I learned about the Deferred Sales Trust from a friend of mine (Call him Joe).  Joe is the head of tax for a moderate sized CPA firm (about 30) with a niche practice.  Here is his account of his encounter with DST

Ever hear about this?  It’s a trademarked term, not a tax term.  I already told a client’s advisor “nope” but was curious if you ever heard of such a thing.

1)      I own a business

2)      You are my advisor

3)      You create a trust where I determine how funds will be invested

4)      I sell my business to your trust and am paid back over 10 years

5)      You sell the business to the buyer that I originally negotiated with.  $0 gain/loss by the trust

6)      If I need money in the future, you as the trust invest in my business

Joe’s evaluation was “a) No economic substance b) I have constructive receipt of the money c) related-party sale (I control the dang trust, I’m the beneficiary no matter what the document says)”.

Other than that Mrs. Lincoln how did you enjoy the play?

A Dead End

Joe had an open mind and discussed the concept further to see how it might work.  It did not go well.

At the end of that call, they told me there was another call scheduled a half hour later with a tax attorney who would answer my questions. But that I just had to sign the NDA form [i.e. non-disclosure agreement]] before that call. Of course I received the NDA form, read it, said nope and told the client not to do it. They claimed the DST structure is proprietary and as part of the NDA I needed to provide evidence of the information I already knew (which wouldn’t be covered by the NDA). I just wasn’t about to sign a document that could restrict my ability to talk to others or tell clients what not to do. The short notice NDA and previously scheduled call that they didn’t tell me about was just too shady for me.

Joe is not alone in hesitating to sign a NDA.  Mike Greenwald of Friedman LLP ( a top 20 firm) told me that a NDA requirement excites his skepticism, as it does mine.

Further Research

If you google Deferred Sales Trust, you will get a lot of hits and if you start talking to representatives, you will get stories similar to what Joe heard.  The implication is that you can have an indefinite deferral of your capital gains tax and substantial control over the funds even going so far as having them invested in your own business.

That such a sweet deal would stand up to IRS scrutiny strains credulity. Reilly’s Third Law Of Tax Planning –Any clever idea that pops into your head probably has (or will have) a corresponding rule that makes it not work.

I spent some time talking to representatives and get a similar story to Joe, but finally, I found somebody who could give me a clearer picture

The Actual Deal

I spoke with Robert Binkele and it all started to make sense.  I should mention that Mr. Binkele is a member of Forbes Councils.  I discovered this in my research.  It didn’t influence me, but I figure if I didn’t mention it, you would think I was not paying attention.

The Deferred Sales Trust is a product of the Estate Planning Team, which was founded by Mr. Binkele and attorney CPA Todd Campbell.  The concept is a lot less exciting as he explains it.

Suppose you are planning to sell a highly appreciated asset and have a buyer lined up.  A DST is established as a single stand-alone entity.  You are not involved in the ownership and are not a beneficiary.  You sell your interest in the property to the DST for an installment note. The DST closes with the buyers. Ten years with interest-only of 5% are terms that are within the realm of reason.

Whatever is negotiated in terms of the note will be commercially reasonable.  The details of the return will be affected by your risk tolerance.  Your relationship to the trust is that of a creditor.  Your collateral is the trust’s underlying investment portfolio which will be structured to be able to pay you your return.

As a creditor, you have influence over the investment approach.  Within reasonable limits, the terms can be renegotiated, but it is not a matter of the trustee willy nilly doing whatever you direct them to.  The modification of an installment note is not a realization event. Among other things, this can allow the term to be extended.

Of course, if the underlying investments do not perform you may find that at the end of the day your collateral does not cover the obligation to you, but as Mr. Binkele explains it there is sophisticated investment planning, including  Monte Carlo simulations to provide decent assurance.

What Is In It For You?

In a traditional installment sale, you are relying on the buyer’s ability to pay you.  You may have a security interest in the asset you sold, but if you wanted it back you would not have sold it. The obligation of a DST is secured by an investment portfolio purpose-built, possibly including hedges to deliver the expected return.

How does this compare with taking the cash and reinvesting it? That depends on how large the capital gain tax obligation is.  If you sold an asset with negligible basis and face a stiff state income tax in addition to federal tax, the tax could be as much as 30% of the proceeds (or more).

If you planned on turning the sales proceeds over to a money manager who would invest conservatively for income and principal preservation, having the deferred capital gains tax continuing to provide a return is a huge advantage.  Once the face of installment notes held by you crosses $5 million, it becomes less exciting as you have to pay interest on the deferred tax attributable to amounts over $5 million.  You can read about that here.

What’s In It For Them?

I’m not going to get into the fees in detail since they vary by the size of the deal and are to a significant extent negotiable. One of the representatives was suggesting 1.5% per year.  When I was talking to Mr. Binkele about it he indicated something like that would be all in including investment management.  The cost for the trust arrangement is more in the 30 to 50 basis point range and in some cases whoever is managing the money might eat it since the arrangement gives them more assets under management.

