Actually, there is only one reason why anyone should defer capital gains taxes: more money.
Capital gains taxes often reduce profits by 40% or more. Finding ways to defer taxes and invest the excess is one of the ways that the 1% continues to build astronomical wealth.
However, no matter your income status, you are wise to consider smart tax strategies whenever you realize a substantial financial gain. You may sell a highly profitable home or business or receive a significant asset windfall such as an inheritance. If you stand to earn $400,000 or more in profit, establishing a deferred sales trust can sidestep the capital gains tax bill for anywhere from a year to 10 years or more.
And now you are the one with more money.
Theory Behind a Deferred Sales Trust
Without going into too much detail, a deferred sales trust (DST) is a tax strategy in which you bypass (defer) the capital gain from an asset sale by not owning the proceeds. When you are ready to sell an asset, you transfer its ownership to the DST instead of making the transaction with the buyer. The trustee will complete the sale and deposit the profit, or principal, proceeds into an investment portfolio owned by the trust and approved by the seller in advance.
You do not owe any capital gains taxes until you begin to receive installments of the principal per your pre-negotiated trust agreement. Yet, the real benefit lies in the ability to use the dollars you otherwise would have paid in taxes in the year of sale in order to deliver a higher amount of income or to generate wealth more rapidly, or a combination of both.
To put a number on it, let us assume that your sale will profit you $600,000, of which lets say about one-third, or about $200,000 would typically be due in taxes in the year of sale. Instead of diluting your equity with an up front tax payment, you keep those tax dollars along with the rest of your equity to fund a DST. Then consider the interest you could be earning just on the $200,000 that otherwise would have been paid in taxes. Assuming you could earn a moderatly conservative 6% return, you could generate an additional recurring annual income of $18,000 that would not otherwise be achievable had you diluted your investment nest egg by the amount of the capital gains tax. Furthermore is the possibility of paying taxes at lower tax brackets during each year you are receiving payments from the trust. Reason being, that a capital gain added to your other income all at once will often place you in or near the top tax brackets, while choosing to only receive payments from the trust each year needed for your desired lifestyle can in many cases reduce your tax bracket by 10% – 15%. The two fold benefit is more money for you and more money invested for your direct benefit and your future.
4 Reasons Why You Should Establish a DST
Now that you have safely tucked your capital gain away and have it working for you, here are four practical reasons why you should be proud of your decision.
1. Shift your focus to having your assets working for you, instead of you working for your assets
Whether you are a business owner looking to retire or a landlord who is growing tired of the tenants, toilets and trash; can’t fully enjoy your desired lifestyle because you are equity rich but cash poor; or just desire the freedom to travel or spend more time with family, being able to unlock your equity while deferring your taxes for greater income and/or growth without the burdens of being a landlord just might be your answer.
2. Shift your strategy to generate more consistent and reliable income
Business owners often experience fluctuating income due to seasonal or cyclical economic conditions and the need to continually invest back into your business to keep it growing. Real Estate Investors can also experience uneven cash flow due to vacancies, deferred maintenance costs, variable mortgage interest rates or outside forces such as rent control.
In both of these cases, owners of these types of assets may find themselves thinking of selling in order to enjoy life more, but conclude that it may be difficult to replace the income they are currently receiving by only being able to reinvest the after tax sale proceeds. Many are surpised to learn that using the DST to defer their taxes quite often creates the ability to actually generate even more income than their current business or real estate investment provides.
3. Reduce risk and volatility in your financial life
Whether you are a business owner or a real etate investor, lets face it, these are liability prone assets subject to forces outside of your control. What if you could swap a single asset in a single asset class which may be subject to various forms of liability, for a more passive and diversified portfolio with none of the same inherent liabilities, that also can deliver consistent reliable income and if desired also target growth through appreciation? This is but one of the typical client profiles that gravitate towards exporation of the DST as the best path towards their desired next chapter in life.
4. You Can Stop Worrying About Your Family’s Future
Simplify your life by removing burdens to living your best life as your lifestyle needs change. Lower your investment risks and secure your financial future. Plan to leave the legacy you want for your family. Will your children have the interest and ability to carry on the family business or to hold on to and properly manage your real estate investments? If so, great but will all your children wish to inherit and participate in managing these types of assets? If not, is there enough inheritance to go around so that each of your children can persue their own dreams? Using the DST may just provide the flexibility you are seeking to allow your legacy to serve each of your children in the way that serves their needs and interests best.
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You do not have to be ultra-rich for a capital gains tax deferment strategy to make sense. Contact us for a consultation, and we will help you structure a DST that meets your needs.