Introducing the Two DST Structures: The Standard DST and the DST Plus
Understanding Capital Gains Tax Solutions
There are relatively few legal structures available to you to mitigate your capital gains taxes, including Charitable Planning, 1031 Exchanges, Opportunity Zones, and Tax shelters in Oil and Gas based on depletion allowances (similar to depreciation write-offs in Real Estate), as well as traditional installment sales. Then, there are complex and expensive separate strategies to deal with the Estate Tax issues.
One of the most intriguing features of the Deferred Sales Trust is the ability to combine both of our two main structures to both defer the capital gains taxes, and to position assets that generate a lifetime income for you and then pass your growing underlying principal to your designated heirs OUTSIDE of your taxable estate (e.g. Not subject to the 40% + estate tax). This combination is what we refer to as the DST Plus.
Remember that the Deferred Sales Trust (DST) is a specialized form of an IRS Code Section 453 Installment Sale. As such, a DST is a legal contract between you and a third-party trust in which you sell an asset to the Trust in exchange for the Deferred Sales Trust’s contractual promise to pay you a fixed sum over a prearranged future period in the form of an installment sale note or promissory note. A DST gives you the ability to control your capital gains tax exposure, reinvestment terms, and installment payments made from the Trust. Even with all of this flexibility, it does come with a particular limitation. That being, while the IRS will allow tax deferral on virtually an unlimited value of your sale, within Section 453, it does impose an additional requirement if your sale generates more than $5,000,000 in net proceeds in one year, (for a single person), or $10,000,000 in net sales proceeds in one year for a married couple.
The requirement under Section 453A imposes an interest charge to the IRS on the amount of taxes that would otherwise be due in the year of sale on the sales proceeds that exceed $5,000,000 or $10,000,000 respectively. The interest rate charged is based on the Federal short-term rate recently as low as 2% to 3%. While this does not eliminate the power and benefits of tax deferral, this can serve to create a drag on the investment earnings you are able to generate for yourself on your tax deferred proceeds.
This is where our companion strategy known as the DST PLUS can be added to your Standard DST Trust structure to eliminate the IRS interest charge. The DST PLUS conforms to a separate section of the IRS code (IRC 72). Under Section 72, you may elect to have your sales proceeds in excess of $5,000,000 or $10,000,000 allocated to the DST PLUS. Under this arrangement, you can elect to receive a fixed income of 10 years or more or during one or more lives. The amount of income you can receive will be based in part on your age and when you want your payments to begin. To many, this would seem to resemble a traditional pension, except that you have an underlying and growing principal that you can pass to your chosen heirs.
You still have the ability to approve how the Trust reinvests your proceeds, but unlike the Standard DST, you will not be able to change your income payments once they begin or access additional lump sums for personal use. The tradeoff here is that there is a high likelihood that your underlying principal will grow in value and upon your death or that of you and your spouse, the entire trust assets will pass to your designated beneficiaries or perhaps a separate trust created to manage your estate for your intended heirs. The other upside is that the trust assets will pass to your heirs outside of your taxable estate, saving 40% or more that can pass directly to your heirs instead of the government.
So here you can see that most people will benefit from the use of the Standard DST. The same goes for high net worth individuals, except that the DST PLUS can often serve as a way for already high net worth individuals or those selling a business or investment asset at a profit of $5 million, $10 million or more, enabling them to blend the extraordinary flexibility of the standard DST with the substantial fixed income and estate tax avoidance of the DST PLUS.
Below we look at a comparison of primary features for the Standard DST and the DST Plus.
| Standard DST | DST Plus | |
|---|---|---|
| Control Over Investments Allocations | Seller directs and/or approves investments to be made by the trust. | SAME |
| Control Over Payout Structure (e.g. DST Note Terms) | Seller directed Promissory Note. Seller approves the Term, the amount and timing of payments they wish to receive and the interest rate on the note (with reasonability standards). | Distributions to client are based actuarially and are not subject to change once payments are selected to begin. Payments will continue thru the client’s lifetime and that of their spouse, if married. The amount of consistent income you desire from the DST Plus can be calculated by how much of your sales proceeds to allocate to the DST Plus as opposed to the Standard DST. |
| Ability to modify or change investment goals or allocations over time | The investment strategy can be modified at any time based on input by the investment advisor and trustee to assist client in approving any changes in investments. Also client could redirect that investments in one category be reallocated to another category, such as a certain bond or equity sleeve reallocated to a real estate investment strategy client has identified, for example. | SAME |
| Treatment of DST at death of Seller | Note can continue after client’s death if that is the client’s designated heirs desire. | The remaining balance of the Trust will pass directly to the client’s intended heir after the death of the client (or both client and spouse, if married). You can name individuals or other types of Trusts to receive the proceeds to provide for your heirs on an ongoing basis. Typically you will also see the value of the Trust assets grow over time. (Because actuary assumptions for investment rates of return are often less than what actually occurs). |
| Estate Tax Treatment | When the client dies, the value of the DST note IS includable in the client’s estate, meaning that it could be subject to estate taxes. (Keeping in mind the 2022 exemption from Estate taxes is $12.06M per individual or $24.12M for a married couple). | When the Trust distributes its assets to your heirs or other trusts for their benefit, it does so OUTSIDE of your taxable estate. This can save 40% plus in estate taxes that your heirs would otherwise be subject to. |
| Tax Code Basis | IRC 453 | IRC 72 |
Keep in mind most client’s who have a need or desire to use the DST Plus, typically also have some of their sale proceeds in the Standard DST to add flexibility to the entire structure.
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