Implications Before Using a Deferred Sales Trust

A deferred sales trust can provide a robust legal solution to help you manage the tax consequences of selling assets that have risen in value. However, understanding the implications of deferred sales trusts can help you make an informed decision when developing a financial strategy to manage your wealth.

There are several issues you should consider when deciding whether to use a deferred sales trust to manage taxes from selling appreciated assets. Let 453 Trust Powered by Pennington Law assist by discussing your options at a free initial case evaluation. Contact us today to schedule yours.

What Are the Risks of Using a Deferred Sales Trust?

Some of the risks and disadvantages of using a deferred sales trust to manage tax liabilities from a capital asset sale include:

• Failure of the Trust – Making a misstep at any stage of forming a deferred sales trust or selling an asset through the trust may lead to the trust’s failure. This could mean the imposition of immediate capital gains tax liability upon an asset owner who sells the asset through a DST, plus interest and fines for unpaid taxes.
• Lack of Immediate Liquidity – Selling an asset through a deferred sales trust means that an asset owner cannot enjoy immediate liquidity from the sale if they wish to defer capital gains taxes from the sale.
• Loss of Control Over Assets – An asset owner who places their property in a deferred sales trust gives up control over the wealth in that property to the trustee.

Who Should Consider a Deferred Sales Trust?

An owner of an asset that has gained significant value may consider selling that asset through a deferred sales trust to manage the tax implications from the sale. Examples of assets you might sell through a DST include:

• Real estate
• Business ownership interests
• Stocks, bonds, and other securities

A deferred sales trust is best suited for an owner who does not require immediate liquidity from selling their asset or who wants to maximize the value of the sale to reinvest it in other opportunities.

Legal and Compliance Considerations to Know

When using a deferred sales trust to manage tax liabilities from selling capital assets, there are compliance requirements and legal implications of DSTs that you should keep in mind. They include:

• The trustee must have complete independence from the asset owner, who cannot control or influence the trustee in any way.
• The trust must conduct the sale of the asset without any prior arrangements or pre-negotiated deals.
• The trust must take actual and constructive receipt of the sale proceeds.
• The former owner becomes liable for any portion of the sale proceeds distributed by the DST.

Alternatives to Deferred Sales Trusts

Other alternatives to deferred sales trusts for managing capital gains taxes from selling an appreciated asset include:

• Installment Sales – A party can spread out capital gains tax liability from selling an asset by conducting an installment sale, under which the buyer pays the purchase price in installments. The seller only pays capital gains tax on the installment payments received during a tax year.
• 1031 Exchange – An owner of investment real estate may defer capital gains taxes on a sale of the property by conducting the sale through a 1031 exchange. In a 1031 exchange, a property owner sells their property through a designated intermediary. When the owner uses the funds from the sale to purchase a like-kind property of equal or greater value than the sold property within a specific period after the sale, the owner owes no capital gains tax on the sale.
• Charitable Remainder Trust – Placing property in a charitable remainder trust can avoid capital gains tax on contributed assets and provide immediate income tax deductions. This also provides asset owners with an income stream for a specific period or for life, with the assets eventually donated to a designated charity.
• Section 121 Exclusion – Residential homeowners may exclude a certain amount of capital gain from the sale of their qualifying property. Homeowners can exclude up to $250,000 of capital gain, or $500,000 for married homeowners who file joint returns. A homeowner becomes eligible for the exclusion if they have owned and resided in the property for at least two years of the five years before the sale, and they have not used an exclusion for another sale within the past two years.

Top Mistakes People Make with Deferred Sales Trusts

The complexity of deferred sales trusts can make it easy for parties to make mistakes using DSTs without the assistance of experienced legal counsel. Some of the most frequent mistakes made with deferred sales trusts include:

• Not Having a Bona Fide Third-Party Trustee – When an asset owner selects a trustee controlled by or affiliated with the owner to manage a DST, the trust may lose the tax benefits of deferring capital gains taxes from the asset sale.
• Selling the Assets Before Forming the Trust – The owner must not agree to sell their asset to the ultimate buyer before creating the trust and transferring the asset to it.
• Taking Constructive Receipt of the Sale Proceeds – An asset owner who has constructive receipts of the proceeds of the asset’s sale may become liable for the full capital gains tax on the sale.

How Much Does It Cost to Create a Deferred Sales Trust?

Creating a deferred sales trust can involve various upfront expenses. In particular, most parties will need to retain legal counsel with specific experience in structuring a deferred sales trust to ensure the party receives the trust’s tax benefits.

After creation, the deferred sales trust will have ongoing expenses due to the need to hire an independent, third-party trustee to manage the trust. Depending on whether the trust reinvests the asset sale proceeds, the trust may also incur ongoing fees from investment brokers or financial advisors.

Plan Your DST with Confidence – Talk to Our Attorneys Today

Before you sell an asset through a deferred sales trust, you should talk to an experienced lawyer to learn more about the issues and risks you should evaluate to plan your trust with confidence. Contact 453 Trust Powered by Pennington Law today for a free consultation with a knowledgeable attorney.