How does a Deferred Sales Trust work?
The Dererred Sales Trust Process
The process begins when an investment property owner transfers his asset to a trust managed by a third-party company on the owner's behalf. The third-party company acts as trustee over the asset, and the owner is the beneficiary of the trust that holds the asset. The trust will then sell the property and manage and distribute the sales proceeds of the trust according to an agreed-upon installment contract that was set up with the trust ahead of time. The sales proceeds can be held in cash, reinvested, and distributed according to the direction of the owner's installment contract.
There are zero taxes to the trust on the sale, since the trust purchased the property from the owner for the same price for which it is sold. The tax code does not require payment of any of the capital gains taxes until an investor starts receiving installment payments that include principal. The owner then is able to control if, when, and how there will be capital gains tax exposure by adjusting the installment contract. The installment contract between the owner and the trust company provides flexible options on when and how payments can be made.
Initially, the owner may have other income and may not need the installment payments right away, which would defer income and capital gains taxes. If an owner wants income but does not want to pay capital gains taxes, he can set up the installment contract to pay interest-only payments from the reinvested sales proceeds. According to IRC section 453, this strategy can defer the capital gains tax indefinitely.