What is a DST?
A Deferred Sales Trust (DST) is a financial structure which allows individuals to defer paying capital gains taxes on a large sales transaction. When you sell a piece of property or other high value asset, you need to report the sale on your tax return for the year in which the sale occurs. When you report the sale, however, you’ll owe taxes on your capital gains upfront. For 2024, federal capital gains taxes are as high as 20% (or higher) depending on your tax status, state you reside in and income–meaning a sizable amount of your money goes to Uncle Sam.
A DST offers an alternative way to handle the transaction. Rather than pay the taxes all at once at the time of sale, a DST can allow you to break up the taxes owed. You still pay capital gains tax, but you break it up, paying only when you receive installment payments from the trust. You can reinvest a large portion of the money you make during the deferment period. Thus, the money deferred on taxes can be reinvested to provide growth over time. This is kind of like an IRA.
How does DST work?
Typical sales transactions involve a seller and buyer only. The seller offers goods or services in exchange for payment from the buyer. The buyer receives the goods and services, while you, the seller, receive payment. If you receive profit from the sale of an asset such as an investment, bitcoin, business, or property, the increase falls under the category of capital gains. You will be required to pay capital gains tax.
When using a Deferred Sales Trust, you and the buyer don’t exchange directly. Instead, you sell your business, property, or other asset to the established trust. Then the trust sells the asset to the buyer. You receive a promissory note from the trust, with an agreement to issue payments in the form of installments; monthly, quarterly, or yearly.
Now, as the noteholder, you must approve where the trust invests the proceeds. Most noteholders maintain the capital gains tax deferral by opting for interest-only payments from the trust. This strategy leaves the principal intact, and only ordinary income tax is owed on the interest payments received. Alternatively, you could choose to withdraw a portion of your profits, in which case you would owe capital gains tax only on that principal withdrawal.
DST vs 1031 Exchange
If your asset is real estate, you may be familiar with a 1031 exchange. It allows you to take the proceeds of a real estate transaction and roll it into another like-kind property. Essentially deferring your capital gains tax. A Deferred Sales Trust (DST) and a 1031 exchange are both strategies used by investors to defer taxes on high-value asset transactions. However, they operate differently and have distinct features.
Asset Types:
DST: Can be used for a wider range of assets beyond real estate, including businesses, intellectual property, cryptocurrency, and more. It allows for the deferral of capital gains taxes on the sale of these assets.
1031 Exchange: Also known as a like-kind exchange, specifically applies to real estate transactions. It allows investors to defer capital gains taxes by reinvesting the proceeds from the sale of one property into another similar property.
Timeline:
DST: Taxes are deferred until the proceeds are distributed from the trust–which could be at a later date chosen by the seller. This flexibility allows for more control over the timing of tax payments.
1031 Exchange: Taxes are deferred only if the seller reinvests the proceeds into a new property within a specific timeframe, typically 180 days from the sale of the original property. The tax deferral is contingent upon meeting these strict deadlines.
Flexibility:
DST: Sellers have more control over the timing and amount of distributions from the trust per the promissory note, as well as the ability to pass on promissory note to their designate beneficiaries. It can provide greater flexibility in managing tax liabilities and financial planning.
1031 Exchange: The rules governing 1031 exchanges are more rigid. They have strict requirements regarding the acquisition of replacement properties within the designated timeframes, leaving sellers with less flexibility and control over the process.
Investment Options:
DST: The funds in a DST can be invested in a variety of assets, including stocks, bonds, mutual funds, bitcoin, real estate, and other investments, providing potential for portfolio diversification and growth.
1031 Exchange: The funds from a 1031 exchange must be reinvested into like-kind real estate properties, limiting the investment options to real estate assets.
Bottom Line
A Deferred Sales Trust is a valuable financial tool that can be used to defer taxes from the sale of large assets. If you are planning to sell a business, property or other significant holdings, a DST may be the tool you need to keep your money working for you longer. Contact our team and we’ll explain how to defer the capital gains tax you owe when you sell your highly-appreciated assets.
Infographic
A Deferred Sales Trust (DST) allows individuals to postpone paying capital gains taxes on major sales, like property, by not requiring immediate tax payment upon reporting the sale in the tax return of the sale year. To learn more about DST, check out the infographic below.
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