Deferred Sales Trust?

[ejalquat]

A group calling itself the Estate Planning Team is heavily promoting what they have trademarked as the Deferred Sales Trust (DST) https://www.myept.com/Deferred-Sales-Trust. It is being marketed mainly as a 1031 alternative that involves transferring title to a trust which sells the appreciated property and defers the capital gains taxes indefinitely. EPT has apparently gotten many law firms and qualified intermediaries to sign on. As the entity acting as the financial advisor for the trust, EPT gets an annual management fee which explains their interest in selling the DST concept. The seller cannot take the trust away from EPT as the seller doesn't control the trust.

Is anyone on this forum familiar with the DST program? They claim to have received a private letter ruling from the IRS that approves of the deferred sales trust (although they don't seem to publish it because they feel competitors will use it).

I have spoken with someone from EPT and an attorney that uses the DST but obviously these are not objective views of the validity of the concept. The trust does seem to be quite independent of the initial seller so attacking it as a sham in the sense that the seller controls the trust doesn't seem accurate. Hiowever, the IRS may find other ways to attack it if so inclined.

I would be very interested in reading 'opposing' views on the DST. Thanks.

[Cathulhu]

A private letter ruling is just that--private. When you say they don't publish it "because competitors might use it", you set off my bs detector. Since the regs on section 1031 exchanges are pretty emphatic about NOT applying to trusts, this sounds like a giant steaming heap. As I recall, there are a group of subjects that IRS will not issue PLRs on, and this sure sounds like one of them. If they're so adverse to publishing the PLR I find myself doubting they have, why not publish the number assigned to it?

I wouldn't give them a cent without actually seeing the PLR (which I believe does not exist) and confirming the number in a law library.

[Famspear]

Here's a page with frequently asked questions about the deal:

http://www.mydstplan.com/jsmith

Here, essentially, they're apparently talking about a type of installment sale under Internal Revenue Code section 453. Here's an excerpt:

Q. If I don’t report any taxes upon the sale of the property to the trust or subsequent sale of the property, when do I incur taxes in a deferred sales trust transaction?

A. The individual receiving the payments will report the income as it is received from the trust.

(Emphasis added).

Well, duhhh...... What a novel concept!

Come on! How would this treatment differ from the federal income tax treatment of any other installment sale under section 453?

Oh, yes, uhm, of course the seller has to pay a fee to the promoters, I guess.

My response to this sales pitch is: So what? The arrangement is a bit difficult to fully evaluate without seeing all the actual documents they use, but I'm thinking that there may be less here than meets the eye.

EDIT: Judging from the information on the rest of the web site, I'd say it looks like a practical joke.

[ejalquat]

It's absolutely not a practical joke. The difference between this and a regular installment sale is that there is no buyer default risk. All the proceeds of the sale are put into the trust so the normal installment sales risk that the buyer defaults on the seller financing is gone.

Also, since the trust can defer the installment payments to the seller indefinitely, the principal inside the trust is compounding based on the pre-tax amount.

[Famspear]

It's absolutely not a practical joke. The difference between this and a regular installment sale is that there is no buyer default risk. All the proceeds of the sale are put into the trust so the normal installment sales risk that the buyer defaults on the seller financing is gone.

Well, if the agreement between the seller and the trust spells that out, then that's theoretically correct -- but only as between the seller and the buyer. The seller still has the risk that the trust itself will not pay the seller according to the contract terms between the seller and the trust.

Also, since the trust can defer the installment payments to the seller indefinitely, the principal inside the trust is compounding based on the pre-tax amount.

Well, whoop-tee-doo! If I'm the seller, I'm supposed to be excited about the fact that the trust can put off paying me indefinitely??!!!?? I'm supposed to be happy about that, just because my principal inside the trust is earning compounding interest?

[ejalquat]

Well, whoop-tee-doo! If I'm the seller, I'm supposed to be excited about the fact that the trust can put off paying me indefinitely??!!!?? I'm supposed to be happy about that, just because my principal inside the trust is earning compounding interest?

Yes, if you're working under the assumption that you're dealing with crooks virtually nothing is safe.

[Famspear]

Well, whoop-tee-doo! If I'm the seller, I'm supposed to be excited about the fact that the trust can put off paying me indefinitely??!!!?? I'm supposed to be happy about that, just because my principal inside the trust is earning compounding interest?

Yes, if you're working under the assumption that you're dealing with crooks virtually nothing is safe.

Oh, do you think the people pushing this are crooks?

The people pushing this do not need to be "crooks," as you put it, in order for this scenario to be a questionable proposition. So far, I've seen nothing impressive about the proposed arrangement -- nothing that would make me be interested in it, and nothing that would make me want to advise a client to get interested in it.

[LaVidaRoja]

Is there something in here that allows you to "independently" borrow money from the trust? The "loan" would not be income to you, would be a liability of your estate at your death, and could be paid off by the amount of income you never received (or were taxed on) That's what I see as the benefit of this arrangement.

[Famspear]

The linked web site lists various "Primary Benefits." The last item on the list is:

Eliminates Risks Associated with Ownership: By utilizing the DST, an asset that is otherwise liability prone is converted into a no risk asset.

