What is a 1031 Exchange?

A 1031 exchange, also known as a like-kind exchange, is a tax-deferred exchange of investment properties. It allows you to sell one investment property and purchase another investment property of equal or greater value without having to pay capital gains taxes on the sale of the first property.

What is a Deferred Sales Trust (DST)?

A deferred sales trust is a financial instrument that allows you to defer capital gains taxes on the sale of a property. It is typically established by a qualified intermediary, who is a third-party facilitator of 1031 exchanges.

Benefits of Using a DST Over a 1031 Exchange

There are several benefits to using a DST over a 1031 exchange, including:

• More flexibility: DSTs offer more flexibility than 1031 exchanges in terms of the types of properties that can be exchanged and the timeline for the exchange. For example, DSTs allow you to exchange real estate for other types of assets, such as securities or partnerships. Additionally, DSTs do not have the same strict deadlines as 1031 exchanges.
• Greater investment options: DSTs offer a wider range of investment options than 1031 exchanges. With a DST, you can invest in a variety of different asset classes, including real estate, stocks, bonds, and private equity.
• Professional management: DSTs are typically managed by professional investment managers, which can save you time and hassle.

How a Member of an LLC or LP Can Take Their Percentage Share and Do a DST While the Other Members or Partners Continue with a 1031 Exchange

If you are a member of an LLC or LP that is dissolving and some members want to do a 1031 exchange and other members want to use a DST, there are two ways to structure the transaction:

• Drop and Swap: In a drop and swap, the LLC or LP distributes the real estate property to the members in proportion to their ownership interests. The members who want to do a 1031 exchange then exchange their property for another property. The members who want to use a DST sell their property to the DST.
• Swap and Drop: In a swap and drop, the LLC or LP exchanges its real estate property for another property. The LLC or LP then distributes the replacement property to the members in proportion to their ownership interests. The members who want to use a DST sell their property to the DST.

Once the transaction is structured, the member who wants to use a DST will need to establish a DST with a qualified intermediary. The member will then sell their property to the DST. The DST will then invest the proceeds from the sale in a variety of different assets, such as real estate, stocks, bonds, and private equity.

The member will not have to pay capital gains taxes on the sale of their property until they receive distributions from the DST. The member can choose to receive distributions from the DST at any time, and they can choose to receive distributions in cash or in kind.

Example

Let's say you are a member of an LLC that owns a commercial property. The LLC is dissolving, and you want to use a DST to defer capital gains taxes on the sale of your property. The other members of the LLC want to do a 1031 exchange.

You can structure the transaction as a drop and swap. The LLC will distribute the commercial property to you and the other members in proportion to your ownership interests. You will then sell your property to a DST. The DST will then invest the proceeds from the sale in a variety of different assets, such as real estate, stocks, bonds, and private equity.

You will not have to pay capital gains taxes on the sale of your property until you receive distributions from the DST. You can choose to receive distributions from the DST at any time, and you can choose to receive distributions in cash or in kind.

DSTs for Business Sales

A deferred sales trust (DST) can be a valuable tool for business owners who are considering selling their businesses. A DST can allow business owners to defer capital gains taxes on the sale of their businesses, which can provide them with a number of benefits, including:

• Increased cash flow: By deferring capital gains taxes, business owners can free up more cash flow for their businesses. This can be used to invest in new growth opportunities, repay debt, or simply increase the owner's personal income.
• Reduced tax burden: Deferring capital gains taxes can help business owners to reduce their overall tax burden. This is because capital gains taxes are typically paid at a higher rate than ordinary income taxes.
• Greater flexibility: DSTs offer business owners greater flexibility than traditional business sales. For example, business owners can choose to sell their businesses to a DST in a lump sum or over time. They can also choose to receive distributions from the DST in cash or in kind.

How a DST Works for Business Sales

To sell a business to a DST, the business owner would first need to establish a DST with a qualified intermediary. The business owner would then sell their business to the DST in exchange for a promissory note or deferred installment contract. The promissory note or deferred installment contract would specify the terms of the sale, including the purchase price, the payment schedule, and the interest rate (if applicable).

The DST would then use the proceeds from the sale to invest in a variety of different assets, such as real estate, stocks, bonds, and private equity. The income generated from the DST's investments would be used to make payments to the business owner under the promissory note or deferred installment contract.

The business owner would not have to pay capital gains taxes on the sale of their business until they receive payments from the DST. The business owner can choose to receive payments from the DST at any time, and they can choose to receive payments in cash or in kind.

Benefits of Using a DST for a Business Sale

There are a number of benefits to using a DST for a business sale, including:

• Tax deferral: DSTs can help business owners to defer capital gains taxes on the sale of their businesses.
• Flexibility: DSTs offer business owners greater flexibility than traditional business sales.
• Professional management: DSTs are typically managed by professional investment managers, which can save business owners time and hassle.
• Diversification: DSTs can help business owners to diversify their investment portfolios.
• Estate planning: DSTs can be used as part of a comprehensive estate planning strategy.

Example

Let's say you are a business owner who is considering selling your business. You are interested in deferring capital gains taxes on the sale of your business. You also want to have the flexibility to choose when you receive payments from the sale of your business.

You could choose to sell your business to a DST. You would first need to establish a DST with a qualified intermediary. You would then sell your business to the DST in exchange for a promissory note or deferred installment contract. The promissory note or deferred installment contract would specify the terms of the sale, including the purchase price, the payment schedule, and the interest rate (if applicable).

The DST would then use the proceeds from the sale to invest in a variety of different assets, such as real estate, stocks, bonds, and private equity. The income generated from the DST's investments would be used to make payments to you under the promissory note or deferred installment contract.

You would not have to pay capital gains taxes on the sale of your business until you receive payments from the DST. You can choose to receive payments from the DST at any time, and you can choose to receive payments in cash or in kind.

How Do I Put the Proceeds to Work?

When it comes to accessing the funds in a deferred sales trust, the seller typically has several options, depending on the terms of the specific trust agreement:

1. Scheduled Payments: The trust can make scheduled payments to the seller over a defined period, providing a steady income stream over time.

2. Lump-Sum Withdrawals: Some trusts may allow the seller to make partial withdrawals or lump-sum withdrawals, providing access to a larger amount of funds at specific intervals.

3. Investment Opportunities: Depending on the terms of the trust, the seller may have the opportunity to reinvest the funds within the trust, potentially allowing for additional growth and income generation.

It's important to note that the specific terms of the trust agreement will determine how and when the funds can be accessed. Sellers should thoroughly review and understand the terms of the trust before entering into any agreement to ensure that it aligns with their financial goals and needs.

Conclusion

A deferred sales trust is a powerful tool for deferring capital gains taxes on the sale of a property. It offers more flexibility, greater investment options, and professional management than a 1031 exchange. If you are a business owner who is considering selling your business, you should consult with a qualified advisor to determine whether a DST is right for you.