Ep. 95 | The Hidden Benefits of Deferred Sales Trusts for Real Estate Investors
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John Tripolsky:Welcome back to the Teaching Tax Flow podcast, everybody. Today, episode 95, we are gonna talk about deferred sales trust. That's right. The countdown is on to episode 100 here on the podcast. But before we jump into today's topic, let's take a brief moment as always and thank our episode sponsor.
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John Tripolsky:Welcome back everybody to the Teaching Tax Full podcast. As you've seen in the description of the episode, you've read the title. You've read the description. You've probably heard us talk about this topic maybe a couple months ago. I feel like we brought it up in something me and Chris may have been talking about.
John Tripolsky:But more importantly, as I mentioned, right, we are only 5 episodes away from episode 100. That is a 100 consecutive weeks of us knocking this out. Great topics, great guests, and, you know, Chris Pacquero is usually on here with me too. So before we get into the topic though, I do wanna mention something. Right?
John Tripolsky:For everybody that's counting down the days to the end of the year, I hate to be the bearer of bad news, but you really don't have that long. So if you think about it, right, you you got, you know, 4 months give or take lots of time technically, to plan, but also lots of time to procrastinate and completely fall on your face. So that being said, I will stop being the bearer of bad news. Chris Pacquero, welcome back to the show. Good sir.
Chris Picciurro:How are you doing? I'm doing great. Thanks for having me back. I'm excited about this episode in the real estate world. We hear a lot about DSTs, which in that context would be a Delaware statutory trust.
Chris Picciurro:But there's another DST. And this DST, I believe, has a much broader scope, and I'm so excited about our guest today. He's gonna talk through what the other DST is. It stands for Deferred Snails Trust. It's an amazing tax planning tool that I personally see happen with many clients.
Chris Picciurro:And, yeah, we're gonna talk through that. I'm always always intrigued to bring a new tax strategy to many of our listeners. So we are you know, as you know, John, in Teaching Tax Flow, we believe your tax return is a verb and not a noun. So if you are getting worried that you're getting close to the end of the year, you might wanna think about having a personalized tax plan put together by your tax professional. If you need help with that, just contact us and we'll help guide you in the right direction.
Chris Picciurro:Now enough of that, I'm excited about our guest, Todd Jackson of Todd Jackson Law. Todd is my absolute go to person on anything deferred sales trust, related. We have worked on mutual clients together. And believe it or not, kind of a confession here, John, you know, get your holy water out. I didn't know what a deferred sales trust was until I met Todd and, was introduced I was introduced to him by a mutual client.
Chris Picciurro:So I'm always learning new strategies, but this is really solid. Todd is also from beautiful and historic Franklin, Tennessee, my favorite city. I'm a little biased. But that's not why we have him on the show. We have people on the show from all over the country.
Chris Picciurro:So, Todd, welcome to the Teaching Tax Flow Show, and thanks for joining us.
Todd Jackson:Of course. Hey. Thanks for having me, you guys. Glad to, be here. I appreciate the introduction.
Todd Jackson:So, before we jump into the the guts, just a little bit of background. So I am, a I'm a tax attorney primarily, but, also an m and a attorney, real estate attorney. So in other words, my phone rings when somebody is selling something at a game. I don't get many calls if somebody's selling something at a loss, but my phone really rings when somebody's selling something and they're facing a capital bank. And they need some planning around that.
Todd Jackson:So, so that's kinda where I come in unless we're, you know, common clients we've had, have been facing that situation. So what what I do has to do with deferral of capital gains. Alright? So, just just to be clear, this is not a a a shelter. This is not a an avoidance of capital gains taxes.
Todd Jackson:It's a deferral. They're going to be paid. They're just gonna be paid over time, and later just like many other deferrals, IRAs and 401ks, all the other deferrals that are in tax code. This is one more. So this is not the Al Capone School of, tax evasion.
Todd Jackson:Right? We don't do that. We we follow the rules and and taxes, are paid. But, just like the benefit of those other deferrals, we use the same benefits, because, obviously, at being asked a simple question, would you rather pay something today or 10 years from now? Most people are gonna say, well, yeah, that'd be cool to pay it a little bit later.
