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Selling a valuable asset that has appreciated allows investors to receive a return. Unfortunately, selling an appreciated asset also means paying capital gains tax on that appreciation. Depending on the sale price, an owner may face a hefty tax bill in the year of the sale. Using a deferred sales trust in conjunction with an asset sale can help owners manage or minimize tax liabilities from the sale.
However, a deferred sales trust must meet specific requirements for an asset owner to legally defer taxes from a sale. As a result, working with an experienced deferred sales trust lawyer can help you receive the benefits of setting up a trust. Contact Pennington Law, PLLC, today for a consultation to discuss your situation.
What is the Purpose of a Deferred Sales Trust (DST)?
So, what is a deferred sales trust (DST)? It’s something that can offer people a means of deferring capital gains tax liability when selling appreciated assets.
An asset owner sells their asset to the DST in exchange for the promise of future installment payments, as defined by an installment note or installment payment contract between the trust and the asset owner. The trust then sells the asset and invests the proceeds to pay the original asset owner per the installment agreement.
When set up correctly, a DST allows an asset owner to pay taxes as they receive payments from the trust rather than paying capital gains tax upfront upon selling the asset.
Who Can Benefit from Setting Up a Deferred Sales Trust?
A person may benefit from setting up a deferred sales trust if they expect to incur a significant tax liability upon selling an asset that has appreciated during their ownership, such as real estate, investments, or business interest.
An asset owner considering a sale of an asset may benefit from using a DST rather than another option for deferring taxes, such as a Section 1031 exchange, if the owner does want to meet the requirements of a 1031 exchange (including acquiring other property of like kind from the sale proceeds). DSTs used in estate planning can benefit families by helping heirs manage tax liability from their inheritances.
How Do I Set Up a DST?
Setting up a deferred sales trust in Arizona involves several steps:
- Consult an Arizona Estate Planning Attorney – A deferred sales trust attorney can help you understand how DSTs work and the pros and cons of using a DST in conjunction with an asset sale and walk you through alternatives to using a DST for tax and estate planning purposes.
- Determine Eligibility for a Deferred Sales Trust – An attorney can also help you evaluate the suitability of a DST for your situation, including whether applicable tax laws will allow you to defer tax liabilities for an asset sale through a DST.
- Structure the Trust – Your attorney can help you complete the paperwork needed to structure the trust, including drafting and executing the trust document and the installment payment agreement between yourself and the trust. Applicable laws and regulations require you to expressly structure the trust as a DST and form it in advance of closing on the sale of the asset or the applicable tax trigger date.
- Transfer the Assets Into the Trust – An attorney can also assist you with transferring the asset(s) into the trust, including executing necessary paperwork like deeds or title transfers.
- Execute the Sale Through the Trust – Once you’ve transferred the asset to the DST, the trust can execute the sale with the purchaser and receive and invest the sale proceedings.
- Manage and Benefit from the Trust – After the sale, the person or company you’ve appointed to serve as trustee of the DST can manage and invest the sale proceeds and distribute income and principal as required by the installment payment agreement.
Advantages and Disadvantages of a Deferred Sales Trust
Deferred sales trusts have various advantages and disadvantages. Some of the benefits of DSTs include the following:
- A DST allows a property owner to defer capital gains taxes from selling the asset over multiple years since the owner pays taxes only upon receiving payment of principal from the sale proceeds from the trust.
- Because taxes only come due upon receiving payment from the principal of the sale proceeds, a person may defer capital gains taxes indefinitely by structuring a DST to pay income only from the invested sale proceeds, keeping the principal in the trust.
- DSTs avoid many trickier requirements of other tax deference structures, such as the “like-kind” requirement of a 1031 exchange.
- Families can use DSTs to avoid probating high-value assets and minimize tax liabilities for heirs by paying them income from the trust.
However, DSTs have some downsides that asset owners should consider before setting up a DST, including:
- DSTs can have high setup and management fees, which may reduce the income available for payment.
- An asset owner must give up ownership of the asset by transferring it to the trust. Furthermore, through the installment payment agreement, they do not become a beneficiary but a creditor. As a result, the owner will have less control over the trust than a beneficiary might.
- When the owner structures the trust to invest the asset sale proceeds, the owner accepts the risk of investment loss, which can adversely affect the amount and timing of payments under the installment agreement.
- DSTs lose some of their tax advantages when the face value of the installment agreement reaches a certain threshold, as owners may have to pay interest on the deferred tax attributable to amounts over that threshold.
Contact Our Arizona Deferred Sales Trust Asset Lawyers Today
When you wish to sell a valuable asset, such as real estate, intellectual property, or a business ownership interest, a deferred sales trust can help you and your family manage capital gains tax liability arising from the sale.
Contact Pennington Law, PLLC, today for a confidential consultation with a deferred sales trust attorney to discuss the suitability of using a DST as part of your transaction and to get help structuring a valid and enforceable trust.