In 2013, I recall my wife's uncle introducing me to Robinhood for the first time. He said it was a game-changer for anyone looking to invest in the stock market. I mostly invested in multifamily real estate at the time to maintain as much control over my investment destiny as possible, but I was also interested in the low cost and quick access to stock purchases. Some of my friends were burned by day trading, but others fared really well.
One of the factors that previously kept me from stock investments was the lack of a 1031 exchange option for stock trading. There is also no depreciation to balance any dividends or cash flow like real estate does.
Perhaps you're in a similar scenario, or you've created or invested in a firm whose stock has appreciated rapidly.
If so, you may find yourself in a position of holding a large amount of concentrated stock in one company as a lifelong investor, an executive, or an employee of a start-up that has been successful and has gone public. Whatever your case may be, you most likely know that “holding all your eggs in one basket” can pose a problem due to a lack of diversification. At the same time, diversifying and selling your highly appreciated stock position may not be the best option due to your capital gains tax liability.
If this is your situation, the Deferred Sales Trust (DST) can assist you in your exit strategy when it comes to selling concentrated stock and then investing in real estate to unlock tax-efficient cash flow.
Issue #1: Market Volatility
“By diversifying your portfolio, you reduce the consequences of a wrong forecast," said Ryan Nauman, market strategist at Informa Financial Intelligence's Zephyr. The main advantage of diversification of your investments is limiting the risk associated with outside forces negatively impacting a large part of your portfolio.
Another positive outcome that does not get much attention is the "opportunity cost” one forgoes when they are not diversified. Nauman puts it this way, "If you're not diversified, you may miss out on growth opportunities in a different asset class that you are not exposed to."
There are multiple benefits to diversifying your concentrated stock position, which can help protect your portfolio over time. However, capital gains tax is a common dilemma investors have to deal with when they consider selling highly appreciated assets of any kind.
Issue #2: Capital Gains Tax
Diversification can be achieved by selling your concentrated stock position and reallocating the proceeds into other stocks or real estate investments, but this comes with a cost due to capital gains tax that would be owed. This is especially true for those earning $1 million or more per year that would see an increase in the long-term capital tax rate to 39.6% if President Biden's “American Families Plan” is implemented by Congress.
Who knows what the future holds for capital gains tax rates? Nevertheless, there is a way out by using a Deferred Sales Trust. You can take advantage of the DST with proper planning that achieves diversification, defers your capital gains taxes, and gives you the ability to purchase investment real estate of your own all tax-deferred.
Diversifying and Deferring via the DST
The Deferred Sales Trust (DST) is a business trust that employs an IRC §453 tax approach. This tax code enables owners selling highly appreciated assets to use a traditional installment sale to defer capital gains realization. Simply put, your concentrated stock is sold to the DST (third-party business trust) that only conducts business with you. Upon the sale, you will receive a secured installment note outlining future fixed installment payments. Next, the DST sells the stock, and the proceeds are reinvested on your behalf. At this time, “constructive receipt” has not occurred since none of the proceeds came to you personally, thus avoiding any capital gains taxes being owed.
During this process, you will work alongside your DST trustee to reinvest the sale proceeds back into investment real estate, cryptocurrency, stocks, lending, and life insurance to name a few investment options available. Keep in mind you as the note holder keep control and must approve any investments your trustee makes. You have control over the terms of the installment note. The ultimate goal for the DST trustee is to execute investments that not only hit your financial goals and objectives but also fit within your risk tolerance.
What Other Assets Can the Deferred Sales Trust Defer Capital Gains Tax On?
- Primary residence
- Bitcoin and other cryptocurrencies
- Investment real estate
- Eliminate the need for 1031 exchange (the whole entity does not have to move)
- GP or LP positions
- Business sale
- Captive insurance
- Carried interest
Note: The minimum-size deal for a DST is $1 million net proceeds and $1 million gain. However, if you have two assets that add up to this amount, you qualify.
Ready to see if this is a good fit for your situation? Schedule a no-cost consultation with an exclusive DST trustee.
About the Author:
Brett Swarts is considered one of the most well-rounded Capital Gains Tax Deferral Experts and informative speakers in the U.S. He is a Deferred Sales Trust Expert, the Founder of Capital Gains Tax Solutions, an exclusive Deferred Sales Trust Trustee, host of the Capital Gains Tax Solutions & eXpert CRE Secrets podcast, and an eXp Commercial Multifamily Broker in Sacramento, CA.