Is the Legal Fee for the Deferred Sales Trust Worth It?
When it comes to selling a highly valued business, cryptocurrency, or property, owners naturally focus on the costs of selling, which can run into the tens of thousands or even hundreds of thousands of dollars. At the end of the day, we all want to maintain and safeguard what we’ve worked so hard to achieve. Sellers who are considering using the Deferred Sales Trust™ (DST) occasionally comment that the additional legal fee to set up the DST is too high; however, after spending time looking at the numbers in detail, most sellers discover that the “opportunity cost” of not implementing the Deferred Sales Trust is substantially higher upfront and over time. Take a look at the following two cases as an example.
A married couple ready for retirement plans to sell their $1 million asset and will owe $250,000 in capital gains tax. The remaining funds will be reinvested to provide a consistent stream of income until retirement. The DST “one-time” legal fee to set up the trust structure would be 1.5% of the sales price, or $15,000 in this case. The seller only pays this cost if they sell and utilize the DST. What is the “opportunity cost” of not implementing the DST for these sellers in terms of “time value of money”?
The capital gains tax of $250,000 would be the initial cost of not employing a DST, leaving $750,000 to reinvest. What good would it do these sellers to have an extra $250,000 to invest utilizing the DST? Let’s imagine the $250,000 was conservatively reinvested to provide a 5% income stream: the breakeven point to cover the $15,000 legal charge in slightly over a year. From this point forward the seller’s legal fee has been recouped and an additional $12,500 in income will be generated each year!
Another benefit of not employing the DST in this deal is the possibility of being in a lower tax rate. This is accomplished by not accepting the entire amount of money at once, but rather paying it out in installments over time. For income beyond $628,301, the existing federal tax bracket rates (married taxpayers filing jointly) would be taxed at a rate of 37%. Assuming these sellers are currently in the 24% tax rate, not taking advantage of the DST would result in a 13% increase in their total income for the year. (2021 IRS Tax Brackets) When looking at the cost from this perspective, the breakeven threshold could be reached as soon as taxes are paid.
Not employing the DST in this deal would also bring on the possibility of having too much equity inside of their taxable estate. Let’s say the married couple’s net worth is over $22 million. The net proceeds being inside of their taxable estate would cost the estate 40% should no other planning be done. The DST solves this by removing ownership of the asset in a creative way at the close of the transaction and thereby removing the equity from the taxable estate.
Another married couple in California used the Deferred Sales Trust to help them sell their $5 million Colorado multifamily property without a 1031 exchange. The biggest stumbling block for this couple was capital gains and estate tax, which was estimated to be roughly 32% of their profit and 40% of their total equity in the property (assessed on the future passing of their estate).
This was computed by adding the following to their $5,000,000 profit:
- State of Colorado (where the property was located) capital gains tax rate of 4.63%.
- Federal capital gains tax rate of 20%.
- Medicare tax of 3.8%.
- Depreciation recapture of approximately 3%.
Total combined around 32% of $5 million = $1.6 million in capital gains tax liability 😬
Estate tax of approximately 40% of $5 million = $2 million 😬😩
The couple was not ready to sell if it meant a $1.6 million tax bill at the close of escrow and another $2 million estate tax at the passing of their assets to their children. In order to solve the above tax challenge, they needed to defer this capital gains tax and eliminate the estate tax once and for all. To solve their tax problem, this couple decided in January of 2021 to complete a Deferred Sales Trust Plus.
The “opportunity cost” in the above scenarios for not using a DST would cost these sellers much more than the “one-time” legal fee upfront. In making any financial decision, looking at the upfront costs is important, but be sure to factor in the “value” (return) and other “benefits” as well.
Two Questions to Determine If the DST Is a Good Fit For You
- Do you have any highly appreciated assets (Bitcoin, CRE, primary home, business, carried interest) that you’d like to sell, delay the tax, diversify the money, and then invest in tax-deferred real estate or securities?
- What would it mean to you to convert your highly appreciated asset — which may or may not be providing any or enough cash flow — to cash flow from passive or active real estate or other investments?
Happy Tax Deferring! 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, 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.