There are strategies out there that could save you thousands of dollars in taxes, but you probably won’t ever hear about them unless you work with an experienced professional.
The Deferred Sales Trust is one of those. It isn’t well known, but it should be. Here’s how it works.
We sometimes have clients who own property for a long time, or a business or some other highly appreciated asset, and they’re reluctant to sell because of the thousands, or hundreds of thousands, of dollars they will have to pay in capital gains taxes.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
They may know about the 1031 Exchange, an excellent tool that allows you to defer paying capital gains taxes on a sale by reinvesting the proceeds into a replacement property. The problem is, some people just don’t want to go back into real estate. They’ve owned property for 20 or 30 years, maybe they were a landlord, and they don’t want to do that anymore.
That’s where the Deferred Sales Trust comes in. By using Section 453 of the Internal Revenue Code, which pertains to installment sales and related tax provisions, it lets people sell a property or business, defer the capital gains tax and roll the money into investments other than just real estate.
So, let’s say you were selling a property for $1 million. Instead of selling directly to a buyer, you would draw up an installment contract with a third-party trust with the promise that it would pay you over a predetermined period. You would transfer the property to the trust, and the trust would be allowed to sell it to the buyer.
Because you sold to the trust in agreement to be paid over time, you wouldn’t have to pay taxes on the sale until you start receiving those installment payments from the trust. So instead of having $700,000 or $800,000 left over after taxes, the whole million is there for the trust to reinvest in stocks, bonds, real estate, annuities or any other type of investment that would generate a greater income stream for the trust to pay you under your agreement with the trust.
You can agree to take your payments over a 10- or 20-year period, or over your lifetime. You can even defer your initial payments and not take anything in earlier years if you don’t need the income. Meanwhile, the money is invested and growing. All the money, not the money minus the taxes.
If you choose to take your payments over a 20-year period, and structure the payments in your installment contract to be 5% ($50,000 a year), you’ll only pay the capital gains taxes on the principal as you receive the money. The IRS code doesn’t require the payment of capital gains taxes until you start receiving the installments.
Anyone who has dealt with capital gains taxes knows they can be pretty high: 15% for single filers with taxable income up to $418,400 ($470,700 for married filing jointly), and 20% if you earn more than that. Plus, you’ll likely have to pay the 3.8% net investment income tax embedded in the Affordable Care Act. Then there are state taxes to deal with, perhaps another 10%. So now you’re talking about approximately 34%, and if you have a depreciation recapture tax, that’s another 25% (another 5 to 10 percentage points higher than the typical capital gains tax rate). You could easily be paying — depending on what state you’re in — 30% to 40% in taxes when you sell. A Deferred Sales Trust could cut that tax bill in half.
For people who have larger estates, the Deferred Sales Trust strategy also can also be integrated with your estate planning to protect your money from estate taxes.
Sorting through complex tax-deferral and tax-exclusion strategies and structures, tax code changes and new regulations and rulings can be daunting — and if you get it wrong, there are consequences.
Talk to a trusted financial adviser about using this powerful strategy to help grow and protect your nest egg, and review the entire strategy with tax and legal advisers before proceeding.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
-
Donating Complex Assets Doesn't Have to Be ComplicatedIf you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Travel trends you can expect this summerThe Kiplinger Letter Domestic trips will trump foreign travel amid economic uncertainties, though some costs are down.
-
Donating Complex Assets Doesn't Have to Be Complicated
If you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Think a Repeal of the Estate Tax Wouldn't Affect You? WrongThe wording of any law that repeals or otherwise changes the federal estate tax could have an impact on all of us. Here's what you need to know, courtesy of an estate planning and tax attorney.
-
In Your 50s? We Need to Talk About Long-Term CareMany people don't like thinking about long-term care, but most people will need it. This financial professional recommends planning for these costs as early as possible to avoid stress later.
-
Social Security Pop Quiz: Are You Among the 89% of Americans Who'd Fail?Shockingly few people have any clue what their Social Security benefits could be. This financial adviser notes it's essential to understand that info and when it might be best to access your benefits.
-
Ask the Editor, May 16 — Reader Questions on Capital GainsIn our latest Ask the Editor round-up, Joy Taylor, The Kiplinger Tax Letter Editor, answers three questions from readers on capital gains.
-
Such Attractive Yields in High-Grade Munis Are Rare and May Not Last LongAccording to this munis expert, the last time munis were this cheap was a brief period in 2023. If you kicked yourself for missing out then, you have a second chance now.
-
Financial Analyst Sees a Bright Present for Municipal Bond InvestorsHigh-tax-bracket investors have an excellent opportunity to secure low-volatility, high-quality returns at yield levels rarely seen in over a decade.
-
I'm an Insurance Pro: How Not to Get Dumped by Your Insurance AgentYour insurance agent or broker might show you the door if you do any of these five things. Being a good customer is about more than paying your bill on time.