Todd Jackson:Get a little bit of a benefit for time value of money. That's what we do. So, that that's kind of the the background. Now this specifically of the deferred sales trust is a, a specific way of, configuring a deferral, strategy. We use what's already in the tax code, and most of the time, we're using installment sale treatment.
Todd Jackson:We can get into what that what that means, but I'll just lay out the most basic way to look at an installment sale. And a whole lot of your listeners have probably done one. That's somewhere along the way. It is simply selling something and being paid later over time for that thing. K?
Todd Jackson:So from a tax standpoint, that's a deferral because, so, Chris, if I buy something from you for $1,000,000 and you're such a nice guy, you say, tell you what? I'm gonna be the bank for you. Because I know, Todd, you don't have any money. So, you say I'm gonna be in the bank. I now own that thing, but I owe you a $1,000,000.
Todd Jackson:Okay? If the IRS showed up and said to you, hey, Chris. We understand you sold this for $1,000,000. Where's our money? You'd say, wait a minute.
Todd Jackson:I haven't got it yet. Right? I mean, I'm going to get it. I'm going to be paid over time. And when I get that money, clearly, I'm gonna pay you as I receive payments.
Todd Jackson:That's an installment. Right? And that's why it's a deferral is because if you were taxed when you sold it, you'd have no way to pay the taxes because you haven't got the money. That concept, the installment sale has been in the tax code for going on a 100 years. You know?
Todd Jackson:So just about as basic of a concept as you can get. That's the basis for how we structure what we do.
Chris Picciurro:No. This is that's important because what we understand when we talk about tax planning and strategy is that your marginal tax rate, remember, that's the number one KPI or key performance indicator or driver when it comes to tax planning and strategy. Your marginal tax rate is not static. Your marginal tax rate's more important than your tax bracket. So that's why when we talk about being able to to spread the the in control, legally and ethically, the recognition of income into different tax years, that's where there's a ton of savings.
Chris Picciurro:So think about this. Todd mentioned tax deferral. Let me let me paint a picture. Let's say you have a $1,000,000 taxable event, and in and if it was all in 1 year, you'd be in a 30% marginal tax rate. It would cost you $300,000 of tax.
Chris Picciurro:If by spreading it over time, you can take that marginal tax rate down to 15 percent, that means it's a $150,000 worth of tax. You've saved yourself a $150,000 worth of tax, yet you have. You have paid tax on that $1,000,000 legally and ethically, but you've been able to spread it out into certain marginal tax rate years that you might have a lower number. Or, excuse me, you might have another tax event that can offset the taxable income. That's why tax strategies don't happen in a bubble.
Chris Picciurro:They work together. So if you have if you're a real estate investor and you're having cost segregation studies done or if you're starting a business and you have business losses in 1 year for for business that's going through growth. You can those are better years when you're in lower marginal tax rate years to absorb the taxable income. And that's what the power of of this isn't some hocus pocus. This is deferring the gain into a look.
Chris Picciurro:Think about this, Todd and John. If I said, I'm gonna fly today from here to Orlando, Florida. I have to look, and I have and I can only fly on Southwest, which has a guy you know, well, I'm just gonna be Southwest. Oh, Southwest, you deserve you should be a sponsor of this podcast if you're listening. I only can fly the times Southwest wants me to fly, and those come with opportunity costs.
Chris Picciurro:They could be financial. They could be, I don't wanna wake up at 4 in the morning, or I don't wanna fly at 10 at night when my flight could easily get delayed. What have I got to pick when I get to fly? That's that's what's happening. And hopefully, I don't know if anyone's ever I just that just that just hit me that that is a way to look at recognizing income.
Chris Picciurro:And, Todd,
John Tripolsky:I actually have a question for you too, and and I think I know the answer to this, but I I almost guarantee some of our listeners have probably begun asking themselves as questions we were talking. So I love your description of a DST and how it's an installment sale. So that way the way you describe it and kinda walk through makes a ton of sense. So I think that's pretty clear. But those that have also listened to many of our podcasts, we talk about 10 30 ones.
