How Are Deferred Sales Trust Funds Protected?

In previous articles we discussed how the Deferred Sales Trust (DST) is a specialized form of installment sale authorized by Section 453 of the Internal Revenue Code. In a DST Trust installment sale, the entire course of the transaction and its continued operation revolves around a secured installment note in favor of you, the seller. In this context, “secured” means that all of the assets in the DST serve as collateral, i.e., security, for repayment of money to you per the note’s terms.

But how are the DST’s assets protected so that this collateral remains good? Actually, in several ways.

Transaction Protection

Typically, the Trust will first set up a controlled bank account to receive and secure the proceeds from the sale of your original substantially appreciated asset(s). The Trustee will then likely transfer the DST funds to an institutional investment custodian such as TD Ameritrade, Bank of New York, Charles Schwab, etc.

While the Trustee makes all DST investments on your behalf, (s)he cannot do this without your prior approval, given via a written authorization that both you and (s)he sign. The bank acts as a de facto escrow agent to verify the signed instructions and then carry out the instructions. The Trustee likely will retain an experienced, trained and vetted investment advisor to help make suitable and prudent recommendations, but the final approval with regard to those recommendations rests with you.

As a second layer of transaction protection, should you ever lose cash or securities from your account due to unauthorized activity, the custodian will reimburse you for the cash or shares of securities you lost.

Diversification Protection

Under a more traditional installment sale, the only asset that backs your ability to be repaid is the asset you used to own, but no longer control.   In many cases that asset is also illiquid, meaning that it is not easy or convenient to seize control over that asset if things go wrong.

Within the context of the installment sales using the DST, your collateral can be repositioned in a more liquid and diversified way as ultimately you make the decisions about.  Between the two, having an installment with diversification is usually a much better approach.

Judgment and Creditor Protection

If one of your creditors or someone else sues you and obtains a judgment against you, the principal and earnings held by the Trust are generally out of his or her reach. Why? Because the DST, not you, owns the assets in it. At worst, the judgment holder might, in some situations, be able to access the contractual distributions the DST is obligated to pay you.

The same holds true if someone obtains a judgment against the Trustee. In fact, your DST fund protection here is even greater. As with any kind of a trust, the Trustee is a fiduciary, i.e., the person who manages and disburses the trust assets for the trust’s beneficiary or its secured creditor, in this case, you. (S)he has no ownership in or claim to either the trust assets or the monies distributed to you per the installment sale agreement.

Buyer Default Protection

Finally, since you are the secured creditor to whom all DST assets are owed, you are in first position to get paid in the event of a default, judgment or bankruptcy on the part of the ultimate buyer of the investment property you sold to the DST and it, in turn, sold to him or her.   Remember that the asset you sold would now no longer be used as collateral, so you would never have to worry about having to take that particular property back.

Our Commitment To You

While no wealth-building method is entirely devoid of risk, Reef Point and the Estate Planning Team™ will work hard to make sure that you understand every advantage and disadvantage involved in a DST. We will also advise you on the best ways to neutralize any potential downfalls. Contact us today for your free DST analysis.