Deferred Sales Trusts are valued by many investors and regular people selling investment properties because they represent an opportunity to defer taxes. Deferring taxes from selling a highly appreciated asset provides the investor or seller with an opportunity to invest the proceeds from the sale of the asset. However, some sellers comment that the legal fee associated with setting up a deferred sales trust is too high to make the benefits of such a trust worthwhile. But is this logic sound? To find out, let’s dive into a case study that illustrates how the cost of choosing not to implement a deferred sales trust is actually higher (both upfront and in the long run) than paying the legal fee required to set up such a trust.
Sale of Valuable Asset
Robert and Carol choose to sell an asset worth $1 million to help them plan for retirement. They know they will owe a substantial amount ($250,000) in capital gains tax on the sale of their asset. They plan to reinvest the remaining funds so they can receive a reliable stream of income until they are ready to retire. A deferred sales trust is arguably the best way to achieve their investment goals.
Setting up a DST will require Robert and Carol to pay a one-time legal fee equaling 1.5% of the sales price ($15,000 in this case). They will only need to pay this amount if they decide to sell the property and use the DST to help them defer their taxes. Eventually, Robert and Carol will need to pay their deferred capital gains taxes (equaling $250,000), but a DST gives them the opportunity to invest the funds from their sale in the meantime.
Opportunity Cost of Not Implementing a DST
To help them decide whether it is worth it to pay the DST legal fee, Robert and Carol need to determine the opportunity cost of not implementing a DST. Without a DST, the couple would pay $250,000 in capital gains tax and would have $750,000 leftover to reinvest. With a DST, the couple would be able to reinvest the $250,000, minus the $15,000 legal fee.
Imagine that the additional $250,000 (thanks to the DST) were reinvested conservatively and provided an income stream of 5%. At this rate, it would take a little more than a year for the reinvested funds to bring in enough profit to cover the original $15,000 legal fee. After that, the couple would make an additional $12,500 every year afterward. By choosing not to implement a DST, Robert and Carol would miss out on all that income!
Entrepreneurs selling their businesses for example love this. In the course of building their businesses they often make decisions on how and when to reinvest in their company. Often they will apply a break even analysis to find out if the proposed investment will pay for itself in terms of cost savings or added revenue within 18-24 months. The DST on average achieves break even in 8-13 months! The same analysis works for sellers of Real Estate and other highly appreciated assets.
If Robert and Carol decided not to utilize a DST, they might also have too much equity in their taxable estate. This could result in higher taxes on their estate. Taking advantage of our DST Plus structure can creatively remove asset ownership when the transaction is finalized and thus remove the associated equity from the couple’s taxable estate.
In conclusion, taking advantage of the DST saves Robert and Carol money in the long run and provides them with a consistent income of $12,500 (conservatively) every year after the first year of investment. Would you like to learn how a DST can benefit you? Contact Reef Point to request an obligation-free consultation.