John Tripolsky:I'd say probably 10% of our episodes. How how does this differ? Is there any similarities to a 10 30 one exchange?
Todd Jackson:Of course. So and and for, for background, I'm actually a 10 30 1 one qualified intermediary. I've got a 10 30 one company, and I do those every day for people. So I I have firsthand, experience with how the 2 of them differ. Right?
Todd Jackson:And so, here are some of the main differences. 1031 has some, restrictions as far as, some timing requirement. So I'm doing a 1031 After I sell a piece of real estate, number 1, I've got 45 days to identify what I'm going to buy next as a replacement. Alright? That's just a standard time frame.
Todd Jackson:Now downside to that generally is I'm not smart enough to sell high in a market and buy low within 45 days in the same market. So that's really a main one of the main challenges to a 1031. Certainly, as an obstacle. People do them all the time, and that's number 1. Number 2 is, you have to purchase whatever you identify within a 180 days of when you sell.
Todd Jackson:So you you your readers probably understand those basics. Now getting into a little bit more of the nitty gritty, another requirement of the 1031 is that you've gotta replace, any debt that you paid in that sale. I'll give you an example. I got a call from somebody that says, hey. I'm selling real estate for 10,000,000, and I've got 5,000,000 in debt, and my tax basis is 5,000,000.
Todd Jackson:So in other words, I'm gonna get proceeds of 5,000,000, and that's my gain. And they say, I want you to do a 1031 for me so I can invest that 5,000,000. And I have to give them the bad news that, no. We're not going to do that. If you do a 1031, you're buying something for 10,000,000.
Todd Jackson:You're using the 5,000,000 in cash, and you're also gonna replace that debt with new debt, right, of 5,000,000. And they say, wait a minute. I'm paying off debt that has a 3 a half percent interest rate. There's no way I'm replacing that with 9% new money. And I say, well, then you're not gonna do a 10.31.
Todd Jackson:And they say, well, I love this price I'm getting. Right? What else can I do? Well, this is one of the times when, the deferred sales trust is an alternative to a 1031 because the requirements that you replace debt, that's a 1031 requirement. And since we operate ours in section 4 53, which is installment sale treatment, There is no such requirement that you replace debt.
Todd Jackson:So they can use truly the gain for investing going forward and not have to replace that debt. So that's one of the main main differences. Another one that comes up a lot that you've probably talked to your listeners about is somebody is either coming out of an asset that doesn't qualify for 1031 or they want to go into an asset that doesn't qualify. The main one that comes up consistently is like a syndication. Right?
Todd Jackson:Somebody says, listen. I'm gonna sell this piece of real estate and I wanna buy into the syndication with this group. The problem is what they're buying is an LLC interest, not real estate. Doesn't qualify. Right?
Todd Jackson:And so that again, that's another 1031 requirement that keeps him from doing it. Only is that a is that a restriction in 1031. With our trust structure, there is no such restriction that the the trust can invest in that syndication without any obstacle because we're not in 1031. Right? So we see that a lot.
Todd Jackson:So there that's just a couple of the ways that they differ. Now to be clear, 10 30 ones are awesome. I do them every day. It's a been in part of my practice for 30 years. Right?
Todd Jackson:But when they work. Right? What I do see, though, that's kind of unfortunate is people will will buy something in a 1031 they don't want. Absolutely don't want this because they feel like they have to or these dire consequences are gonna happen. That's when this trust structure is a good option because you're not forced to make a bad decision.
Todd Jackson:Because, again, we don't have those time restrictions in this. Right? Somebody might tell me, hey. Yeah. I may or may not wanna buy my real estate, but I wanna sit on the sidelines for a year or 2.
Todd Jackson:Well, 10:31 not an option for that, but those time constraints. So we just gotta freeze it up to where it's not quite as bricked as far as this timing goes.
Chris Picciurro:Right. Because, ultimately, the 10 the DST, the deferred sales trust, it has flexibility. It has a lot more flexibility. But I wanna talk about, Todd, is you mentioned when when your phone rings when a transaction occurs. If somewhat who's a good candidate for this and when should they contact you?
