Overview of the Deferred Sales Trust™

Investors must address the issue of capital gain taxes when selling or disposing of real estate or other personal property ("assets").  Real estate or personal property that has appreciated or grown in value while owned by the investor will trigger capital gain taxes upon the sale or disposition of the asset.  In addition to capital gain taxes, asset sales or dispositions may also trigger depreciation recapture in the year of the sale or disposition. 

Generally, most investors are searching for tax planning strategies that will allow them to defer, exclude or avoid the payment of their capital gain taxes and depreciation recapture taxes.  Sorting through all of the various tax-deferral and tax-exclusion strategies and structures that are available to you can be very complicated and confusing.  You should always review your capital gain tax and depreciation recapture tax situation and the various tax deferred and tax exclusion strategies with your tax and legal advisors before proceeding with any transaction.

1031 Exchange May Not Be the Right or Best Solution

Investors have generally flocked to the 1031 exchange in order to defer the payment of their capital gain taxes and their depreciation recapture taxes, if any.  The 1031 exchange is an excellent tool when you wish to defer the payment of your capital gain taxes generated from the sale or disposition of your real property or personal property. 

Your capital gain taxes and depreciation recapture taxes can be deferred indefinitely by using a strategy commonly referred to as 'swap until you drop.'  Your capital gain and depreciation recapture taxes are deferred throughout your lifetime until you ultimately stop 1031 exchanging and sell or dispose of the property and recognize and pay your capital gain and depreciation recapture taxes. 

However, the 1031 exchange requires that you acquire one or more like-kind replacement assets in order to defer the payment of your capital gain taxes when you sell an asset.  What about those of you that are selling an asset and do not want to acquire a replacement asset, especially an asset that can be difficult to locate like-kind replacement property for such as the sale of a business operation?  You just want to sell the asset and move on with your life, but you do not want to pay all of your capital gain taxes in the year of sale. 

Installment Sale Strategy

This situation can be easily solved with an installment sale note, which is often referred to as a seller carry back note or seller financing, pursuant to Section 453 of the Internal Revenue Code.  You would structure the sale or disposition of real property or personal property to include seller financing where you finance all or a portion of the acquisition of your real or personal property by the buyer. 

The installment sale strategy has positive and negatives like any other tax deferred strategy.  Your capital gains can be deferred over the period of the installment sale note depending on how the note is structured and how much of the transaction is financed using the installment sale note.  Your depreciation recapture is generally recognized and taxable in the year of sale and can not be deferred over the term of the note.  This last issue is always a big surprise to investors when tax time comes around.

Possibly the biggest negative is the risk that the buyer will default on the installment sale note.  The process to foreclosure or otherwise resolve the situation can take time and money, and the asset may have been damaged by the buyer in the meantime. 

The Deferred Sales Trust™ can eliminate this risk and provide some other great advantages in structuring the sale or disposition of your real estate or other personal property so that you can defer the payment of your capital gain taxes over time rather than paying them all in the year of sale. 

What is a Deferred Sales Trust?

The Deferred Sales Trust™ or DST™ just might be the tax-deferred solution you are looking for as an alternative to the 1031 exchange.  The Deferred Sales Trust can be a very effective tax-deferred strategy because you do not acquire any like-kind replacement property. 

Deferred Sales Trusts are also drafted pursuant to Section 453 of the Internal Revenue Code just like an installment sale.  Your capital gain is recognized, but it is deferred over a predetermined period of time that you choose in advance.

Using the Deferred Sales Trust reduces your risk exposure related to the seller carry back note because the buyer must pay for the asset(s).  The Deferred Sales Trust receives the sales proceeds and may defer the payment of your capital gain taxes by preventing your receipt of the sales proceeds until a future date when the periodic payments are made.

No Guidance from the Internal Revenue Service, Yet

As noted above, Deferred Sale Trusts are drafted pursuant to Section 453 of the Internal Revenue Code.  However, The Internal Revenue Service has not yet ruled on this tax-deferral strategy.  There are a number of Deferred Sale Trust Private Letter Rulings (PLRs) pending with the Internal Revenue Service, but none have been issued so far.

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