When you wish to sell one of your high-dollar, highly appreciated assets, one of your main concerns likely is the amount of long-term capital gains taxes you will have to pay. This is where the Deferred Sales Trust (DST) can solve your problem. Using this tax-saving strategy, you can sell your asset with no immediate capital gains liability. Instead, any capital gains taxes you owe can be deferred almost indefinitely.
The DST itself, however, comes with its own concerns. The main one is that it must qualify as an installment sale under Section 453 of the Internal Revenue Code in order for you to receive the favorable capital gains tax deferral treatment.
This, in turn, depends on making sure that your DST meets the following four considerations:
- The trust must be a legitimate one, not a “sham trust.”
- It must have an independent trustee, one not related in any way to you.
- The trust, not you personally, must own the asset at the time of its ultimate sale, and you must retain no residual ownership interest in it.
- You must have no constructive receipt of any of the sale proceeds.
Let’s look at each of these considerations in more detail.
1. Legitimate Trust
In the 1980 case of Markosian v. Comm’r, the tax court established the following 4-factor test for determining the legitimacy of a DST:
- The taxpayer’s relationship to the transferred property must materially differ before and after the trust’s creation.
- The trust must have an independent trustee.
- The trust’s economic interest must pass to the designated trust beneficiary or beneficiaries.
- The taxpayer must respect the restrictions placed on the trust’s operation.
2. Independent Trustee
In the 1981 case of Lustgarten v. Comm’r., the Fifth Circuit established that a DST’s trustee must be independent and not related in any way to the taxpayer. IRC Section 1239(b) defines a related person as any of the following:
- Any person or entity related to or controlled by you.
- Any trust of which you or your spouse is a beneficiary, except one in which your interest is a remote contingent interest as defined by Section 318(a)(3)(B)(i).
- An executor and beneficiary of your estate.
3. Property Ownership at Time of Sale
This one is easy. To qualify as an installment sale, you must transfer, i.e., sell, your property to the DST rather than to your intended buyer. The trust itself then must sell the asset to the ultimate buyer.
4. Constructive Receipt
If the DST fails in any of the first three respects, you will be deemed to have constructive receipt of the ultimate sale proceeds. This means that the entire sale amount will be imputed to you for income tax and capital gains tax purposes because you controlled it, even though you did not actually receive it.
Making Sure Your DST Passes Muster
The best way to ensure that your DST meets all the requirements imposed by IRC Section 453 and other laws is to establish it through Reef Point. Not only are we and the professionals on our Estate Planning Team well versed in the qualifications needed for a DST, but Greg Reese, our principal and managing member, is one of only 13 trained, vetted and approved Independent DST Trustees in the country.
You can therefore rest assured that your Reef Point DST will be the safe and legal tax-saving strategy you’re looking for when you sell a highly appreciated asset. Contact us today to find out more.