As a real estate investor, a solid exit strategy is important for maximizing your returns and minimizing tax liability. Selling properties or using a 1031 Exchange both have their benefits, but there’s a lesser-known option that could transform the way you approach your real estate investing: a Deferred Sales Trust (DST).
Why Choose a Deferred Sales Trust?
A 1031 exchange is a commonly known tax strategy which allows investors to delay paying capital gains tax when buying and selling real estate investments. If you use a 1031, the IRS gives you 180 days from the time you sell one property to reinvest the money back into another like-kind property. This strategy is limited to those who are using the real estate for business or investment purposes. This option doesn’t work for selling your primary residence. A Deferred Sales Trust isn’t limited in the same ways. Here are the benefits of using a DST:
Deferred Taxes
One of the primary reasons to consider a Deferred Sales Trust is its ability to unlock tax savings. Instead of immediately paying capital gains upon the sale of a property, a DST allows you to defer those taxes and spread them out over time. This strategy can result in substantial tax savings, allowing you to retain more of your profits for reinvestment in real estate or other investments.
Reinvestment Flexibility
Unlike a 1031 exchange, a DST gives your options for how to reinvest your funds. You’re not limited to putting your funds back into like-kind properties within a 180-day timeframe. With a DST, you can diversify your investment portfolio beyond real estate and into stocks, bonds, mutual funds, cryptocurrency, and more. Not only do you have flexibility of diversifying into other asset classes, but you also have the ability to reallocate investments and re-enter the real estate market at optimal times. With the DST you can truly sell high and buy low with no time restrictions.
Asset Protection
Another advantage of a Deferred Sales Trust is asset protection. By placing your assets into a trust, they’re sheltered from lawsuits or other tax claims. This protection can provide peace of mind knowing that your hard-earned assets are safeguarded against unforeseen circumstances.
Wealth Disbursement
When structured appropriately, you can pass on assets directly to your heirs while minimizing estate taxes and probate costs. The trust structure allows you to skip all that, passing your wealth with your beneficiaries. It allows you to leave a legacy for future generations.
How to Execute a Deferred Sales Trust
Selling investment real estate through a Deferred Sales Trust requires collaboration with a team of knowledgeable professionals. This team typically includes a tax attorney, an unrelated third-party trustee, and a financial advisor. Together, they ensure that the DST is feasible and aligns with your investment goals and objectives. Assuming the DST is a good fit, this team will establish the trust and coordinate with you, your real estate broker, and all other parties involved in managing the sales transaction. It is crucial to form the trust before selling the investment property and to have an unrelated third-party trustee in place to maintain the deferral of capital gains tax.
Here’s how this strategy actually works in practice once you have a committed buyer in place to purchase your property.
1. Sell Your Property to the Trust
Rather than conducting a traditional sale and directly receiving the proceeds, which would trigger your capital gains tax owed, you sell your asset to the trust and in return receive a promissory note.
2. The Trustee Sells the Real Estate
The trustee then sells the property to the buyer, which is typically done on the same day your asset was sold to the trust, as a “simultaneous close.” The buyer receives the real estate, and when the transaction is complete, the trust receives the proceeds. The trust will then start to pay you, the seller, in multiple installments as guided by the promissory note.
3. Payment Structure
Instead of receiving a lump sum from the proceeds, which would trigger capital gains taxes, you receive smaller amounts according to a payment structure established by the trust. The payments are tailored to your needs. By piecing out your profits, you’re given flexibility and control over the cash flow of the proceeds. This also extends that control to any capital gains taxes you may owe, spreading it out over time, rather than all at once. The promissory note also can be set-up to pay interest only payments keeping the capital gains tax 100% deferred.
4. Reinvest
The structure of the DST allows you to defer capital gains taxes by not receiving the profits all at once. You get to keep more of your profits and can reinvest those funds into other investments or retirement savings.
Start Planning Now
The flexibility of a Deferred Sales Trust supersedes the 1031 exchange. There are no strict timelines, and you are not limited to reinvesting back into real estate. The trust is also not limited to only managing real estate sales. You can use the trust for other high-value asset sales like businesses, cryptocurrency sales and more. However, you will need a deferred sales trust trustee to manage the trust.
A Deferred Sales Trust requires professional expertise. Working with experienced tax attorneys and Deferred Sales Trust trustees can help you set up this strategy correctly and legally defer capital gains taxes. If you’re considering selling real estate in the near future, contact Capital Gains Tax Solutions for a free consultation. We’ll go over how a DST could work to help you keep more of your profits.
Infographic
As a real estate investor, it’s important to have a solid exit strategy to maximize returns and minimize tax liability. Consider using a Deferred Sales Trust (DST), as it offers unique benefits. Find out more in this infographic.
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