What is a Deferred Sales Trust and How Does it Work?

If you're a property owner looking to sell an asset such as real estate, you may be facing a significant tax bill on the capital gains you'll realize from the sale. However, there's a little-known tax strategy called a deferred sales trust that can help you defer those taxes and potentially reduce your overall tax burden.

Deferred Sales Trust Basics
So, what is a deferred sales trust? A deferred sales trust is a type of tax strategy that allows property owners to defer capital gains taxes on the sale of assets, typically real estate (but could also be a business interest). The seller transfers the ownership of the property to a third-party trust, which then sells the property to a buyer. The trust holds the proceeds from the sale and pays out a stream of income to the seller over a specified period of time.

By using a deferred sales trust, the seller can defer the payment of capital gains taxes until they receive payments from the trust. This allows the seller to spread out the tax liability over time and potentially reduce their overall tax burden. Additionally, the seller may be able to invest the funds held in the trust and potentially earn a higher rate of return than if they had paid the taxes upfront.

Simply put, it's a type of trust that allows you to defer the payment of capital gains taxes on the sale of an asset by transferring ownership to a third-party trust. Here's how it works:

1. Transfer ownership of the asset to the trust. Instead of selling the property directly to a buyer, you'll transfer ownership to the trust, which becomes the legal owner of the asset.
2. Trust sells the asset to a buyer. Once the trust owns the asset, it can sell it to a buyer and hold the proceeds from the sale.
3. Trust pays out a stream of income to you. Instead of receiving the entire proceeds from the sale upfront, the trust will pay out a stream of income to you over a specified period of time.

By using a deferred sales trust, you can defer the payment of capital gains taxes until you receive payments from the trust. This allows you to spread out the tax liability over time and potentially reduce your overall tax burden.

Investing Deferred Sales Trust Assets
Once funds are in the trust and awaiting distribution, you may use them to invest. The money that would have ordinarily been sent to the IRA is now yours to invest the funds held in the trust and potentially earn a higher rate of return than if you had paid the taxes upfront. You can invest in stocks, bonds, funds, ETFs…anything.

Additionally, a deferred sales offers far more investment flexibility than a 1031 exchange. In a 1031 exchange, you are locked into another “like kind” property. No such restrictions exist for a deferred sales trust. In fact, with proper guidance, a deferred sales trust can help you get out if a bad 1031 exchange.

As with many financial problems, it is best to seek the advice of a financial planning or tax professional before entering into any transaction. A deferred sales trust set-up improperly can have dire consequences. However, when set-up correctly you can safely defer capital gains taxes. Contact us for guidance.