Chris Picciurro:Because there are some similarities with the 10 30 one exchange as far as timing. I mean, it it don't I believe you have to have the trust instruments started before the sale occurs. We I'm sure you could speak to that a lot better than I can.
Todd Jackson:Of course. Yeah. Yeah. So just you know? So so, by way of background on this on the structure, absolutely has to be done before the sale.
Todd Jackson:Right? Because what we do, just like a 1031, as far as the the purpose of it, it's to avoid, actual receipt of money. Right? There's nothing we can do to defer gains if you've received the money. And we also need to avoid constructive receipt of the money.
Todd Jackson:So that's a a term the IRS uses. That means, yeah, you may not actually have the money in your account, but there's no obstacles from getting it. For and a good example is somebody calls me and they say, hey. I wanna I wanna defer gains on my sale. And I say, okay.
Todd Jackson:When are you closing? They say, well, I closed yesterday, but I don't have the money yet. And I said, well, where is it? Well, it's in the attorney's trust account. And that says, well, what are the conditions to you getting that?
Todd Jackson:They say, well, they just need my wiring instructions. Well, that's constructive receipt. That's tax well, there's not anything I can do about that. So what we do then is we get this in place ahead of all of that to where none of that has happened yet, and we get the structure in place because what we need to happen is we create the installment sale, not with the with the buyer of that asset. Right?
Todd Jackson:Because you can always do that. So, Chris, if you're selling a piece of real estate, you can sell that to the buyer. You can agree to be the bank and finance. Right? Well, the downsides to that are, number 1, what if they don't pay you?
Todd Jackson:Right? Then you have to take that asset back, Right? Because you have to foreclose on it. But if by then they've destroyed it to where it's not worth anything near what you're owed, That's the downside. Right?
Todd Jackson:So we create the installment sale ahead of all of that between a new trust that I established and that seller. So the installment sale is between, the trust, which is an unrelated party to them as as just not there's no common ownership, anything like that, between the seller and his trust. And that asset now is is owned by the trust. The trust is the seller to to the buyer. Right?
Todd Jackson:So that's done, and the installment sales in place before that sale happens. And now the trust is the receiver of of the funds, from that sale. And those funds are invested by the trust to service that note that's payable with interest and everything else that's negotiated, to that seller. And then from there is what Chris already talked about, is you're taking that gain instead of having it all hit at once. It's hitting over time on a schedule that you, that you arrange.
Todd Jackson:Right? So that so, yes, absolutely has to be, you know, in place ahead of all of that.
Chris Picciurro:So all of that so, obviously, I've I've talked about flexibility. Another thing is control. That's, I think, when Todd, when when we hear people on the teaching tax law community, they're concerned about, okay. I put this money into the trust. That's the negative of the 10 30 one exchange.
Chris Picciurro:A lot of times, if you put your money into a syndication, you don't have control of that asset. Can you talk a little bit about, what are some of the things that so so if I if I created a a deferred sales trust for myself, and let's say I sold, you know, my, whatever, I found a baseball card or some big cost, some collectible or something like that, or I, you know, I have an asset that I'm selling and and I put it, you know, I create this trust and I have a big capital gain that I defer. The cash goes into the trust. Can I still invest that into different, you know, stocks, bonds, mutual funds? What are some of the am I the trustee of the trust or the beneficiary?
Chris Picciurro:How does that what's my role then is is probably the better question.
Todd Jackson:Okay. So that's a good that's a great question. And we we're gonna go back to the what we just talked about a minute ago, which is constructive receipt. So we have to create this and maintain it in a way that prevents you from having constructive receipt to where that triggers all the gains. And what that means then is you can't be the trustee.
Todd Jackson:You can't be the owner of it slash beneficiary. Right? All of those things. The relationship this is the central to the whole thing. The relationship between the trust and you as the seller is that of an installment sale, which is borrower trust lender, Chris.
Todd Jackson:Right? Borrower lender because we have to maintain, the fact that they're that you're totally an unrelated party for the trust. For example, I've got a house. Right? And my lender on that house is Bank of America.
Todd Jackson:Right? That's a that's a borrower lender relationship. Well, I'm not related to Bank of America. I've got nothing to do with them other than not owe them money. Right?
