In October 2001, Steve Jobs did something that would change the way we experience music forever when he introduced something entirely new — the iPod — which eventually led to the creation of the iPhone and iPad. Jobs knew consumers weren’t looking for a faster CD or better phone or better laptop. They wanted something totally new.
When it comes to choosing a tax deferral strategy, are you as a taxpayer looking for something new, or are you satisfied with the status quo?
Here are a few questions to consider when choosing a tax deferral strategy:
If you’re considering using a Deferred Sales Trust as a tax deferral strategy, you’re bound to have questions. You might wonder if it will open you up to the risk of an audit. Or — even worse — would you have to pay tax if the DST isn’t legal? We’ll answer these questions and more below.
The answer is no; however, it depends on how you define “new.” It is new for many investors and CPAs who have heard of it before. Or some CPAs may have heard of it, but they have not experienced its practical application for their own clients, so it is still new to them.
The fact is that the Deferred Sales Trust™ is not a recent invention. In fact, DSTs are over 25 years old. The IRS Section tax code known as IRC 453, which is the foundation of the structure, predates the 1920s and is known as a “seller carry back” or “owner financing.” There have been thousands of successful closings, billions under management, and over a dozen no-change IRS audits.
Many investors learn about the DST during the final few weeks before closing their assets. They are faced with large tax and a CPA or trusted advisor who has never heard of the DST, has never had any clients close one, or has confused it with the Delaware Statutory Trust (1031 exchange family).
It’s natural to feel uncertain about using the Deferred Sales Trust when the stakes are high, the timing of closing is imminent, and those you have trusted the most to help you build your wealth and file your taxes are not confident in the structure.
So, should one use the DST even when their inner circle of advisors says no or advises against it? This decision is up to you; however, keep in mind that it’s easy for someone to say no when it’s not the tax they are paying and when there is no upside for them one way or the other.
Think about the outcome for your CPA. If they say yes to something they are unfamiliar with, like the Deferred Sales Trust, then they hold some blame for any loss you may experience as a result. If they say no, then they have nothing to account for.
It’s best to engage in the due diligence process and bring your CPA along for the ride in the passenger seat rather than having them catch up in a car behind. This way, your CPA can see for themselves that the Deferred Sales Trust is a perfectly legal and highly valuable tool for their clients. In fact, more often than not, CPAs in this situation go on to offer the DST to their future clients.
Yes, Deferred Sales Trusts are absolutely legal as long as the proper practices are followed, such as using a third-party, unrelated trustee.
If you are a new DST investor, the technique of establishing a DST can be complex compared to an LLC formation. It’s often the DST process complexity that is beyond the knowledge of the typical investor, causing uncertainty and skepticism. The biggest thing is understanding you are becoming the lender and are not the owner of the DST. In other words, you will have lent money to it.
A key fact to consider is there have been thousands of DSTs formed and billions of equity under management over a 25-year period. However, some people believe trusts are unlawful merely because they are unfamiliar with them.
Some follow 1031-qualified intermediaries who don’t want you to know about the Deferred Sales Trust, since it is a competitor of the 1031 exchange.
Some 1031 bloggers release negative opinions of the DST legal structure and classify it with other installment sale strategies that have not held up with the IRS, such as the Monetized Installment Sale method.
Some are scared off by the deferred sales trust California Franchise Tax Board (FTB) memo that requires them to withhold 3.33% tax on certain types of 1031 exchanges that the FTB deemed to be improper. The actual memo released by the FTB did not mention the Deferred Sales Trust — the reference to the Deferred Sales Trust in question was added by a 1031 exchange blogger.
Education brings clarity and confidence. Deferred Sales Trusts are, thankfully, legal, and DST tax attorneys provide lifetime audit defense, but investors must learn how to use them. Rather than going it alone, investors should seek the advice of a Deferred Sales Trust expert and bring a CPA or tax professional to ensure that steps are carried out appropriately.
Ready to see if this is a good fit for your situation? Schedule a no-cost consultation with an exclusive DST trustee to learn about all the benefits of the DST. Goals for the meeting:
Please 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.
Happy tax deferring!
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, is 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.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.