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What ’ s A Deferred Sale Trust ?
This trust can help you defer capital gains on business sales , though some charitable trusts can , too .
By Matthew Erskine
RECENTLY , A PRIVATE EQUITY FUND manager approached me for my insight on a business sale . He knew a person selling a business who was complaining about the amount he ’ d have to pay in commissions , fees and capital gains taxes . The manager asked if I knew a way of selling a business to a trust with an installment sale — so the trust could then sell the business , reinvest the proceeds and generate a yield higher than the installment payments .
There is such an entity for this arrangement , and it ’ s called a deferred sale trust . These trusts have been promoted as sophisticated estate planning tools , allowing business owners to defer capital gains taxes on the sale of their highly appreciated assets .
Wealthy individuals already turn to established structures such as charitable remainder trusts and charitable lead trusts , but the deferred sale trust offers them another option .
Here , we ’ ll take a comprehensive look at how these trusts operate — looking at their benefits and risks — and we ’ ll compare them with charitable remainder and lead trusts when it comes to tax efficiency .
Understanding Deferred Sale Trusts
A deferred sale trust is essentially a form of installment sale structured as a trust . In a typical arrangement , the property owner sells the appreciated asset to the trust in exchange for a promissory note , which pays the seller a predetermined installment amount over time . The trust later sells the business asset to a buyer and receives sales proceeds . Since the property own- er sold the asset to the trust as an installment sale , they do not immediately recognize capital gains . Instead , these gains are deferred if the payments meet the Internal Revenue Service ’ s installment sale requirements .
The key components here are the promissory note , through which the seller receives periodic payments , spreading the capital gains over several years ( and reducing the tax burden ). The arrangement also requires an independent third-party trustee , often a bank or professional fiduciary . This entity manages the trust , ensuring compliance with the IRS .
Because this is an installment sale , the gains are recognized only as the payments are received , which can lower the business seller ’ s total tax bill paid if they fall into a lower tax bracket in future years .
The Benefits
Deferred sale trusts offer several benefits to individuals with highly appreciated assets , including real estate , privately held business shares and high-value collectibles . Again , the capital gain is spread out over time , which can reduce the seller ’ s immediate tax burden and give them more investment flexibility . The
DECEMBER 2024 | FINANCIAL ADVISOR MAGAZINE | 53