Deferred sales trusts (DSTs) are often used to minimize taxes on real estate sales. But how do deferred sales trusts work? In this guide, you’ll learn the basics of DSTs, as well as the potential tax benefits they can provide.
What Is a Deferred Sales Trust?
A deferred sales trust, or DST, is a type of trust created to defer capital gains taxes on the sale of an asset, such as real estate, business interests, or stocks. It works by allowing the seller of the asset to transfer ownership of it and receive payment over an extended period of time, rather than selling it directly for a lump sum of cash. This arrangement allows the seller to spread out their tax liability and potentially save money on taxes.
How Do Deferred Sales Trusts Work?
A DST is composed of three parts: the grantor (the seller), the trust (which owns the asset) and the custodian (which administers the trust). When a DST is established, the grantor transfers ownership of their asset to the trust. The trust then legally owns and processes payments for the asset over a specified period of time. The custodian keeps track of all transactions and reports to both the grantor and any relevant tax authorities.
They work by allowing the seller to defer the payment of taxes by transferring the ownership of the asset to a third-party trustee, who then sells the asset on the seller’s behalf.
Here’s how it typically works:
- The seller enters into a contractual agreement with a third-party trustee, who agrees to purchase the asset from the seller at an agreed-upon price.
- The seller transfers ownership of the asset to the trustee, who then sells it to a buyer.
- The proceeds from the sale are held in a trust account, which is managed by the trustee.
- The seller can then receive payments from the trust account over a period of time, typically several years, instead of receiving the entire sale proceeds upfront.
- During the deferral period, the seller’s capital gains tax liability is reduced or eliminated, as the seller only pays taxes on the payments received from the trust each year, rather than the entire sale price.
- At the end of the deferral period, the seller may receive a lump sum payment of any remaining trust funds or continue to receive payments over a longer period of time.
Who Benefits from DSTs?
Generally, those who benefit the most from DSTs are individuals or companies selling real estate that has appreciated significantly in value. Because of the structure of a DST, sellers can take advantage of tax savings while still receiving payment for their asset. It also allows them to avoid capital gains taxes and estate taxes. Additionally, because payment is spread out over time through a DST, sellers may be able to better manage their finances than if they had received all proceeds at once.
What Are the Drawbacks and Risks of Using a DST?
DSTs can provide substantial tax savings for sellers of assets. But it’s important to be aware of the drawbacks and risks. For sellers who do not have a structured plan to use the income from their DST wisely, the funds could be depleted quickly in unwise investments or purchases. Additionally, DSTs often include additional fees or commissions that could reduce the overall returns of a sale if they are not accounted for properly. Finally, changes to tax laws could also mean changes to how DSTs are taxed, resulting in less savings than originally anticipated.
Let Us Help You Set Up a Deferred Sales Trust.
It’s important to note that deferred sales trusts are complex financial arrangements that require careful planning and execution. We can help you get the maximum benefit from the sale of your asset. Call us today at 602-443-4888.
