A Deferred Sales Trust (DST) is a way to defer capital gains tax for high-value asset transactions. While a DST is a solid strategy, there are some common myths and misconceptions about how they work and how beneficial they can be. Understanding how a DST can help you before you sell your property or business is vital if you want to make it work for you. Let’s clear up some of these common misunderstandings about Deferred Sales Trusts.
1. DSTs are Too Good to be True
Some people believe that DSTs offer unbelievable tax benefits with no risk. While DSTs can provide real capital gains tax deferral benefits and potential investment growth–they are not without risks. DSTs don’t prevent you from paying taxes, they allow you to defer the capital gains tax payments. Depending on how your trust and promissory note are structured, you will still need to pay taxes on the portion of the profits that are paid out to you. How much and how often will be determined by how the trust pays you. For instance, a DST promissory note can be structured to make interest-only payments, which maintains the deferral status of the capital gains tax owed.
2. DSTs are Only for the Wealthy
While DSTs are often used by high net-worth individuals and business owners, they can be beneficial for a wide range of sellers, including those with moderate assets. Many homes purchased 30 years ago in desirable areas of the country have appreciated significantly. Taxes on the profits from this type of sale could be significant. Whether or not a DST is right for you depends on individual financial goals, tax situation, and the nature of the asset being sold. Capital gains tax can exceed 33% when accounting for both federal and state obligations. Additionally, in certain situations, high-income earners may be subject to the Net Investment Income Tax (NIIT), which adds an additional 3.8% in tax. Even if this is your first time selling a business or large asset, you can take advantage of this tax deferment strategy too.
3. DSTs are an Illegal Loophole
DSTs are a legitimate tax planning strategy that complies with IRS regulations and guidelines. However, like any tax strategy, they must be structured correctly to ensure compliance with the tax code. Working with experienced professionals who specialize in DSTs can keep everything above board and legal. To use a DST, you should begin planning well in advance of your asset sale.
4. DSTs are Only for Real Estate
While DSTs are commonly used in real estate sales, they can be used for a variety of high-value asset transfers, including businesses, cryptocurrency, and more. Because of their flexibility, you can transfer the profits between asset types. For example, if you sell a business using a DST, you can then use the trust to invest that money in investment real estate. By using the trust to purchase investment real estate, you have deferred capital gains tax on the profits of your real estate sale and now have a vehicle to grow those profits.
5. DSTs are Too Complex
While DSTs involve legal considerations, they can offer more flexibility and control over how and when you pay capital gains taxes. While the process may seem complex, knowledgeable advisors can help simplify the process and ensure that the trust is tailored to meet your specific needs and goals. Your financial advisor should answer all your questions and be transparent about what level of management will be required over the years.
6. DSTs are Only for Avoiding Taxes
While deferring capital gains tax is a significant benefit of DSTs, they can also provide other advantages. Sellers may choose to use a DST as a way to protect their assets and pass on the wealth to future generations. A DST allows the trust to invest in a variety of options like stocks, bonds, mutual funds, cryptocurrency, and other financial vehicles to maximize the trust growth and diversify your portfolio.
7. DSTs are the same thing as a 1031 exchange
While DSTs and 1031 exchanges both enable individuals to defer capital gains tax payments, the 1031 is more stringent on when it applies. A 1031 exchange only applies to real estate transactions and must be completed within 180 days of the initial sale. A 1031 allows you to roll the profits from the sale of one property into the purchase of another similar property. DST’s can be used for the sale of real estate and other types of high-value assets like businesses or cryptocurrency.
Don’t believe everything you hear about Deferred Sales Trusts. They are real, legal, and can offer significant benefits for those selling high-value assets. DSTs are more flexible and offer more control than similar tax strategies like 1031 exchanges. With a DST you can not only defer capital gains tax, but also protect your assets and pass your wealth onto your posterity. Consulting with tax and financial planning professionals can help you implement this tax strategy.