Pros and Cons of Deferred Sales Trusts
Carl E. Sera, CMT
August 11, 2023
A Deferred Sales Trust (DST) is a legal framework that allows the seller of an asset, such as real estate or a business, to postpone paying taxes on the proceeds of the sale. The seller transfers ownership of the object to the trust, which then sells it to a buyer. Rather than receiving all the selling earnings simultaneously, the seller receives payments from the trust over time (think installment sale) while the sale funds remain in the trust.
Because they are only required to pay taxes on the sale profits once they receive payments from the trust, delaying the receipt of the sale money may allow the seller to reduce their immediate tax obligations. While several tax deferment strategies exist, the Deferred Sales Trust (DST) provides you with benefits and flexibility that the others don’t. Still, it’s not for everyone.
In this article, we will look at the pros and cons of a DST to give you a better understanding of what it is and how it could benefit you.
Pros of Deferred Sales Trust
One of the primary advantages of a DST is the ability to postpone taxes on asset sales. By transferring asset ownership to the trust, the seller can defer paying taxes on the sale gains until they begin receiving payments from the trust. As a result, the seller may be able to save a significant amount of money and minimize their tax liability and has the potential to play some tax arbitrage instead of just paying one big tax payment to Uncle Sam.
Payment Terms That Can Be Changed
A DST allows the seller to tailor the payment terms to their needs. It could entail determining the size and timing of payments and adjusting payment terms in response to changes in their financial situation. This adaptability could be helpful for sellers who want to control their income and cash flow better.
Investing the selling proceeds in diverse assets may assist the seller in diversifying their portfolio, thus lowering risk. It could be beneficial for sellers who want to reduce their exposure to a specific asset or market.
A DST can be an effective estate planning tool, allowing the seller to transfer assets to their offspring while potentially cutting estate taxes. It may increase the likelihood that the seller's money will be protected and distributed by their preferences.
1031 Exchange Rescue
For those investors who need help to successfully exit a 1031 exchange into 1031 property or a Delaware Statutory Trust, the Deferred Sales Trust may be an appropriate option, provided that your Qualified Intermediary is willing to send the investment assets to the trust. Opportunity Zone Funds are also potential backups.
Purchase Additional Property
Suppose, for some reason, you'd like to purchase additional property without having to meet the strict 1031 exchange requirements. In that case, the DST allows you to form an LLC to purchase other property without the 1031 restrictions. This will enable investors more time to make an educated decision while keeping their funds in short-term treasuries while they keep looking. You probably know you can't do a 1031 exchange for the property flippers out there. The DST may be a way for you to keep growing without taking a big haircut on every flip.
Cons of Deferred Sales Trust
Creating and administering a DST can be difficult, necessitating the assistance of experts like lawyers, accountants, and financial consultants. As a result, it may be more costly and time-consuming than other tax-deferral strategies.
Creating and maintaining a DST may be expensive, canceling off any possible tax benefits. A DST's pricing may include trustee costs, legal and accounting fees, and other expenses.
To qualify, the seller must meet specific criteria, and not all assets are eligible for a DST. It could entail having a large tax bill, being willing to postpone payment, and accepting the risks associated with the trust structure.
There is a possibility that the trust will operate differently than planned, which might lead to income loss and force the seller to pay taxes on the sale profits earlier than planned. The trust's risk is affected by the agreement's content, the trustee's financial situation, and other elements.
Step Up in Basis
While deferring capital gains taxes is the primary point of Deferred Sales Trusts, the reason why they're allowed is that our friend in Washington does receive the tax payment. There is no step-up in cost basis for those family members.
Because the sale earnings are stored in trust and distributed over time, the seller may only have limited access to them during the trust's duration. It can restrict the seller's freedom to invest or spend the money however they see fit. Overall, a DST may be a helpful estate planning and tax deferral tool for those who qualify.
Before choosing if a DST is the best course of action for your particular situation, it is essential to thoroughly weigh the drawbacks and potential hazards of such a plan and speak with a group of experts.
A Deferred Sales Trust (DST) can help people manage their income and estate planning needs while delaying taxes on the sale of an asset. However, some disadvantages exist, such as complexity, expense, eligibility restrictions, risk, and a lack of liquidity.
Before deciding whether a DST is the best course of action for your specific situation, it is critical to thoroughly weigh its benefits and drawbacks and consult with a group of experts. Are you thinking of working doing a Deferred Sales Trust?
Sera Capital is a wealth management consulting firm specializing in all aspects and all available tax-efficient exit options for business owners, real estate investors, and developers. Our team works with you and your advisors to examine all available solutions, including 1031 Exchanges, Delaware Statutory Trusts, 721 UPREITS, Opportunity Zone Funds, and Section 453 Installment Sales, including Deferred Sales Trusts and Structured Installment Sales. We have two mottos. The first is “We help landlords and business owners exit tax efficiently,” and our second is “When you want out, call us in.”