How Deferred Sales Trusts Help in Real Estate Transactions

Owners of high-value residential, commercial, or investment property often ask about strategies for reducing capital gains taxes before selling. Fortunately, various legal strategies can help property owners manage the tax implications of a real estate sale, including deferred sales trusts (DSTs). Working with knowledgeable legal counsel can help you structure a DST tailored to your financial objectives. Get the help you need from the experienced attorneys at 453 Trust Powered by Pennington Law.

Recognized as the Best Deferred Sales Trust Law Firm in the U.S. in 2024, our national practice includes experienced professionals in areas such as asset protection, trust and estate planning, financial reinvestment, wealth preservation, and tax law. Firm founder Andre Pennington has earned recognition for his legal work, including listings in Super Lawyers, Best Lawyers in America, and Lawyers of Distinction, as well as appearances in publications such as The New York Times, The Wall Street Journal, USA Today, and Forbes. We’ve built an IRS-compliant program under one roof to ensure you receive top-quality service in all aspects of your case or legal matter.

If you want to learn more about selling real estate property in a trust, contact us today for a free consultation with one of our trusted deferred sales trust lawyers.

How Deferred Sales Trusts Work in Real Estate Transactions 

A deferred sales trust (DST) is a legal strategy used in real estate to lessen the tax impact of selling highly appreciated assets. Selling the property outright can trigger significant capital gains taxes due in the year of the sale. By selling real estate property in a deferred sales trust, you can delay capital gains taxes if the transaction is structured so the seller does not have constructive or actual receipt of the sale proceeds. Sale proceeds are distributed in accordance with the terms set out in an installment contract.

Here’s a breakdown of how it works:

• Transfer – Once you decide to sell through a DST, you transfer the property to the trust in exchange for an installment agreement. The agreement governs how the trust will pay the proceeds from the real estate transaction to the owner.
• Sale – The trust sells the property to the ultimate buyer, receiving and potentially reinvesting the sale proceeds to generate income.

A DST can reinvest proceeds from a real estate sale into non-real estate assets, such as stocks, bonds, or mutual funds. The former owner then pays capital gains taxes on any portion of the installment payments distributed by the trust in the tax year. Properly structuring the trust is crucial to avoiding IRS compliance issues. A 453 Trust attorney can assist during the process to prevent potential errors that could trigger tax penalties.

Benefits of Using a Deferred Sales Trust for Property Sales

A deferred sales trust can offer real estate investors various legal and financial benefits when selling appreciated assets.

• Tax deferral – By placing your property in a DST, you can spread capital gains tax obligations over multiple years, reducing the immediate tax burden associated with a real estate sale.
• Flexibility – Other methods, such as Section 1031 exchanges, also allow for capital gains tax deferral. However, 1031 exchanges require reinvesting only in “like-kind” property and have strict time limits. Deferred sales trusts do not have the same constraints.
• Estate planning – Incorporating a DST into a comprehensive estate plan may assist in estate planning and the potential transfer of wealth, depending on how the DST is structured.
• Control over distributions – Since you set the distribution schedule in your installment schedule, you can plan for a steady income stream over time, potentially safeguarding your financial future

Legal Requirements for Using a DST in Property Transactions

To obtain tax benefits, a deferred sales trust for a real estate transaction must meet specific legal requirements, including:

• Pre-sale formation – A property owner must establish the deferred sales trust before negotiating a sale of their property.
• Bona fide third-party trustee – A DST must have a third-party trustee who is unaffiliated with the property owner and free from the property owner’s influence or control.
• Installment agreement – The property owner must transfer their real estate to the DST in exchange for an installment contract.
• No receipt of proceeds by the property owner – The trust must receive the sale proceeds. If an owner has actual or constructive receipt of the proceeds, they may become immediately liable for the full capital gains tax liability from the sale.

Tax Strategies for High-Value Real Estate Sales Using DSTs

DSTs can provide various tax-planning opportunities for owners of high-value real estate. Since a property owner pays taxes only on the DST distributions they receive in a given year, they may defer income and potentially limit exposure to higher tax brackets, subject to IRS rules and proper trust administration.

Additionally, deferred sales trusts may help mitigate estate tax exposure, potentially reducing tax liability after the owner’s death. 

When Should You Consider a Deferred Sales Trust for Real Estate?

You might consider using a deferred sales trust when selling real estate due to various considerations, such as:

• You own an asset, such as a multi-million-dollar parcel of real estate, that has appreciated during your ownership.
• You want to reinvest the sale proceeds into other asset classes, which other legal options, like Section 1031 exchanges, do not permit.
• You want to set up an income stream funded by the sale proceeds for retirement purposes.
• You want to integrate a deferred sales trust into your estate planning strategy for potential tax savings and ease of wealth transfer to your heirs.

Pros and Cons of Deferred Sales Trusts in Real Estate Deals

Using a deferred sales trust to sell real estate has advantages and disadvantages. Some of the pros of deferred sales trusts for real estate transactions include:

• Deferring capital gains taxes by spreading payments over multiple years
• Ability to reinvest the full sale proceeds within the DST, potentially accelerating wealth growth while preserving tax deferral
• Flexibility in the timing of reinvestment and in the types of asset classes open for investment

However, using a deferred sales trust can have drawbacks, including:

• Strict procedures for setting up the DST to ensure IRS compliance and avoid immediate tax liability and penalties
• Loss of direct ownership of the property to the trust
• Ongoing management fees and administrative costs for the independent third-party trustee
• Lack of immediate liquidity from the sale, as distributions must occur over time for tax deferral

Protect Your Real Estate Gains —Speak With Our DST Attorneys Today

If you need legal help for real estate transactions, information about installment sales, or assistance with asset management, an experienced attorney from 453 Trust Powered by Pennington Law can explain strategies that may potentially minimize your tax burden and increase proceeds from the sale. Call or contact us today for a free initial consultation.