Todd Jackson:That's what we do here because we have to have it to where you're not related because if you're a related party, the deferral cannot work. Right? Now but to your specific question about control, you are a secured creditor, right, just like Bank of America is on my end ops, which means that you've got a security interest on everything that's in this trust, which means trustee, financial adviser, anybody that's that's making investments, they have to get your approval before anything's done because, again, you're the secured creditor. They can't just do what they want because you've gotta you've gotta lien a security interest. So that gives you creditor control, right, as opposed to actual possessive control that's within your account in a field very much like the same thing, but that's what is required to keep the relationship to Agneson.
Chris Picciurro:And then the trust could invest in I mean, what do typical the trust do the trust typically have a brokerage account or a savings account or what are what are typically the things that they they park their money into?
Todd Jackson:So they'll it'll be a brokerage account. So, obviously, we want the trust to be, this is a preservation strategy. Right? This money wants you want the money to be there tomorrow. So usually Schwab, Fidelity, the largest clearinghouse's, brokerage account is where, the money is is managed.
Todd Jackson:Okay? Now what the trust can invest in, there's not any restriction. It can invest in anything. That's never the conversation. Okay?
Todd Jackson:A 100% of the conversation is what it should invest in. For example, Chris says, hey. I wanna put, all my money in Bitcoin. Right? Well, can he do that?
Todd Jackson:Well, yeah. The trust can do that. Should it do that? Absolutely not. Right?
Todd Jackson:So that's what I'm saying is it can invest in anything, but it's gonna be geared around what it should invest in based on what's, you know, fits the risk tolerance, make sure it's a reasonable investment, that it's, you know, it's gonna preserve, that asset. But at the same time, produce some income because it has to have the income to pay the interest on a bad installment note. So what's invested in is tied more directly to the risk tolerance. What's, you know, what's, the creditor is going to allow to be invested in. Right?
Todd Jackson:So if Chris is super conservative, right, maybe he goes into treasuries, which are paying really well right now. Right? If he says, hey. That's great. 5a half is cool.
Todd Jackson:But if I wanna get, you know, 7, 8, what do I what do we need to do? And the financial adviser is gonna say, why you gotta take on some risk to to go from treasury, no risk essentially, to, you know, a little higher than that.
Chris Picciurro:You need to take on some level of risk. Alright. So we talked about timing when you start the trust. So if you're listening to this and you're you have an imminent large capital gain event that might occur, that's the time to start thinking about a deferred sales trust. We also talked about what the trust can do as far as operationally, from a 30,000 foot view level, what it can invest in.
Chris Picciurro:We know that the trust is is meant to preserve the money, and grow the the the assets or the money in the trust to pay, to pay back the loan from the person that that started the trust. But, Todd, can you talk a little bit about on the back end? So how how do how does someone get the money out of the trust and ultimately recognize that income over a certain amount of a certain amount of years? And what's the typical lifespan of this of such a trust?
Todd Jackson:Of course. So the the promissory note for the installment sale drives all of that. Right? It has the terms for how long, what kind of payment structure, interest rate, and all of that. So it's a contract.
Todd Jackson:So it's all driven by that document. Right? And, that that's how it, goes through for the for its, you know, for its scheduled, the structure. Right? Usually, that's gonna start out with, say, 10 years.
Todd Jackson:Right? On a note. Gives us time to kinda have, you know, spread it out, have a payment structure. But, yeah, this so that document controls how that's paid out.
Chris Picciurro:Is there a maximum amount of that the that the note can be, entered into?
Todd Jackson:Yeah. So it's gotta be the IRS says it's gotta be commercially reasonable. Right? Or something you could get at, at a at a bank, similar type of loan. So we can't do a 20 or a 30 year.
Todd Jackson:So 10 years is pretty standard. They will do. Okay.
Chris Picciurro:Okay. So if someone so for for someone listening, if you've got any, like I said, a long a capital gain that's coming through, you're interested in doing some tax planning and potentially spreading that gain up to, give or take, at least 10 years, this is something that you want to consider. And, Todd, to wrap things up, who's who's gonna be the best avatar for you? In other words, at what point is does this make sense when you associate the tax mitigation and the cost? What type of capital gain should be, you know, obviously, if you sold your Apple stock for a $3,000 gain, this is probably not the best, best structure for you.
