Our Deferred Tax Strategy [“DTS”] is a type of IRC Section 453 installment sale, also known as a “seller carry-back” sale. Under this code section, the seller may achieve significant tax-deferral benefits by not receiving actual or constructive receipt of the proceeds at the time of the sale, instead receiving payments made to them over time. Moreover, the DTS has greater flexibility than a conventional installment sale with respect to risk management, the repayment timeframe, and the trust’s investment selection.

The process starts with initial due diligence and prospective marketing and market research. If the transaction is viable, the trust and property owner will negotiate to reach terms for the asset[s]. If the transaction is feasible, the property owner, [“seller/taxpayer”], sells ownership of the property/capital asset to a dedicated trust [the“trust”].

Next, the approved and DTS trained trustee of the trust pays the seller/taxpayer for the property/capital asset. The payment isn’t in cash, but with a payment contract called an “installment sales contract” which is a private agreement between the trust and the seller/taxpayer. The terms of payment are established in advance and pursuant to the sale contract negotiated by and between the seller/taxpayer and the trustee.

The payments may begin immediately, or they may be deferred for some period of months or years. The trust then sells the property. There are generally minimal capital gains taxes due from the trust on the sale, since the trust often purchases the property for a price and value similar to what it may get sold to a third-party Buyer.

The seller/taxpayer is not taxed on the sale since he or she has not yet received any cash for the sale. Payments may begin immediately but oftentimes a seller/taxpayers will choose deferral because they have other income and don’t need the payments right away.

Deferral is strictly an option. It is important to understand that payment of the capital gains tax to the IRS is done with an “easy installment plan” as the seller/taxpayer receives the payments. Part of the payment received is tax-free return of basis, part is return of gain which is taxed at capital gains rates, and part is interest.

On top of that, the tax payments will be made with depreciated dollars. The tax dollars will likely be worth less than they are today due to inflation. If invested properly, the money in the trust could potentially grow at a greater rate than that of inflation and even the distribution rate, and ensures the necessary liquidity to pay back the note due to the seller/taxpayer. The interest rate in the note to you is dictated by the IRS to be a fair and arms length or a competitive rate, i.e., 6% to 8%.

While we have primarily focused on capital gains tax, the amount of gain due to straight line depreciation is also deferred with our DTS. However, if you have taken accelerated depreciation in excess over straight line, this amount is not deferrable.

There is proper diversification by the DTS Trustee when investing the DTS’s funds. The DTS Trustee may invest in REIT’s, bonds, annuities, securities or other “prudent investments” that are suitable to help assure the trustee’s performance in repaying the seller/taxpayer pursuant to the held installment sales note. The DTS Trustee’s reinvestment of the proceeds may result in more or less risk depending on the nature of where the proceeds are reinvested. An inherent goal of the trust’s investment objective is simply to produce the cash flow necessary for the scheduled installment sales note payments to the seller/taxpayer.

Those of us who own highly appreciated assets such as homes, commercial real estate, and businesses are often reluctant to sell those assets due to the capital gains tax and depreciation recapture costs associated with the sale. With our Deferred Tax Strategy [“DTS”], the Matthew James team presents a solution that allows a seller to defer their capital gains tax and potentially reduce the overall tax burden.

Additionally, many people do not realize the high costs associated with estate tax and with having to wait for “step-up” values. The DTS offers a smart, functional, and legal way to address these issues.

Our DTS utilizes IRS tax code that allows the seller of the property to defer capital gains taxes due at the time of sale over a period of time that is selected by the Seller/Taxpayer in advance. It may be a fit for owners of businesses or real estate that has significantly appreciated, or for those who are having trouble finding suitable, qualified property exchanges.

Deferring taxes legally is not new. Some commonly used tax deferral methods include 1031 exchanges, charitable trusts, and traditional seller carry-back installment sale contracts. Trust law predates the formation of the U.S. law and tax law. Various types of trusts are used by millions of Americans to protect and preserve their wealth for themselves and their heirs.

The DTS can be used with any kind of entity, e.g., LLCs, S or C-election corporations, as well as individuals who own real estate, rental properties, vacation homes, farm or commercial properties, hotels, vacant land, industrial complexes, retail developments, and raw land, to name a few.

1.  Flexible Payment Options: 

The repayment terms and schedule can be structured in a variety of ways to best serve he needs of each specific taxpayer. This includes anything from minimal repayment of principal or rapid amortization. In addition, the commencement of payments can be immediate or can be delayed into the future.

2.  Liquidity & Diversification:

Can potentially convert an illiquid asset, like a business or commercial real estate, into a diversified portfolio of liquid investments. This can help reduce risk and volatility by preventing overexposure to a single asset class.