There is a subtle tax advantage.  The trust is paying its own taxes and the fees are expenses of the trust. Your position is as a creditor of the trust.  That means that the fees are reducing your gross return rather than passing through to you as deductions that are likely not useable.

Does It Stand Up?

So to know for sure, I would have to sign an NDA and then I couldn’t write about it.  You are selling to an independent third party and everybody has business reasons for doing what they are doing.  It has been going on for two decades so if it were being disallowed you would expect it to have generated a Tax Court decision by now. It hasn’t.

One of my sources remarked to me that if the plan worked, it would have been reverse-engineered by now.  Who knows? Maybe it has been.  Dawn Hallman wrote this piece Deferred Sales Trust – What’s All the Hype? for the Oklahoma Bar Journal.

While the concept seems simple, the application is not. This is a very useful tool to share with clients; notwithstanding, careful selection of the drafting attorney and the third-party trustee is paramount to the success of the DST. Having a working knowledge of the DST allows you to identify potential users. There are many intricacies to make a DST work as planned.

Reilly’s Fourth Law of Tax Planning – Execution isn’t everything, but it’s a lot.

I spoke with Ms. Hallman and found that she was not aware that the Estate Planning Team has claimed a trademark on the term DST Deferred Sales Trust. (See Update)

Mr. Binkele told me that the NDA is not there because of concern about competition but rather to prevent the irresponsible from pushing the envelope too hard and ruining it for everybody. He is an enthusiastic advocate for the technique waxing poetic on the amount of good that it does by allowing transactions to occur that the threat of capital gain recognition would otherwise thwart.

Is It For You?

It all depends on what you compare it to.  If what you were going to do was just pay the capital gains tax and then turn the balance over to a money manager who charges a fee based on assets under management, it seems like a DST  or something like it might be just the thing.  Your current return will be based on a higher number because of the deferred capital gains tax.  If the manager eats the cost of the trust arrangement so much the better, but of course that might indicate that the fee was higher than it needed to be to begin with.

What I can’t reach a conclusion on is whether the trademarked DST offered by the Estate Planning Team is the only way to achieve the result.

Why All The Hype?

The sad reality of practicing a profession is that in order to make a living you have to do some actual work yourself or pay somebody pretty good money to do the actual work.  The Estate Planning Team taps into the frustration that professionals of different sorts have with that reality.  There will be $17 trillion being transferred as people in my age bracket (I’m 67), you know, drop dead in the next twenty years.  Here is your chance to sweep some crumbs off the table as that big cake is sliced.

The Estate Planning Team (EPT), is a membership organization with a turn-key marketing plan and the support of tax and legal professionals to help you tap into this wealth transfer by providing your clients with capital gains tax and estate planning (probate avoidance) solutions.

When you join Estate Planning Team you can offer your clients the Deferred Sales Trust™ (DST), a strategy to defer capital gains tax on the sale of highly appreciated property. With additional planning the DST can reduce or eliminate estate tax (death tax).

The ability to defer capital gains taxes over an extended period of time is an obvious benefit to your client, but how does it increase your personal business income? (Emphasis added)

Well, we explained that above.  You get a piece of the fee for work that other people do.

Conclusion

Getting a return on deferred capital gains tax is clearly a good thing.  It is reasonable to expect that if somebody helps you to do that they are going to get paid – somehow. Rewarding the sharp tax thinking by turning over stewardship of a big piece of your wealth might be a bit much.

The Deferred Sales Trust offered by the Estate Planning Group might be a good solution, but it is probably not nearly as good as you thought it might be from listening to the freelance sales force.

Other Coverage

C. Grant Conness has A Real Estate Exit Strategy That Can Save on Capital Gains Taxes  on Kiplinger. Frankly, it reads more like a pitch than an analysis.

There is a pretty short reddit discussion with some sharp barbs.

I’ve worked with a few guys who tried to sell them and they don’t seem that useful to me personally. I don’t mean to sound condescending, but theguys selling them are often less-than-brilliant CRE brokers looking for clever ways to get owners to sell.

Overall, I have not been able to find any independent analysis.  “Deferred Sales Trust” looks like a tax concept and you will find plenty of articles that purport to explain it failing to mention the product aspect.

Update

Ms. Hallman was concerned about that trademark issue.  She chided me on not doing more research (Also on getting her name wrong, which is really beyond the pale on my part.  Very sorry).  I could have looked the trademark up on TESS (Trademark Electronic System Search) and learned that it is Dead and Abandoned,

I’m not ready to take a course in intellectual property law, but I did some more poking around on the issue.  The Estate Planning Team is claiming a “common law” trademark on “Deferred Sales Trust”.  I found this discussion of dead trademarks here.

The United States Patent and Trademark Database (USPTO) is a database where all trademarks are collected. A business should verify on the database that the mark they’re using is in fact unique. If a mark is already registered and signaled as “live,” then no one but the owner can use it. If a mark is “dead,” then another business can attempt to register it, but it’s often not this simple.

Even if a trademark is listed as dead, the original company or another party can be using the mark and therefore owning the Common Law rights to it.

I’ll give you a further update if Mr. Binkele gets back to me on this.