Using a DST to Defer Capital Gains on Various Assets

Tax deferral is an important consideration for everyone. Various tools are available to accomplish these goals, some more well-known than others. At 453 Trust Powered by Pennington Law, we focus on a lesser-known strategy for deferring capital gains tax burdens — the deferred sales trust (DST).

Our lawyers like to call the deferred sales trust “The Tax Tool You Didn’t Know You Had.” DSTs offer a more flexible method for deferring capital gains compared to traditional options, such as 1031 exchanges. They allow individuals to reinvest the proceeds from appreciated assets into new investments, while deferring and spreading out the capital gains tax from the original sale over several years.

If you’re curious about how to save on capital gains when selling your high-value assets, a deferred sales trust could be the answer for you. However, a DST must be structured properly to remain compliant with IRS rules and avoid triggering tax consequences. At 453 Trust Powered by Pennington Law, we can help you determine whether a DST is a suitable strategy to protect your interests.

Our nationally recognized lawyers are well-rounded professionals who bring tax law, estate planning, financial advising, and wealth preservation knowledge under one roof. Rather than outsourcing various responsibilities to multiple firms, we focus on providing holistic services that reduce the margin for error and offer a comprehensive plan for wealth management. Contact us today for a free consultation and learn more about our legal services.

Who Qualifies to Use a Deferred Sales Trust for Capital Gains Deferral?

Anyone who owns a capital asset that has increased in value during the party’s ownership may qualify for using a deferred sales trust to defer capital gains taxes. Qualifying assets may include:

• Real estate, including residential, investment, and commercial properties
• Business ownership interests
• Stocks, bonds, and other securities
• Valuable artwork or collectibles

How to Use a DST to Defer Taxes on the Sale of Real Estate or Rental Property

A property owner can use a deferred sales trust to defer capital gains taxes when selling real estate or investment properties. The process involves transferring the property to the trust before entering into a contract to sell it to the ultimate buyer.

In exchange for transferring the property to the trust, the owner receives an installment payment contract, which governs how the DST will pay income and principal from the sale proceeds to the owner. The DST then sells the property to the final buyer and receives the sale proceeds, which the trustee can reinvest into other income-generating or growth-oriented investments on behalf of the seller. The former owner pays capital gains taxes on the sale only when they receive distributions of the sale proceeds from the trust.

Deferring Capital Gains on Business Sales Through a Deferred Sales Trust

Deferred sales trusts can also help business founders interested in deferring capital gains when they sell their business upon retirement. A business owner can transfer their ownership interests to a deferred sales trust and receive an installment payment contract. The DST can then sell the business to a buyer and receive the sale proceeds. The trust can reinvest the sale proceeds and pay income to the former business owner or distribute the sale proceeds according to the installment payment contract, with the former owner obligated to pay capital gains taxes on those distributions of sale proceeds.

Can You Use a DST to Defer Taxes on Stocks, Bonds, or Other Securities?

In certain circumstances, you can use a deferred sales trust to defer capital gains taxes from selling privately held stocks, bonds, and other market securities. To do so, you must first transfer your investments to the trust in exchange for an installment payment contract. The trust then sells the securities and receives the proceeds, on which it pays no capital gains tax. The trust can reinvest the proceeds into other securities with higher growth potential or securities that provide income through dividends. As the creator of the DST, you pay capital gains taxes on the sale of your securities only when you receive payments of the sale proceeds from the trust.

What Are the Legal and IRS Compliance Requirements for Using a DST?

A deferred sales trust takes advantage of the tax rules applied to installment sales under IRC 453. When a party sells an asset through an installment sale in which they do not receive the entire purchase price in the same tax year as the sale, tax law allows the seller to defer paying capital gains on any sale proceeds until the year in which they receive those proceeds.

A deferred sales trust can comply with IRS requirements for using the installment sale method of taxation by following specific steps:

• An asset owner must form the deferred sales trust before entering an agreement to sell the asset to the intended buyer.
• The deferred sales trust must have a bona fide third-party trustee who is independent of the asset owner.
• The asset owner must transfer the asset they wish to sell to the deferred sales trust. In exchange, the owner receives an installment payment agreement that outlines how the trust will pay the sale proceeds to the owner.
• The trust sells the asset to a bona fide third-party buyer and receives the sale proceeds. The asset owner cannot accept any legal or beneficial interest in the proceeds or take possession of the proceeds.
• The owner only pays capital gains taxes on the sale when the deferred sales trust distributes proceeds from the asset sale to the owner.

Pros and Cons of Using a Deferred Sales Trust Across Different Asset Types

Different assets have different pros and cons when using a deferred sales trust to manage capital gains taxes:

• Real estate – The benefits of using a DST with real estate include greater flexibility in reinvestment opportunities and avoidance of the strict timing restrictions imposed by a 1031 exchange. However, deferred sales trusts have ongoing operational expenses as the trustee manages the sale proceeds and distributes them to the property owner.
• Business ownership interests – Selling a business through a deferred sales trust allows you to defer and distribute the tax liability from the sale of a significantly appreciated company, potentially reducing your overall tax impact. Cons include not realizing immediate liquidity from the sale, as the sale proceeds must initially be allocated to the trust.
• Securities – One advantage of using a DST to manage capital gains taxes on securities is the ability to defer taxes and potentially receive more favorable tax treatment through structured installment payments. However, you give up ownership of your investments to the trust.

Call Us Today to Learn How a Deferred Sales Trust Could Work for You

If you’re thinking about selling an asset that has gained in value, a deferred sales trust attorney from 453 Trust Powered by Pennington Law can provide personalized guidance in a free consultation. Call or contact us now to get started.