Let’s first get to the Elephant sitting in the room regarding the DST™ and the controversy regarding whether the DST™ is simply a Private Annuity Trust with a different name.
Under the U.S. tax law, U.S. Citizens and residents must declare their income by filing tax returns and must pay tax on their income, and the taxpayer has a legal right to avoid or minimize taxes. Commonly established tax deferral methods include 1031 exchanges and installment sales (IRS 453). Various types of trusts are used by millions of taxpayers to protect and transfer assets to their heirs outside of probate and to minimize having to sell estate assets to pay estate taxes.
The Private Annuity Trust
The creation and implementation of Private Annuity Trusts (PAT) were banned by the IRS in October of 2006. The basic idea of the PAT was to utilize capital gains deferral by transferring a highly appreciated asset to a Trust in exchange for payments for life. After the Taxpayer’s death, the annuity in the PAT would go to the heirs of the Taxpayer as designated in the annuity beneficiary designation. The cited legal authority for the PAT were based on Treasury Regulations, which can be (and were) change(d) at a moments notice. The PAT could sell inventory. Depreciation recapture is not immediately taxable upon exchange and the Trustee of the PAT could be family members who allegedly were not controlled (but were in reality controlled) by the Taxpayer.
The Deferred Sale Trust™ or the DST™
The DST™ is based upon Statutory Authority, Internal Revenue Code section 453. The DST ™ is not based upon a Treasury Regulation and it would take an ACT OF CONGRESS to change the legal authority by which the DST™ is founded.
The next consideration is the Trust structure. In order to be a valid Trust, the Trust analysis has to pass a two part inquiry: (1) is there a legal trust in existence and (2) is the Trust a SHAM for income tax purposes?
A trust must have 4 elements to satisfy legality and include: Intent, Trust Property, Lawful Purpose and an Identifiable Beneficiary. Once the 4 elements have been established for the creation of a trust, then the trust must be analyzed to determine if it is a tax sham and an additional 4 factors must be reviewed in detail to ascertain economic substance for Federal Tax purposes. This “Test” is commonly referred to as BUCKMASTER vs. Commissioner, TC MEMO 1997-236 and briefly includes:
(1) The taxpayer’s relationship to the Asset before and after the trust formation.
(2) An INDEPENDENT Trustee (No ownership or control vested in the taxpayer.
(3) No economic interest passed to other beneficiaries of the trust.
(4) No restrictions imposed on the taxpayer by the trust or the laws of the trust.
So…..is the DST™ an IRS Accepted Tax Strategy?
I have recently received a written legal opinion from a California Law Firm licensed to practice in the U.S. Tax Court that THE DEFERRED SALES TRUST™ ALLOWS FOR THE (1) LEGAL DEFERRAL OF CAPITAL GAINS, (2) PASSES SCRUITNY UNDER THE BUCKMASTER TEST (3) NOT A REPORTABLE TRANSACTION (4) NOT A STEP TRANSACTION AND (5) IS CLEARLY DISINGUISHABLE FROM THE PRIVATE ANNUITY TRUST In addition a Private Ruling Letter has been requested from the IRS and is pending.
The DST™ is founded upon IRS accepted Strategy to Defer, not the avoidance, of the lawful payment of Capital Gain taxation. While this is a relatively new strategy combining existing statutes of established tax law and trusts, it must be PROPERLY administered by licensed and trained DST™ Estate Planning Professionals, Trust Attorneys and Trustees. This is not a do it yourself project or one to be undertaken with untrained and inexperienced advisors. Done properly the benefits may be extremely rewarding. On the downside, the consequences could be devastating if not done correctly and interpreted by the IRS as a tax sham.
Has the Elephant left the room yet? I hope you are still with me because here is where it gets interesting.
Will the DST™ eliminate the 1031 Tax Deferred exchange?
No way. It is strictly another option for the taxpayer who may for a variety of reasons “Want Out” of ownership of assets that have a large capital gain tax consequence. For Example:
(1) You may want to sell because you are seeking retirement and feel managing your real estate or business is no longer something you want to undertake.
(2) You may want to sell because your investment appreciation is worth more than the monthly cash flow.
(3) You may want steady income and asset protection.
(4) You simply hate to pay the taxes.
(5) You may want to sell but cannot locate an acceptable property to complete a 1031 exchange.
(6) You realize that with the DST™ structure you can invest ALL your sale proceeds including the capital that would have been paid to capital gains taxation and receive an increased income stream.
(7) You realize that properly structured with estate planning you can pass on assets to beneficiaries free of estate taxes.
It is interesting to note that while capital gains tax at the federal level is 15% and while some states do not have capital gains tax, California has a 9.3% capital gain tax for an overall 24.3% tax rate. Now that hurts. So while the real estate market is currently having issues, a taxpayer could actually sell his California property 10% below market value enhancing a sale and still have 14.3% more capital in the trust earning income. Does this make it easier to complete a sale and still provide a benefit to the taxpayer?
Interested in obtaining more in depth information?
There is so much more to the Deferred Sale Trust ™. A brief article can be accessed at http://www.trustguardant.com/news/24/strategic-management-of-tax-liability/ If interested your next step in learning how to access the knowledge to assist your clients, (and perhaps yourself) possibly market the DST™ yourself with your own web site, and where legal, potentially earn solicitor fees is to execute a Non Disclosure Agreement (NDA).
This new tax strategy is going to create many opportuniities for both the public and the real estate industry. Contact me directly for the NDA and I will answer your questions or if appropriate refer you to appropriate legal advice council.
About The Guardant Network
Guardant Investments, Inc., the Guardant Investment Fund LLC and Guard Equity Holdings LLC. are devoted to retirement education in self directed IRA accounts, non-correlated alternative investments for Qualified California Residents only and foremost education of the National real estate community (Residential and Commercial) and the general public about the new Deferred Sales Trust TM
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 (including any attachments) 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.
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Although it is rarely likely to be the case, if one could find a 1031 exchange property and could in the alternative use this trust arrangement, which would likely be the best choice for the property owner making the choice?
Are there specific advantages to the trust that would have one make that choice and venture into new territory instead of using the tried and true 1031 option?
If one is really at arms length after transferring property to the trust, what are the risk modifiers to prevent the trustee from having sticky fingers, for example?