Why the IRS Allows Deferred Sales Trusts and How You Can Benefit

Many wealthy individuals and families have used deferred sales trusts for years to manage and mitigate the tax implications of selling high-value assets like real estate, businesses, and other investments. Deferred sales trusts take advantage of specific taxation rules under the Internal Revenue Code. However, correctly setting up a deferred sales trust requires in-depth legal knowledge and experience.

A seasoned attorney from 453 Deferred Sales Trust Powered by Pennington Law can walk you through the financial and tax benefits of deferred sales trusts and whether you should structure your asset sale through one of these trusts. Contact our firm today for a free case review to discuss your proposed asset sale and your financial needs and goals to learn more about the advantages of deferred sales trust — “The Tax Tool You Didn’t Know You Had.”

What Is a Deferred Sales Trust and How Does It Work?

After hearing about deferred sales trusts, you may wonder, “What is a DST?” A deferred sales trust (DST), also known as an installment sales trust, allows an asset owner to manage the capital gains tax burden arising from the sale of an asset that has appreciated during ownership. DSTs leverage tax laws that permit taxpayers to defer paying capital gains taxes from an asset sale when they structure the sale per the requirements outlined under the Internal Revenue Code.

How does a DST work? In a deferred sales trust, an asset owner transfers the asset they intend to sell to a bona fide third-party trust. The trust must have a trustee independent from the asset owner; if the asset owner can exercise any influence or control over the trustee, they lose the tax benefits of the DST. In exchange for transferring the asset to the trust, the owner receives an installment payment contract from the DST. This contract outlines how the trust will pay the principal and income from the proceeds of selling the asset to the owner.

The trust then sells the asset to a bona fide third-party purchaser and receives the sale proceeds. The former asset owner cannot take any legal title or beneficial interest in the sale proceeds; if they do, they may lose the tax benefits of the DST. The trust holds the sale proceeds and may reinvest them as permitted by the trust document and the installment payment contract.

The trust begins paying the former asset owner principal from the sale proceeds or income generated by reinvesting the proceeds, as outlined in the installment payment contract. The former asset owner pays no capital gains tax on the asset sale until the trust pays them the principal from the sale proceeds. If the trust only pays income and holds the principal from the sale proceeds, the asset owner may indefinitely defer capital gains tax. However, a DST cannot avoid capital gains tax permanently, as the distribution of the sale proceeds at any point in the future will trigger tax liabilities.

Why Does the IRS Allow for DSTs?

People who hear about deferred sales trusts may wonder about the relationship between the IRS and DSTs. A deferred sales trust takes advantage of the taxation method outlined in IRC §453. This statute permits a property owner who sells their asset at a gain to defer capital gains tax until the owner receives payment of the sale price.

IRC 453 can enable an asset owner to spread out their receipt of the purchase price for their asset over a period of years, stretching out the tax burden of the property sale over time. Because a deferred sales trust allows a property owner to defer the payment of principal from the sale proceeds, a DST can leverage the taxation method under IRC 453.

What Are the Tax Benefits of a DST?

Property owners may structure their asset sales through a DST to take advantage of tax benefits. Some of the tax benefits of deferred sales trusts include the following:

• Spreading Tax Bills Over Multiple Years – A property owner may use a DST to spread the capital gains tax bill from their asset sale over several years, making taxes more affordable than paying the full capital gains tax bill in the year of sale.
• Timing Capital Gains Taxes for More Advantageous Years – Property owners might use DSTs to spread capital gains taxes from a sale. Doing so means potentially accessing the lower 15 percent long-term capital gains tax rate or offsetting capital gains with capital losses incurred in future years.
• Deferring Capital Gains Tax Indefinitely – A property owner may defer capital gains tax indefinitely if the DST does not pay any principal from the sale proceeds.

What Are Other Benefits of DSTs?

Some of the other benefits that property owners can obtain by structuring a sale of their asset through a deferred sales trust include the following:

• Flexibility in Reinvesting Assets – Unlike other structures that enable property owners to defer capital gains taxes through reinvestment, deferred sales trusts offer greater flexibility in how a party can reinvest the asset sale proceeds. For example, a deferred sales trust does not have the “like-kind” requirement of a 1031 exchange or a 1031 exchange’s timing requirements. Instead, property owners can reinvest their wealth in a wider class of assets without having to meet strict deadlines to preserve the tax advantages of a DST.
• Ability to Preserve Asset Value – By deferring capital gains taxes through a deferred sales trust, a property owner can preserve the value they’ve gained in their asset and reinvest that full value into new investments.
• Creation of Family Wealth – An asset owner might use a deferred sales trust to create a family wealth fund, reinvesting the sale proceeds and having the trust distribute only income generated from those assets to the owner and their family members.

What Are Key Components of a DST?

The key components of a DST include the following:

• Bona Fide Third-Party Trustee – A deferred sales trust must have a bona fide third-party trustee independent of the asset owner, which means the owner cannot control or influence the trustee. Otherwise, the IRS may view a DST as a sham trust, potentially exposing a property owner to capital gains taxes, penalties, and interest.
• Installment Payment Agreement – A property owner and the deferred sales trust must secure the transfer of the property from the owner to the trust via an installment payment agreement, which governs how the trust will pay the sale proceeds to the owner.
• Receipt of Sale Proceeds – The deferred sales trust must take title and possession of the sale proceeds. The former property owner cannot have any constructive or beneficial interest in the sale proceeds beyond their right to receive payments under the installment payment agreement.

Are There Any Requirements I Should Know About DSTs Beforehand?

Deferred sales trusts have several legal requirements that property owners should familiarize themselves with before attempting to structure a sale through a DST. Not meeting all these requirements may result in the trust’s failure, exposing a property owner to the full amount of capital. gains taxes on the sale, plus any applicable penalties, fees, and interest.

Some of the major requirements for DSTs include the following:

• Pre-Trust Sale Formation – A property owner must establish the trust, appoint the trustee, and transfer the asset they wish to sell to the trust before reaching any agreement to sell the asset to the ultimate buyer.
• Due Compensation – The trust must receive fair compensation by selling the asset to a bona fide third-party purchaser.
• Trust Must Conduct the Ultimate Sale – The trust must handle all aspects of the sale process to the property’s ultimate buyer, including receiving all legal and equitable interests in the sale proceeds.

Why Choose 453 Deferred Sales Trust Powered by Pennington Law?

Deferred sales trusts involve complex tax laws and rules. A single mistake can cause a DST to fail, potentially exposing a person who has sold a high-value asset to capital gains taxes, penalties, fees, and interest on unpaid taxes. As a result, you need legal counsel with extensive experience structuring deferred sales trusts.

Choose the legal team from 453 Deferred Sales Trust Powered by Pennington Law to help you set up a compliant DST tailored to your specific needs and goals. Our work has earned us recognition as the Best Deferred Sales Trust Law Firm in the U.S. in 2024. Furthermore, our nationally recognized law firm has a team of highly experienced professionals who practice across a variety of legal and financial fields, including:

• Tax law
• Asset protection
• Financial advisory services
• Estate and trust planning
• Wealth and fiduciary matters
• Irrevocable trusts
• Professional third-party trustee duties
• Financial reinvestment
• Insurance

Contact Our 453 Deferred Sales Trust Lawyers Today

When you sell an asset that has gained in value, you may owe capital gains taxes. A deferred sales trust attorney can show how DSTs can reduce capital gains taxes and allow you to keep more of your hard-earned wealth.

Discover how 453 Deferred Sales Trust, Powered by Pennington Law, can help you structure a deferred sales trust tailored to your specific needs and objectives. Contact us today for a free, no-obligation initial consultation.