you sell real or personal property or a business to the DST in exchange for a tax break. Get Legal Assistance with Probate.
The tax attorney prepares the documentation and implements the Deferred Sales Trust at the closing of the sale, which can be done through escrow or by an attorney. DST Properties and Sponsors are currently in Place. The Estate Planning Team, which was founded, created the DST.
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A deferred sales trust The DST is a new alternative to the 1031 exchange that allows the taxpayer to defer the gain on a sale. If you require trust, demonstrate what you require to safeguard your legacy. These deferred sales trust attorneys have specialized knowledge.
A DST does provide legal assistance, unlike a 1031 exchange. The year was 1999. Todd Campbell, principal founding attorney of Campbell Law, a CPA, LLM, and tax attorney, created the Deferred Sales Trust, which is a proprietary strategy for investors.
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A Deferred Sales Trust is a legal agreement prepared by an attorney between an investor and a third-party trust in which the investor sells real estate to the trust in exchange for future payments. Ad Legal Service Since 1999. If you require trust, demonstrate what you require to safeguard your legacy.
This strategy is known as the Deferred Sales Trust, or DST, and should not be confused with the Delaware Statutory Trust, also known as a DST under IRC 1031. The Deferred Sales Trust is only available through the Estate Planning Team and a tax attorney who has a lot of experience with this type of trust.
We Win Cases Free Evaluation Get Started. For over 20 years now, the Deferred Sales Trust has allowed businesses and real estate investors to defer capital gains tax and generate more money through reinvestments in the long run. Binkele and attorney and CPA Todd Campbell.
DST stands for Deferred Sales Trust, and you have rights. The pre-tax proceeds from the sale are as follows:
Create a trust for 500–1500. A deferred sales trust, or DST, lets you put off paying capital gains taxes while still making money from investments made after you sell your assets.
A DST can be an extremely useful estate planning tool. When you reach retirement age, you can choose to receive payments on an as-needed basis or to receive payments from any interest earned on funds held in trust. Those payments, however, will result in a taxable event.
A DST can also help 1031 exchange investors who were unable to complete their exchanges but still want to defer capital gains from the sale of investment assets. Furthermore, to ensure the trust is valid and properly managed, estate planners, tax professionals, and qualified intermediaries with experience in setting up and operating deferred sales trusts are required.
Frequently Asked Questions
How is a deferred sales trust taxed?
The trust either keeps the undistributed proceeds as cash or invests them. Although you can defer any capital gains taxes generated by the sale of the investment property, any principal payments generated by the trust will result in capital gains tax liability.
Is a deferred sales trust irrevocable?
The DST is an irrevocable trust, and the grantor (in this case, the taxpayer) cannot also be the trustee.
How much does it cost to set up a deferred sales trust?
approximately 1.25 to 1.5 percent
There is no charge for the initial consultation, or for establishing your trust. There is a one-time legal fee of approximately 1.25 to 1.5 percent. Subtract that from the 35 percent to 45 percent in taxes you’d have to pay on the gains you’re facing. That’s a very good deal for such a low price.
What is the difference between a deferred sales trust and a Delaware Statutory Trust?
The Delaware Statutory Trust allows a real estate investor to maintain an investment position in real estate without the burden of personal management. A real estate investor can use the Deferred Sales Trust to sell a highly appreciated property while deferring the payment of capital gains taxes.