Can a Deferred Sales Trust Be Used for Mergers and Acquisitions?
The answer is yes. According to the Institute for Mergers, Acquisitions, and Alliances, more than 17,000 mergers and acquisitions took place in North America in 2020, totaling over $1.5 billion in sales. Due to the complexity and magnitude of these deals, proper planning is crucial to avoid roadblocks in mergers and acquisitions, especially when it comes to capital gains and estate taxes.
Deferring Capital Gains Tax Using the Deferred Sales Trust
With larger mergers or acquisitions, knowing your company’s capital gains tax implications before merging or being acquired is important. Many individuals feel trapped by 30%–50% in capital gains tax and depreciation recapture because they don’t have a strategy to defer this capital gains tax. They may also be unaware of options to defer this tax. The Deferred Sales Trust™ (DST) can allow you to defer hundreds of thousands to millions of dollars in taxes if or when your company moves forward with a merger or acquisition. No deal is too big for the DST; however, the minimum-size deal typically starts with at least $1 million in gain and $1 million in net equity.
Let’s say your company will have at least a $1 million gain from a merger or acquisition. The capital gains tax could potentially exceed $300,000. The Deferred Sales Trust has helped thousands of individuals defer this capital gains tax, giving a larger “nest egg” for future investments. The net proceeds received from a merger or acquisition can be invested in business ventures, real estate, mutual funds, stocks, REITs, and much more.
Overview of the Deferred Sales Trust
A Deferred Sales Trust is a business trust that employs an IRC §453 tax approach. It enables owners selling highly appreciated assets to use a traditional installment sale to defer capital gains realization. Since 1996, the DST has helped investors and business owners defer capital gains tax and unlock equity into cash flow. It has a proven track record of success — 3,000+ closings/billions under management.
Prior to deciding to move forward or going too far with a merger or acquisition, it’s critical to have a no-cost consultation. The primary objective of this meeting is to assess your position, address any questions you may have, and determine whether the DST is a good fit for you.
Timing is of the essence and it’s important to set up a no-cost consultation with a DST-certified trustee prior to deciding to move forward or going too far with a merger or acquisition. The main goal for this meeting is to evaluate your situation, answer questions you may have, and see if the DST will be a good fit. A reasonable rule of thumb is that the asset you’re selling should have a net profit of at least $1 million and a gain of at least $1 million. If you decide to proceed with the DST for your merger or acquisition, your next meeting will be with a DST tax attorney and a registered investment advisor.
You can also invite others to this meeting, including your:
- Real estate broker
- Business broker
- M&A attorney
- Independent attorney
- Other trusted business professional
Collectively, you and the above parties will meet to examine whether the DST is a viable option for your proposed merger or acquisition. Your financial and next business or real estate venture goals will also be discussed, as well as your risk tolerance for investments and the payment amounts you wish to receive when the funds are transferred to a DST bank account.
If a DST is a good fit for you and you’re ready to move forward, the DST tax attorney will form a DST, and the team will work with you and your representatives to sell your company to the newly formed DST.
In exchange, you will receive a DST installment note with scheduled pre-agreed installments. Following the completion of a merger or acquisition, the “sale profits” will be directed to the DST. This allows you to avoid taking constructive receipt and put the proceeds in a tax-deferred account, similar to an IRA or a 1031 exchange.
Understanding Constructive Receipt
You must sell your firm to the DST and without receiving the cash to avoid constructive receipt and defer your capital gains tax. Once the business is sold to the DST, the DST can now sell or merge with the new entity. As a result, when the final transaction is completed, the DST receives the “selling money,” not you. This is what prevents you from receiving actual or constructive receipt of the funds, which is the foundation of an installment sale and allows you to defer the capital gains taxes.
From here on out you will work closely with the team to execute the investment plan based on your needs, wants and risk tolerance, and the payback of your money.
Your unaffiliated third-party independent trustee administers all parts of the DST after it closes, but only as and when you authorize them. For example, when you sell an asset to the DST, the trustee has the monies transferred to the DST’s safe bank account, which requires your signature, his signature, and the signature of the bank officer to open.
The trustee administers all parts of the DST after closing, but only if you authorize them to. For example, when you sell an asset to the DST, the firm has the funds transferred to a specific DST secure bank account that requires your signature, the firm’s signature, and the signature of the bank officer to open. It’s similar to having a long-term escrow account. This is the account from which the DST buys investments you authorize and has the bank make payments to you according to the terms of your installment contract, with your agreement.
Two Questions to Determine If the DST Is a Good Fit For You
1) Do you have highly appreciated assets of any kind you would like to sell, delay the tax, diversify the money, and then invest in tax-deferred real estate or securities?
2) What would it mean to you to convert your highly appreciated asset — which may not be producing or providing enough cash — to cash flow from passive or active real estate, or other investments?
Happy investing! For more information, check out: Why You Should Consider Using the Deferred Sales Trust (DST) Now More Than Ever
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 the Founder of Capital Gains Tax Solutions and host of the Capital Gains Tax Solutions podcast.
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.