A client recently asked me this question: “What, in your opinion, is the possibility that a change in presidential or congressional leadership brought about by this year’s elections could lead to the closing of the DST tax loophole?”
This is a great question. Why? Because sellers of appreciated assets who are considering using a DST (Deferred Sales Trust) as a vehicle for deferring capital gains on the sale of their assets will likely be using this strategy for anywhere from a few years to several years or longer.
My opinion is that you have nothing to fear. The good news is that a DST is not a tax loophole. It’s a special kind of installment sales contract that allows you to defer capital gains. Section 453 of the Internal Revenue Code specifically authorizes the installment method when selling appreciated assets such as real estate, businesses, etc. Tens of thousands of sellers have used installment sales as a strategy over the past 90 years or so.
For example, have you ever sold your business where the sales terms included the buyer paying part of your sales price in installments over a period of years? Or when selling a piece of real property, have you ever carried back part of the selling price to provide seller financing for your buyer? Possibly you did this to get a better price, to defer your payment of capital gains or to incentivize someone to buy your difficult-to-sell property.
Similar to the laws regarding 1031 exchanges and retirement plans such as IRAs and 401(k)s, certain tax deferral strategies are not only mainstream, but the government long ago decided it was in the public interest to make them part of our tax code. In the case of retirement plans, they discovered that it was in the public interest to allow employees to save for retirement more quickly using tax deferral so that fewer people would be dependent upon the government at retirement. They also discovered that the Treasury Department ultimately collected more in tax dollars. Win for us, win for them.
When it comes to 1031 exchanges, they learned that giving real estate investors a tax incentive to sell their real estate investments stimulated more economic activity and supported enterprises such as the following:
- Real estate brokerages
- Lending institutions
- Escrow institutions
- Tax preparers
Without this tax break, far fewer people would sell their appreciated real estate, they would be less inclined to invest in improvements and we would not have all the additional economic activity that creates jobs and supports families. Also, at the end of the day, the Treasury again tends to collect more money than if they taxed every real estate transaction at the time of sale.
My studies of government and policy show it’s true that we see a lot of crazy stuff and our politicians do not always seem to think about or understand the unintended consequences of their actions. At the same time, the policies that tend to stand the test of time, such as Social Security, Medicaid, IRAs and 401(k)s, seem to share one overriding principle: They’re in the long-term public interest.
I think we are on pretty safe ground with IRC 453 and government-sanctioned tax deferral policies. No matter who has won various elections, we can only hope that they find ways to expand these types of benefits for our citizens in the future.
If you’d like to learn more about DSTs and the benefits they provide, contact Reef Point online or call us at (714) 581-5376.