In August of 2021 for the first time ever, a seller of the cryptocurrencies Bitcoin and Ethereum used the Deferred Sales Trust™ (DST) to defer capital gains tax. You can, too, once you understand the Deferred Sales Trust structure and IRS guidelines.
The Deferred Sales Trust is based on the U.S. Tax Code (IRC 453), which allows deferment of capital gains on highly appreciated property using a traditional installment sale. For more than 20 years, the DST has helped in the deferment of capital gains in real estate as well as other highly appreciated assets like public stocks, private stock, businesses, and primary residences.
When using the installment sale (IRC 453) method to defer capital gains tax on the sale of your highly appreciated assets, the IRS has established guidelines qualifying the transaction. Let’s take a look at how the Deferred Sales Trust follows these guidelines.
1. Initial Requirements
For the DST to hold up in the tax code, an unrelated third-party trust and trustee are required. It is key that both the trust and trustee are independent of you. Once they have established your financial goals and objectives, a trust is tailored by a DST trustee — an unrelated third party — to sell your highly appreciated asset.
2. Selling Your Asset
The pathway to deferring your capital gains taxes will start with selling your appreciated asset to the trust first, which will then sell to the buyer. If you are selling Bitcoin or other cryptocurrencies, you will transfer the asset to a newly formed exchange account first before the coin is sold to USD. A promissory note in return will be given to you by the trust, laying the timeline of future payments based on your financial goals and objectives.
3. Constructive Receipt
Having a DST set up to sell your highly appreciated asset along with a DST trustee is crucial to avoid taking what the IRS calls “constructive receipt/actual receipt.” This would be a “taxable event” for you and would trigger the payment of the capital gains tax you owe in the current tax year. To avoid triggering this, the net proceeds from the sale will be directed to the DST, not you, thus keeping you in a deferral status since you have not taken constructive receipt.
4. Deferring Depreciation Recapture
Can the Deferred Sales Trust defer depreciation recapture for an investment property? It depends. Is your mortgage above your basis? If it is not, then depreciation recapture most likely can be deferred using the Deferred Sales Trust; however, here are a few other questions to consider:
- Did you use straight-line depreciation?
- Did you have a company conduct a cost segregation study, and then did you accelerate your depreciation schedule based on those findings?
Please be aware that if you depreciated your real estate investment using the accelerated method rather than the straight-line approach before selling it to your DST, you may need to recapture the amount of these excess deductions if your mortgage is above your basis and if the section of deprecation is 1245 or 1250.
For example, the equipment cannot be deferred with the DST, and oftentimes Section 179 is used to depreciate equipment, so the Section 179 depreciation would not be eligible for deferral using the DST. It’s important to bring in your CPA, gather your depreciation schedules from your tax returns from previous years, and consult with a DST tax attorney to gain clarity here.
5. Promissory Note
With your DST now funded from selling your highly appreciated asset, you now own a secured promissory note (installment) that lays out your payment plan. This includes what amount is owed to you, the interest that is being charged to the DST, payment amounts, and specific dates of each payment. Remember that capital gains tax is still owned and is now in a deferral state. Another way to think about this would be to think of the DST as the “Delayed Tax Trust.”
Next Steps
Ready to see if this is a good fit for your situation? Schedule a no-cost consultation with an exclusive DST trustee to learn about all the benefits of the DST. Goals for the meeting:
- Hear your story!
- Understand your financial and investment goals.
- Evaluate if using the Deferred Sales Trust to sell your highly appreciated asset will make sense for you and serve as the best solution to your tax deferral goals.
Please note the minimum-size deal for a DST is $1 million net proceeds and $1 million gain. However, if you have two assets that add up to this amount, then you qualify.
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 podcast, and an eXp Commercial Multifamily Broker in Sacramento, CA.