You likely already know that Section 453 of the Internal Revenue Code authorizes you to sell your highly appreciated asset by means of an installment sale, thereby allowing you to defer your capital gains taxes. You may also know that a Deferred Sales Trust is a special proprietary type of installment sale. But have you ever compared the two head-to-head to determine which offers you more advantages? If not, read on. You’re in for a very pleasant surprise!
Conventional Installment Sale
There’s no doubt that the main advantage of an installment sale to you, the seller, is that it allows you to defer your capital gains taxes. You realize gain, and therefore must pay taxes, only on the amount you receive for each payment.
Unfortunately, however, conventional installment sales, have several major disadvantages. Consider the following:
- You must act as your own financing agent for the sale.
- Your only collateral is the asset you sold; you must trust the buyer to maintain the property in as good a condition as you did.
- If the buyer defaults, your only recourse is to foreclose, which likely will take considerable time and cost considerable money.
- If the buyer refinances, you likely will realize the entire remaining balance all at once and have to pay capital gains taxes in a large lump sum.
- This refinancing risk always hangs over your head, giving the buyer an enormous incentive to pressure you to change the repayment terms.
- Since your only collateral is the asset you sold, you have no diversification.
Deferred Sales Trust
Using a Deferred Sales Trust when you sell your highly appreciated asset gives you all of the same advantages as a conventional installment sale, but none of the risks and disadvantages. In other words, a DST puts the control back where it belongs: with you.
Here’s how it works:
- You meet with the Estate Planning Team, whose tax attorney creates your DST.
- You sell your asset to the third-party DST in exchange for a secured DST installment contract, the terms of which you control.
- The DST’s Independent Certified Trustee sells the asset to your intended buyer.
- The sale proceeds come into the DST rather than coming to you personally; since the trust, not you, “owns” the cash, you have no constructive or realized gain on which to pay taxes unless and until you begin receiving payments from the trust.
- You control when you begin receiving payments from the trust and the amount of those payments; for instance, if you want to receive no payments at all until you retire, you can do so.
- You control the types of investments your Trustee makes with the trust funds; you can choose virtually any kind of investment, including stocks, bonds, ETFs, mutual funds, real estate, REITs, annuities, even life insurance policies, and thereby diversify your holdings.
By utilizing the DST and choosing Reef Point to create and manage it, you have taken an asset that is otherwise “exposed” or liability prone and converted it to a no-liability asset. In addition, you have “rolled over” your asset into a fully diversified investment portfolio, all while deferring your capital gains taxes.