3.  Enhanced Retirement Income:

Can provide a stream of income for retirement based on the pre-tax proceeds from the sale instead of the after-tax proceeds, which are likely to be substantially less.

4.  Maintains Family Wealth:

Helps to maintain wealth within the family in a number of ways. First, by avoiding a massive drain of equity at the time of the sale, resulting from the immediate recognition of the full capital gains tax liability at the highest rates. Second, by potentially providing significant estate planning benefits. And finally, our Deferred Tax Strategy [“DTS”] can provide estate liquidity so that significant assets of the family do not have to be liquidated under less- than-ideal circumstances.

5.  Estate Tax Benefits:

The DTS can be combined with additional planning to accomplish an estate freeze for estate tax purposes, and to potentially remove the proceeds of the sale from the seller’s taxable estate beyond the amounts exempted by the unified credit. Further, the ability to select the state in which to domicile the trust can provide additional tax savings.

6.  A 1031 Exchange Alternative:

Unlike a 1031 Exchange, the proceeds from the sale do not have to be invested in “like-kind” property in a very short timeframe to achieve tax deferral.

7.  Can Sever Partnership Interests:

When a partnership or other ownership group sells an appreciated asset, they do not need to remain together to achieve tax deferral, as is typically the case with a 1031 Exchange. Each individual owner can have their own DTS, the assets of which can be managed to each taxpayer’s own individual risk tolerance and preferences.

8.  Asset Protection:

Subject to State specific laws, and in conjunction with additional planning, the taxpayer can potentially secure asset protection by utilizing our DTS.

9.  Probate Avoidance:

With additional planning, our DTS can help avoid the delays and expense of probate.

Long-term capital gains tax is simply defined as the tax we pay on the profit we make when we sell a capital asset we’ve held for a year or more. Capital gains tax is calculated by subtracting what you paid for the asset from the net selling price. The current long term capital gains tax rate for a capital asset owned for one year or longer is typically 15% – 20% for Federal taxes.

Back in 2013, there was an additional Federal tax added on income, known as the Investment Income Tax [Funding Medicare]. This Investment Income Tax has an applicable rate of 3.8% on some [but not all] income from interest, dividends, rents [less expenses] and capital gains [less capital losses]. Most states charge 5% to 10% on top of that [CA is as high as 13.3%], making the total tax run as high a 37.1%. If there was depreciation taken on the asset, the cost basis is lowered by that amount, thus increasing the taxable gain!

Even with your primary residence, factoring in your tax exemption of $250,000 each for husband and wife, you may still have a hefty tax surprise with your capital gains taxes when you sell your property.

That isn’t the end of the story for the total tax effect. Capital gain is added to the taxpayer’s adjusted gross income [AGI]. This may raise the“floor” above which one can take a number of itemized deductions and affect, consequently, the Alternative Minimum Tax.

This could result in a large decrease or total loss of those deductions, which makes the effective, but hidden, capital gains rate much larger than the stated federal and state rates. And, of course, tax payment obligations would begin immediately.

To make matters worse, the capital gains and depreciation recapture taxes must be paid in the following tax year after the sale of the asset.

1.  Flexible Payment Options: 
When appreciated property/capital assets are sold, capital gains tax on said sale is generally deferred until the seller/taxpayer actually receives the payments.

2.  Estate Tax Benefits:
May accomplish an “estate tax freeze” for estate tax purposes.

3.  Maintains Family Wealth:
When properly structured, the principal inside the subject installment sales note can be preserved with “interest only” or partial principal payments, creating the potential to pass on a large portion of the note principal to your legal heirs with proper estate planning.

4.  Estate Liquidity:
Converts an illiquid asset into monthly payments.

5.  Retirement Income:
Provides a stream of income that can be used as retirement income.

6.  Probate Avoidance:
With proper estate planning.

7.  Eliminates Risks Associated with Ownership:
By utilizing our Deferred Tax Strategy [“DTS”], you have taken an asset that is otherwise “exposed” to liability and potentially converted it to a “no-liability” asset.

Nothing is required to be given away to charity as happens with the competing strategy known as a Charitable Remainder Trust. The DTS allows all due principal and accrued interest to be paid to the seller/taxpayer via a custom prepared installment sales agreement, whereas the Charitable Remainder Trust often pays income [interest] only.

The DTS has the potential and likelihood to yield more bottom line dollars to the property/capital asset seller/taxpayer than a Charitable Remainder Trust [CRT].

The DTS has the ability to generate substantially more wealth over the long run than a direct and taxed sale. It may be superior to the Charitable Remainder Trust [CRT], installment sale or like-kind property exchange in many respects. Consult with your tax advisor to ascertain the potential benefits of this option.