June and John were a gregarious couple who owned and operated a successful upscale restaurant in San Francisco. They not only owned the restaurant, but also the building in which it was located. While they loved their business, they were now in their late 50s and looking forward to retirement. As often happens, however, none of their three grown children had any interest in taking over the business.
Discreet inquiries to commercial real estate brokers revealed that they could sell their business and its building for at least $10 million. After commissions and other costs, this would give them a net profit of $9.3 million.
While this was certainly good news, June and John had two major concerns: the amount of capital gains taxes they’d have to pay and how to preserve their family wealth to pass on to their children.
Potential Tax Situation
Their basis in the business, consisting mostly of the purchase price of their building and the improvements they’d made to it, was $1.5 million. Consequently, they would have a long-term capital gain of $7.8 million when they sold, leaving them facing payment of the following taxes:
- 20% federal capital gains taxes = $1,560.000
- 13.3% California state capital gains taxes = $1,037,400
- 3.8% Medicare tax = $296,400
The result? A whopping $2,893,800 in taxes and only $4,906,200 remaining for their retirement and to pass on to their children. Ouch!
What they needed was an exit strategy that would allow them to sell their business without paying capital gains taxes and therefore preserve their family wealth. Did any such strategy exist?
Enter the DST
Yes, it did—and does. It’s called the Deferred Sales Trust (DST), and it makes the perfect exit strategy when selling a business or other highly appreciated asset. This legal, safe, tested and proven tax strategy is a proprietary form of the installment sale method authorized by Section 453 of the Internal Revenue Code.
In addition to deferring June and John’s payment of capital gains taxes, the DST also let them turn their illiquid asset into a liquid one by allowing their Reef Point Independent Certified DST Trustee to reinvest their entire $9.3 million net sale proceeds in whatever “prudent investments” they desired. Assuming even a very conservative 5% rate of return, this amounted to $465,000 in annual interest that their installment note could pay them without their facing any capital gains tax liability.
Standard DST and DST Plus
Remember June and John’s second major concern about selling their business? They wanted to preserve and continue to grow their family wealth to pass along to their children. Once again, their Reef Point-managed DST provided exactly what they needed to accomplish this goal.
They put some of their sale proceeds into a Standard DST and the remainder into a DST Plus. They thus gained not only the advantages offered by a regular DST, but also the additional advantages offered by its companion.
Under the DST Plus, they will continue to receive installment note payments during their respective lifetimes. Thereafter, the remaining balance will pass directly to their children outside of their estate. This could save their heirs as much as 40% in estate taxes.
What Can the Standard DST and DST Plus Do For You?
All in all, DSTs solved both of June and John’s concerns about selling their business. If you’d like to find out how one or both of these unique tax strategies can work for you, contact Reef Point today.