Can a Deferred Sales Trust Hold Income Without Immediate Distribution?

If you’re curious about how to manage the tax implications of selling an asset that has gained in value, you may wonder whether a trust can reinvest the sale proceeds and keep the income generated from that reinvestment. When structured appropriately, a deferred sales trust can serve as a strategic tax deferral tool that enables you to grow your wealth more effectively.

At 453 Trust Powered by Pennington Law, we can answer these questions and suggest strategies that can make the most out of your wealth. Our team includes experienced estate planning attorneys, tax professionals, financial advisors, and others who can provide comprehensive, IRS-compliant services under one roof.

Contact us today for a free consultation to learn more about the rules governing deferred sales trust income distribution.

Types of Investments a DST Can Hold

Unlike other legal strategies that can defer capital gains taxes from asset sales, a deferred sales trust has broad flexibility on the type of investments it can hold. People use DSTs to liquidate and reinvest wealth contained in assets such as:

• Real estate
• Business ownership interests
• Securities
• High-dollar-value collectibles

When a deferred sales trust receives the proceeds from an asset sale, the trustee can reinvest those assets into almost any class of investment, such as stocks, mutual funds, municipal bonds, or Treasury bonds, potentially generating income and growth while complying with IRS rules and the terms of the trust agreement.

Potential Downsides of Delaying Distributions

Although delaying distributions of principal and income from reinvested wealth in a deferred sales trust may seem advisable, as the growth of wealth may accelerate due to the effect of compound interest, keeping money in a DST may have disadvantages or unintended consequences, such as:

• Possible loss of wealth if the DST’s investments decline (e.g., stock market downturn)
• Potentially higher tax liabilities when distributions are made, due to your income level or future changes in federal tax law
• Delayed access to liquidity in the wealth accumulated
• Loss of control over the assets, since a deferred sales trust requires the original owner to give up ownership and management to the trustee

Situations Where Immediate Payout May Be Better

Circumstances where a person may want to take immediate distributions from a deferred sales trust include:

• Needing it for personal expenses, like major medical treatment or long-term disability care
• Having capital losses that can offset gains from a distribution
• Qualifying for a lower capital gains tax bracket now, with expectations of higher taxes in future years if they end up in a higher bracket
• Concerns about possible increases in capital gains or income tax rates
• Planning for retirement and a steady income stream to fund a desired standard of living

Is It Possible to Retain Income Without an Immediate Payout?

When establishing a deferred sales trust, an asset owner can create an installment payment contract outlining the schedule for the distribution of principal and income generated from the sale and reinvestments. This means that the owner and the trust can negotiate a payment schedule that has a long deferral period before payments begin. During this period, the trustee can reinvest the sale proceeds and any income generated from those investments. An installment agreement can structure the payment schedule to meet the former asset owner’s specific financial needs and objectives.

Rules and Regulations on DST Income 

Because a deferred sales trust uses the installment method of taxation under IRC 453, the original asset owner becomes liable to pay capital gains taxes only when the DST distributes principal from the sale proceeds. However, certain exceptions may impose immediate tax liabilities, such as any part of the gain on the sale representing recaptured depreciation or the obligation to pay interest for over $5 million in outstanding installment obligations.

For example, if you transfer an asset with a $200,000 basis to a DST and it sells for $1 million, your $800,000 gain could be distributed over 10 years in $100,000 annual installments. In that scenario, you would report $80,000 of capital gain each year and pay taxes accordingly (assuming a 15 percent capital gains tax rate).

Furthermore, when the deferred sales trust distributes income generated from reinvesting sale proceeds, the former owner may owe income taxes on that distributed income.

Investment Growth While Income Is Retained 

Allowing a deferred sales trust to retain income generated from reinvested sale proceeds can help continue to grow wealth. For example, a reinvestment of $1 million of sale proceeds earns an annual return rate of five percent. By retaining income after the first year, the trust can generate a five percent return on the new total amount — $1,050,000 — which can continue to compound over time.

Alternatively, a deferred sales trust may slowly distribute principal from the sale proceeds to the former owner, enabling them to realize liquidity from the asset and satisfy their capital gains tax liability, while retaining income generated from the principal and reinvesting that income to continue building wealth.

Get Advice on Holding Income from Our Deferred Sales Trust Attorneys

At 453 Trust Powered by Pennington Law, we call a DST “The Tax Tool You Didn’t Know You Had.” But before choosing this method for your asset sale, it’s crucial to understand the key aspects of deferring distribution and the importance of setting up a DST accurately. Working with experienced legal counsel can help you establish a deferred sales trust designed to help your wealth grow over time.

Our nationwide practice is backed by professionals recognized by the Forbes Financial Council, The Wall Street Journal, USA Today, and legal rating services, including Super Lawyers, Lawyers of Distinction, and Best Attorneys in America.

Contact 453 Trust Powered by Pennington Law today for a knowledgeable deferred sales trust lawyer.