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IRC 453 Installment Sales: Can the DST still work if the Seller is doing a Seller Carry-Back note directly with the Ultimate Buyer? Part 2 of 2

Reef Point LLC · February 28, 2023 ·

Puzzle pieces with text “Tax tips”, calculator, note pad, computer keyboard and mouse on a blue wooden background

Yes, the seller may incorporate both a Deferred Sales Trust and a direct seller carry-back with the ultimate buyer.

Both techniques are governed by the same IRS Code (IRC 453) and both allow the Seller to defer taxes until periodic installment payments are actually received.

In either case, the Seller is effectively acting as the bank or the mortgage holder and loaning money to the buyer (or the DST Trust in the case of the DST)  to be repaid at an agreed upon schedule with interest back to the seller.

It should be noted that a direct carry-back between a individual seller and an individual buyer  (not using the Deferred Sales Trust, or DST)  results in some additional risks born by the seller and certain leverage points for the buyer.

The risks for the seller can include:

  • Foreclosure Risk – Risk of having to foreclose on the property in the event the buyer does not make all of their scheduled payments –
    • what if they did not properly maintain the property or the value of the property declined in the intervening period?  You could incur a loss of income, perhaps have to invest more money in the property to get it saleable again,  re-incur costs associated with re-selling the property such as commissions, title, escrow, etc..
  • Collateral Risk – Risk of having the property or business they used to own but no longer control as the sole source of collateral for repayment of their “loan/mortgage”.
    • In the event the seller has to foreclose it is possible the value of the property declines in value resulting in a partial loss to the seller.
  • Prepayment/Refinance Risk – Risk that the buyer may seek to refinance through a bank or other financial institution –
    • If the buyer refinances, the seller would be paid off in full and have to pay all the taxes in a lump sum shortly thereafter.
  • Renegotiation Risk – Risk that the buyer may try to renegotiate the seller carry-back note to extract more favorable terms for themselves, such as a lower interest rate, reduced payments or a longer carry period.
    • The seller can always say no, but the leverage the buyer could exert is simply to refinance with a bank forcing you to receive and pay taxes on the proceeds of your seller carry-back note.

Impact of Direct Seller Financing (Carry-Back) when using the

Deferred Sales Trust (DST)

There are two methods to assess this situation.  When the DST is implemented, any unneeded cash proceeds from the sale will be placed in the trust, preventing the seller from being subject to constructive receipt and avoiding the responsibility of paying taxes on the funds received by the trust.

For the portion of the sales/purchase price represented by the seller financing (carry-back), the seller may usually elect one of the following options:

  •  Seller elects to personally service direct payments from buyer on the note.
    • With this option, the seller will directly receive the installment note payments from the buyer and personally manage the risks associated with servicing the note.
    • In the event the note matures or the buyer signals that they are planning to pay off the note early, such as by refinancing with a bank, the seller has the option of “selling the note” before the payoff occurs to their DST for the exact amount due.
    • When this might be beneficial for the seller.   If the amount of monthly or other regular payments called for in the note are consistent with the seller’s lifestyle income needs. 

As a comparison, if you were to think of income payments as if they were coming from your IRA or 401(k), typically you may only wish to withdraw/receive an amount of income necessary to support your desired lifestyle needs, and only pay taxes on what you choose to receive, as opposed to over-withdraw and pay taxes on money you don’t yet need.

  • Seller elects to have the seller carry back note payments sent directly to, and serviced by the Trustee of the DST Trust.
    • If the regular payments that the buyer is supposed to give to the seller are more than what the seller needs to maintain their desired lifestyle, it might be better for the DST (Deferred Sales Trust) to receive the payments from the buyer and only give the seller the amount they actually need and are willing to pay taxes on.   E.g.  Perhaps the payments from the buyer are $10,000 per month but the seller only currently needs $5,000 per month for lifestyle.   In this option the $10,000 received by the DST is not taxable initially.   Then when the DST immediately remits $5,000 to the seller, that is what the client will report for tax purposes at the end of the year and the other $5,000 will be added to the DST investments to continue to grow tax deferred until the seller chooses to begin withdrawals from there.

Deferred Sales Trust, Tax Strategy

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As an authorized and approved Trustee for the Deferred Sales Trust and Member of the Estate Planning Team (EPT), Reef Point, LLC promotes the use of the Deferred Sales Trust™ or other estate planning techniques and is not responsible for recommendations made by other members of the Estate Planning Team, including the Deferred Sales Trust or other tax, legal or estate planning strategies.

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