IRC § 1031(a)(2)(D), was enacted as a part of the Tax Reform Act of 1984 to exclude partnership interests as eligible 1031 exchange property. Many limited liability companies are taxed as partnerships; so combined there are many owners who may be wondering how to most efficiently sell their interests.
One possible option to consider is a Deferred Sales Trust.
Partnership Interests Qualify for Section 453 Installment Tax Treatment
While partnership interests can qualify, you may not use a DST for “inventory” (dealer-type property held primarily for sale to the public) or for “publicly traded stocks or securities” because of the restrictions in IRC § 453(b)(2), (k)(2).
Deferred Sales Trusts (“DST”) are a sophisticated form of an installment sale note. Recognition of capital gains taxes are deferred over a predetermined period of time.
In a DST, a DST trustee is conveyed the asset, so that the trustee can immediately sell it and retain the sales proceeds. A client may defer the recognition of the capital gain taxes, because the trustee is buffering the client form receipt of the sales proceeds until a future date when the periodic payments are actually paid-out by the trustee and received by the client.
These periodic note payments from the trust will be made pursuant to a written installment agreement (like a seller carry-back note) that is negotiated during the creation of the Deferred Sales Trust. The client can tailor the agreement so that the payments meet their income needs.
More Reliable Than Traditional Seller Carry-Back Notes
A deferred sales trust may be better than the typical seller carry-back note (or contract for deed as used in real property transaction) because in a DST, a seasoned, experienced trustee holds the net proceeds from the sale. You do not have to worry about the buyer failing to fully perform like in a normal installment sale because a reliable institutional trust is administering the funds.
Better Asset Protection than Owning in Your Own Name
By transferring your property into a DST and letting the trustee sell the asset, you may also protect yourself from the potential harassment of predatory creditors. The idea is that if the proceeds are not held directly in your name, then it is harder for predatory creditors to locate or seize. This is a limited asset-protection strategy of converting property into less accessible assets so that a potential creditor will be inclined to settle more quickly and for less.
Setting Up DST Installment Tax Treatment
Deferred Sales Trusts are governed by an intricate set of tax rules. For example, the tax deferral applies only to capital gains and ‘normal depreciation' recapture tax, but does not apply to ‘accelerated depreciation' recapture. You really need to work with experienced Deferred Sales Trust administrators. Go to www.mydstplan.com/1031podcast or call me toll-free at 1-877-373-1031.
© 2011 Jeffrey R. Peterson - All Rights Reserved
Jeffrey R. Peterson is President of Commercial Partners Exchange Company. His company is a facilitator of standard deferred 1031 exchanges, build-to-suit construction improvement exchanges, reverse exchanges and aircraft personal property exchanges. Mr. Peterson is an adjunct professor at William Mitchell College of Law and a frequent speaker and CLE presenter throughout the Midwest for various business and professional organizations on numerous issues related to 1031 exchanges.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Disclaimer: This material has been prepared for general informational purposes only. It is not intended to, and does not, constitute legal advice.