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If you’re considering selling a high-value asset that has dramatically increased in value, you may worry about losing some of the profit from the sale through capital gains taxes. However, tax laws provide several options for deferring or mitigating tax liability from property sales, including deferred sales trusts. An experienced attorney from Pennington Law, PLLC can explain the pros and cons of a deferred sales trust (DST) and advise you on whether you should use one for your property sale.
Reasons to Hire an Arizona Deferred Sales Trust Attorney
An Arizona deferred sales trust attorney from Pennington Law, PLLC can protect your rights and interests during a property sale in several ways. We can:
- Review your financial circumstances and the details of your asset sale
- Discuss your needs and goals to determine whether a deferred sales trust is the right tool to help you meet them
- Establish a DST correctly to avoid losing the trust’s tax benefits, paying substantial capital gains taxes, or potentially paying penalties, fees, or interest
- Structure your deferred sales trust to meet your unique goals, such as paying out sale proceeds over a schedule that minimizes the financial burden of capital gains taxes or deferring taxes entirely by only paying income from reinvested proceeds
Who Should Consider a Deferred Sales Trust?
Property owners might think about setting up a deferred sales trust in connection with the sale of highly appreciated assets to defer and extend the payment period of capital gains taxes. Examples of asset sales that may benefit from a deferred sales trust include:
- High-value real estate
- Business ownership interests
- Artwork or other high-value collectibles
Deferred sales trusts can also play a part in a family estate plan. A DST can defer capital gains taxes indefinitely by investing the sale proceeds and paying only income generated by those investments. Thus, a person or family that owns a high-value asset can indefinitely defer capital gains taxes on the sale proceeds while enjoying income generated by investing them. A DST also removes the assets from the estate, reducing the overall taxable estate value.
Pros of Deferred Sales Trust
Some of the benefits of using a deferred sales trust include:
- Deferred taxation – The biggest advantage of a deferred sales trust is deferring capital gains tax on asset sales. Sellers can defer tax liabilities from the sale, with tax becoming due as the trust pays the proceeds from the sale to the seller in installments.
- Control over income – Deferred sales trusts allow property owners to control the cash flow they receive from selling their property by structuring the trust to pay principal and income over a long period.
- Diversification – Property owners can diversify their portfolio by using a deferred sales trust to invest the proceeds of a property sale into other investments, such as new properties, business interests, or stocks/bonds.
- Avoiding the restrictions of a 1031 exchange – Deferred sales trusts are more flexible than 1031 exchanges, which are specifically for real estate and have stringent time requirements for selling and buying properties of like kind.
Cons of Deferred Sales Trust
Deferred sales trusts also have potential drawbacks that property owners should consider before establishing one. These include:
- Cost – Deferred sales trusts can have high upfront and ongoing expenses, including legal fees for specialized attorneys with experience establishing deferred sales trusts, trustee/accounting fees, and investment expenses.
- Risk – Sellers assume the risk of not structuring their deferred sales trust properly and losing the tax benefits. Even when a seller properly establishes a deferred sales trust, they may assume the risk of investment loss if they choose to invest the sale proceeds.
- Restrictions on liquidity – Because a deferred sales trust distributes money from the proceeds of a property sale over time, a property owner cannot benefit from the liquidity event of an asset sale.
Eligibility for Deferred Sales Trusts
To become eligible to use a deferred sales trust in an asset sale, an owner must transfer the asset to a trust managed by a third party completely independent from the asset owner. A family member of the asset owner or a corporation in which the owner holds an interest cannot manage the trust. In exchange for transferring the asset to the trust, the trust agrees to pay the owner the sale proceeds per the terms of an installment contract.
The trustee — not the asset owner — must conduct the asset’s sale. The owner cannot have actual or constructive receipt of the sale proceeds. Instead, the sale proceeds must go to the trust, which pays the proceeds to the owner according to the installment contract.
Due to a DST’s strict eligibility requirements, property owners should consult an experienced deferred sales trust lawyer to learn how to structure the trust to provide maximum benefits.
Alternatives to Deferred Sales Trusts
Property owners have several alternatives to deferred sales trusts for deferring or mitigating taxes, but the right tool and strategy will depend on each individual’s circumstances. The wealth management and estate planning lawyers at Pennington Law, PLLC can advise on potential alternatives to a DST, such as a:
- 1031 exchange
- Installment sale
- Charitable remainder trust (CRT)
- Donor-advised fund
- Monetized installment sale
- Section 121 exclusion (primary residence only)
- Opportunity Zone Funds
Contact Pennington Law, PLLC, For Assistance
Before selling a high-value asset, talk to the attorneys at Pennington Law, PLLC about the suitability of a deferred sales trust for your situation. Firm founder Andre Pennington is a wealth attorney, registered financial planner, and tax strategy attorney with clients in Arizona and nationwide.
No matter how big or small your assets may be, our legal team is here to find solutions that preserve your wealth and protect your legacy. Contact us today for a confidential consultation with a deferred sales trust lawyer.