You may already know that when you sell a high-dollar, highly appreciated asset utilizing the Deferred Sales Trust (DST), you pay no upfront federal capital gains tax on the proceeds. In 2022, that’s a savings of 20% if you’re a married taxpayer filing jointly and your sale proceeds push your household income up to $517,200 or more in the year of sale. But don’t forget State Income Taxes and the recently adopted Obama Care tax that could increase your overall liability to over 37%.
What you may not know, however, is that the DST also provides you with an additional 10% or more in tax savings. How is this possible?
Let’s look at an example based on the assumption that you’re a married California taxpayer who desires to sell the family business that you and your spouse have owned and operated for years. You expect a selling price of $10 million and a gain of $9 million.
State Income Tax
California imposes a state income tax. For 2022, you would pay 12.3% if your sale pushes your household income above $1,260,739.
By the way, California taxes your capital gains as ordinary income, so the 12.3% includes them.
You would also pay the 3.8% Medicare tax, sometimes referred to as the Obamacare tax, as a married taxpayer filing jointly because your adjusted household income for the year of sale exceeds $250,000.
This 3.8% Medicare tax added to the 12.3% California income tax amounts to an additional 16.1% that you will pay in taxes without DST intervention.
The Tax Cliff
While your taxes will vary depending on the state in which you live and the capital gains your sale generates, there’s no doubt that selling a highly appreciated asset puts you on the edge of a high tax cliff. The DST prevents you from falling over it. It’s not just a tax deferral strategy, but also a tax engineering strategy. Consequently, it makes the perfect exit strategy.
How the DST Works
In a nutshell, the DST is a 5-step process as follows:
- You meet with the Estate Planning Team before selling your asset.
- The Team’s tax attorney creates your DST in accordance with your investment goals and objectives and income needs.
- You sell your asset to the DST in exchange for a secured installment sale contract, i.e., a promissory note.
- The Team’s Reef Point Independent Certified DST Trustee sells your relinquished asset to your intended buyer and takes the proceeds into the Trust, with neither you nor it paying any capital gains taxes.
- The Trustee then begins investing these proceeds into the investments of your choice and making payments to you according to the terms of the note.
When Do You Pay Taxes?
You pay income taxes only on the amount you receive from your DST each year. In all likelihood, this will be interest income only, so you’ll still pay no capital gains taxes. You pay these only at such time as part or all of your DST income in any given year includes trust principal as well as interest.
If you’d like to find out how the DST can save you hundreds of thousands of dollars when you sell one of your high-dollar, highly appreciated assets, simply contact Reef Point.