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Previously an underutilized financial tool, the deferred sales trust has grown into a popular device for many estate planners. By working within IRS code 453 when you create a deferred sales trust, you’re afforded the opportunity to defer the capital gains tax of a sale when selling real estate and other business assets related to capital gains tax. Once you’ve closed your deal, your proceeds go immediately into a trust, and are only taxable once the means from the sale are received. This effectively allows you to take resources from your sale and reinvest them immediately into investments that usually are not permitted by capital gains tax law.  Essentially it provides a loophole to allow you to broaden your capital gains investments

A deferred sales trust can be tricky and needs to be set with appropriate care for you to maximize your tax benefits.  The steps are relatively simple:

  • Form a third party trust to be managed by a third party trustee
  • Sell your asset to the trust with an installment sales contract
  • The trust then sells the real estate to the buyer
  • The third-party trustee allocates the new resources or provides installment payments to the initial seller
  • Capital gains tax is applied on any principal amount the seller receives

 

That notion of capital gains only being applied to the principal is what makes a deferred sales trust such an enticing option. You will have to pay your capital gains tax regardless, but if your initial investment into the trust is devoid of capital gains, you have a larger pool of money to invest. For example, if your asset nets you 2 million dollars and goes right into the trust, you’re investing 2 million dollars. But if you don’t use the trust and want to invest your capital gains returns, you’ll have to suffer a 15% tax hit leaving you with 1.7 million dollars to invest.

The only real potential downside to a deferred sales trust is that it does require an independent third party to moderate the trust.  There are plenty of companies willing to provide this service, and you are even allowed a degree of control over what you choose to invest the trust in. This, of course, will cost you money, but frankly, many still consider it to be worth the investment.

Deferred sales trusts are not a golden goose or the get-rich-quick scheme that will keep the government away from your earnings. It’s a straightforward tool to help you modestly grow your wealth by investing extra money the government would have been able to tax. Luckily this concept has been utilized for several years now, and no court of law has felt the urge to provide any ruling on it, which means this option is both viable and reliable.