John D. Rockefeller once stated, “Own nothing, but control everything.” Part of what I think he meant was, “What you don’t own can’t be taken from you,” which is a fundamental rule of asset protection. If he were here today, I wonder if he would also say, “Earn everything, but control the timing of receiving it.”
In the new Biden economy, taxes are higher. Robert Kiyosaki taught us all about cash flow and I’m curious — if John D. Rockefeller were here today, would he say cash flow is no longer the clear number-one way to preserve wealth? Perhaps he would say we must now build wealth for ourselves and our families via tax flow. Tax flow is considering the tax consequences or advantages of investing in a certain asset type or structure, as well as considering the timing of receiving earnings.
How the Deferred Sales Trust is like an IRA
1. Tax-Inferred Investment Account
A traditional tax-deferred account is a designated savings account or investment option that doesn’t require that you claim the investment income earned inside the account on your tax return. The funds do need to remain in the account to qualify. You defer paying taxes until you withdraw from tax-deferred savings or cash in the investment.
The Deferred Sales Trust is like an IRA since an IRA is a tax-deferred investment account where you do not have to take the net proceeds in the year your highly appreciated sale is made. The earnings that accumulate in the DST can be delayed a few years. Therefore, the funds in the DST will be fully tax-deferred until they’re paid back to you. This can result in a significant improvement in the investment performance of the DST portfolio.
It is important to note that, for the minimum size deal to make sense for a Deferred Sales Trust, the deal must be $1M of net proceeds and $1M gain.
It is recommended that you receive some payment over the first few years of the DST; however, there are no minimum required distributions. This is tax flow at its finest. Receive funds when it makes sense for you. It’s similar to selling when you have bonus depreciation from a new CRE property you just purchased with a brand-new depreciation schedule. If the timing is right and you have enough bonus depreciation, you may be able to offset your capital gain.
2. Lower Adjusted Gross Income (AGI)
A tax-deductible IRA contribution lowers your adjusted gross income (AGI) as well as your tax rate. Not receiving income from a DST where you previously were receiving income — from, let’s say, an apartment complex or a sale of a business — works the same way to potentially lower your adjusted gross income.
For example, a recent Deferred Sales Trust client sold his business for $2.6 million in Alabama and deferred around $600,000 in capital gains tax. He is in his 40s and his household earnings are in one of the highest tax brackets. He could have received the $2.6 million immediately and invested the funds into cash-flow-producing assets, for which he may not have been able to shelter the income.
Instead, this client chose to become the lender to the Deferred Sales Trust and receive no payments for a few years in exchange for installment payments from the DST over time. The earnings are somewhere around $200,000 per year in the DST. This $200,000 is compounding and growing in the DST as he waits to receive it at a later date — a date on which he may retire and have a lower active income and cash flow. This can be perfect timing for the tax flow strategy, allowing you to receive income when it’s ideal for you tax-wise.
Who does the Deferred Sales Trust work for?
Virtually any individual or entity can utilize a DST to defer capital gains taxes on the disposition of a qualifying asset including primary residence owners, investment real estate, businesses, public or private stock, cryptocurrency, artwork, and collectibles. Gather the sale of multiple assets into one DST to make your estate plan simple and clear. Here is a video with Kevin Harrington from Shark Tank discussing the selling of stock and using the Deferred Sales Trust.
Does the IRS allow the Deferred Sales Trust?
So far, the answer is yes. The Deferred Sales Trust has a long track record of success and has withstood scrutiny from both the IRS and FINRA since 1996. It is a tax strategy based on IRC §453, which allows the deferment of capital gains realization on assets sold using a prescribed installment method.
In simple words, if you sell an asset for $10 million using an installment sale contract and finance 100% of the sale, you as the seller have not received constructive receipt of the cash. You have become the lender. You don’t pay tax on what you have not received if you follow IRC §453, since it allows you to pay tax as you receive payments. The buyer you lent money to will typically pay an agreed-upon amount of down payment to you upfront, for which you would pay tax. The buyer would then pay the rest of the purchase price to you plus interest in installments over a specific period of time. The deferral takes place as you wait to receive payment — typically, three to five years.
Can it do the same for you? What are the steps?
Sorting out capital gains tax deferral strategies can be confusing. The goal is to find a tax deferral strategy with a proven track record that gives you tax flow, the flexibility of timing to receive earnings, debt freedom, liquidity, diversification, cash flow, and the ability to move funds outside of your taxable estate, all without using a 1031 exchange at the same time.
Here’s to making the best decision for you, your family, and your estate, no matter what the final decision will be for the Biden administration on the new tax proposal policies.
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.