Disadvantages of Deferred Sales Trusts
Carl E. Sera, CMT
August 14, 2023
If you want to sell highly appreciated assets like stock, cryptocurrency, business, real estate, or another asset, the capital gains tax that may be triggered may be the most difficult obstacle. The Deferred Sale Trust (DST) is one of several tax-deferral strategies accessible to you.
The following are some disadvantages to assist you decide whether the DST is a good fit for your future exit strategy. While we usually weigh pros and cons, and Deferred Sales Trusts do have many pros; this article only emphasizes the cons.
Disadvantages of the Deferred Sales Trust
Certain Aspects Of A Sale May Not Be Eligible For Installment Treatment.
Aside from the fundamental rules, a Deferred Sales Trust has many moving parts and necessitates a complex legal structure to ensure that you are not held liable in the future for taxes that you thought were deferred. Your case may be complicated further since, while all states must generally comply with IRC 453, not all components of your sale may be qualified for installment method reporting.
For example, if you are selling your company, you must allocate the whole sales price across the various asset classes that the company has. These classes are broadly defined as follows:
Cash and Equivalents
Securities, Accounts Receivable
Intangibles – includes non-compete agreements, trademarks, trade names, licenses etc.
Some of these may be eligible for the DST "Plus" program, but not all.
Entities May Not Recognize DSTs
If you're using a DST to salvage a failed 1031 exchange, be sure your Qualified Intermediary (QI) recognizes it as a genuine exchange alternative. A QI who is unfamiliar with the approach may refuse to send funds to your Trustee, or there may not be enough time left in your exchange for your QI to finish their education and internal vetting. This can create a potential problem.
As a result, it is critical that you conduct thorough research and interview the Trustee and DST team with whom you will be working. Their general knowledge and attention to detail may spell the difference between a successful trust creation and a crippling tax bill. Even if your QI refuses, there's still another way to potentially defer your capital gains tax through Opportunity Zone Funds (OZs). With QOZs, you get to keep your cost basis, put it in your pocket, and only invest the capital gain.
Your Tax Obligation Does Not Go Away.
As with any tax reduction or deferral strategy, there is no argument against an in-depth review of the procedure with your independent accountant. Every situation is unique, and you don't want to be surprised by an unexpected tax bill. It is important to emphasize that this technique simply postpones capital gains taxes; it does not remove them.
When you start receiving principal payments from the principal investment, the current capital gains tax rate will apply. Even if you organize your trust disbursements on an interest-only basis to avoid realizing a capital gain, you will still be responsible for paying income taxes on those payments. Hiring a great financial advisor is critical. That tax payment does not go away.
Understanding and Reducing the Risks of a Deferred Sales Trust with Sera Capital
While no wealth-building method is completely risk-free, the Sera Capital investment team will work hard to ensure that you understand every advantage and disadvantage involved, as well as advise you on the best way to mitigate any potential disadvantage.