Chris Picciurro:But what where does it start making sense in from a tax perspective?
Todd Jackson:Yeah. I usually say if you've got a if you've got a capital gain that exceeds $500,000, right, That's starting to get into the area to where this this could make some sense. Right? Anything anything less than that, the structure is probably a little bit cumbersome for smaller gains to where, they're really not gonna see, as big a benefit. So just and there's really no real number.
Todd Jackson:Right? But that's kinda just a general area to kinda arbitrary to to go by.
Chris Picciurro:Gotcha.
Todd Jackson:Rule of thumb.
Chris Picciurro:Well, I do, I do have a couple fun questions to end this. Obviously, we're gonna put all your information in the show notes if someone you know, once you listen to this, if you're interested in that, we're gonna give you the opportunity to reach out to Todd. And, also, you know, if you're if you're in our in our defeating taxes private Facebook group or following us on any social medias, reach out to John, myself, or Todd. All like I said, all that information will be in the show notes, and we're happy to, make sure you get put in the right direction. But, Todd, I've got a few fun questions to wrap things up, nontax related.
Chris Picciurro:Alright? And the first one is if, tell me one thing that might surprise our listeners about you that someone might not know.
Todd Jackson:Well, I'm kind of the I guess I've got a career ADHD, so I'm gonna run down a real quick list. So in addition to being an an attorney, MBA, 10/31 QI, I'm a real estate agent. I'm a title insurance licensed agent. I'm an m and a adviser. So I kind of can't help but wear a bunch of ads at the same time, but there there there's some there there's some, reason for that is because it's so hard to separate all of those things, because they're all interconnected on those transact
Chris Picciurro:Cool. I think it's a
Todd Jackson:good comprehensive approach. So I'd I call it ADHD, for our career. Nice. Tell what would be an ideal weekend for you? Wow.
Todd Jackson:Alright. So probably a, a nice dinner with my wife followed by 36 holes on Saturday. Plan go. I get in trouble if I just say the golf part.
Chris Picciurro:I know. Should yeah. Well, our our wives don't listen to our podcast, so we're we we put them under the throw them under the bus all the time. Unless we tell them not to listen to it, then they somehow will listen to that one. That's just how it works for Con and I.
Chris Picciurro:Do you have a team any what's your favorite sports team? Oh, wow.
Todd Jackson:You know, I've always been a, San Antonio Spurs fan. I'm a I'm a big basketball fan. And Tim Duncan started, at Wake Forest where I was in law school and MBA school. And so I got a chance to meet him as I was going out. He was coming in.
Todd Jackson:Was an immediate fan, super nice guy. And 5 rings later, now retired, I kinda became a permanent Spurs fan. So if I if I had to pick 1,
Chris Picciurro:that's it. I did I didn't know you're a demon deacon. That's pretty cool. Last question, it's a fun one. What's your favorite cereal?
Todd Jackson:Well, it's gotta be peanut butter crunch, Cap'n Crunch, because anybody who doesn't agree with that has mental problems of some sort.
Chris Picciurro:Oh, we we go through peanut butter like water in our house.
John Tripolsky:You go.
Chris Picciurro:And and all peanut butter and chocolate related, cereals, but I do like myself some Golden Grahams once in a while.
Todd Jackson:Of course.
John Tripolsky:Awesome, gentlemen. Awesome. Why well, Todd, we appreciate you joining us on this one. For sure, Chris, thank you for, obviously getting back on your own show. And, Todd, actually, I have a bunch more questions on these that I'm gonna have to hold out until next time when, when we have you back.
John Tripolsky:Maybe dive into the dive into the weeds a little bit on this if you're so inclined to join us back here.
Todd Jackson:Glad to come back anytime.
John Tripolsky:So, well, we're gonna hold you to it. And on that note, we will see everybody back here again on the teaching tax flow podcast next week about the same time of day ish. Different topic,
Chris Picciurro:though.
John Tripolsky:So we will see everybody or I should you should stress, I should say, very soon.
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