No, that is incorrect. First, the bundle of seller's rights under an installment sale contract with the Deferred Sales Trust as described in the linked web site (and the comments by the first poster above) is by no means a "no risk" asset. Not even close.

Second, there is no such thing as a "no risk" asset.

[ejalquat]

So far, I've seen nothing impressive about the proposed arrangement -- nothing that would make me be interested in it, and nothing that would make me want to advise a client to get interested in it.

Here's what makes it potentially interesting to me. For a seller in NYC (where I live), federal, state and city cap gains will amount to about 25%. On a 5M gain, that would be 1.25M eaten up by the IRS, NYS and NYC. That money is gone. The seller is left with 3.75M which presumably will be invested in something. (I'm using a basis of 0 for this example)

The DST allows you to defer that tax. The annual trust fee is about 1.25%. Many financial advisers charge 1% to manage assets, so the trust may be paying an extra 0.25%. The principal is 5M. If the trust is earning say 6%/year, the added income on the 1.25M difference in principal is $75,000/year. The income is paid out of the trust and is not subject to the original gains tax. Admittedly (and I'm not belittling this) you cannot spend the principal without triggering the gains taxes, but there are certainly many people that don't need or want to "spend" the money and would possibly just invest it in stocks and bonds anyway.

[Famspear]

Here's what makes it potentially interesting to me. For a seller in NYC (where I live), federal, state and city cap gains will amount to about 25%. On a 5M gain, that would be 1.25M eaten up by the IRS, NYS and NYC. That money is gone. The seller is left with 3.75M which presumably will be invested in something. (I'm using a basis of 0 for this example)

The DST allows you to defer that tax.....

Well, it's the federal income tax law that allows you to defer the tax. If it's a section 453 installment sale, it's a section 453 installment sale. The tax effect is the same whether you sell the assets to the trust or you sell the assets to someone else.

.....The annual trust fee is about 1.25%. Many financial advisers charge 1% to manage assets, so the trust may be paying an extra 0.25%. The principal is 5M. If the trust is earning say 6%/year, the added income on the 1.25M difference in principal is $75,000/year. The income is paid out of the trust and is not subject to the original gains tax.....

And that's because the interest income is not a capital gain. Again, the tax effect is the same, whether the installment sale is made to the trust or to someone else. There is nothing special or different about transferring the asset to the trust.

.....Admittedly (and I'm not belittling this) you cannot spend the principal without triggering the gains taxes, but there are certainly many people that don't need or want to "spend" the money and would possibly just invest it in stocks and bonds anyway.

Or, to put it more precisely, you cannot receive the principal without triggering the gains tax -- the capital gains tax. Again, the tax result is the same whether you are using the Deferred Sales Trust or, alternatively, just transferring the asset to someone else.

I haven't read the entire web site, but one question you might want to ask yourself is: What security do you have if the trust encounters financial difficulty and cannot pay you?

Think of it this way. If you were to sell the asset to a third party in an ordinary installment sale, you can retain a security interest in the asset sold. If, on the other hand, you instead sell the asset to the Deferred Sales Trust, and the Trust then sells the asset to the "ultimate" third party buyer, do the documents provide you with any kind of security interest in the event the Trust has problems and cannot pay you? If so, in what asset? In the assets of the Trust?

Now, suppose you do retain a security interest in some asset or assets of the Deferred Sales Trust. Since you seem to be telling us that the Trust is under no contractual obligation to repay the principal to the seller at any particlar time, one question would be: Under this scenario, what exactly would be an example of a default event, anyway (other than, perhaps, a failure to pay interest on a timely basis)?

[jg]

A Private Letter Ruling is a matter of public record; so any reluctance to provide a reference to the ruling on fear of disclosure to competitors is nonsense, as stated.

When the PLR is read, it may contain a caveat at the conclusion of the private letter ruling to the effect that the ruling does not address the potential application of section 7701(o), which caveats should be understood not to create an inference that the doctrine is in fact relevant.

In my opinion, such a transaction as you have described may be subject to the economic substance doctrine that was codified via section 7701(o), in 2010.

See http://fedtaxdevelopments.foxrothschild ... no-111152/

In an effort to provide uniformity to the tax law, Congress enacted section 7701(o) codifying the economic substance doctrine. The Congress adopted the Service’s approach, i.e., a two part conjunctive test which requires both (objective) economic substance and (subjective) substantial business purpose. The legislative history notes that the codification was not intended to replace or surplant existing precedent. Under the economic substance doctrine, first the transaction under evaluation must result in a meaningful change in the taxpayer's nonfederal-income-tax economic position and, second, the transaction must also have a substantial nonfederal-income-tax purpose. Both prongs must be satisfied based on the taxpayer’s generally required burden of proving its position by a preponderance of the evidence. The taxpayer is not required, per se, to establish a pretax profit to establish economic substance but can use this standard to meet the statutory requirement by demonstrating that the present value of the anticipated pretax profit is substantial in relation to the present value of the expected net tax benefits that would be allowed from the transaction

Much guidance has yet to be issued on section 7701(o), as discussed in the ABA Tax Section 65-page comment letter on Notice 2010-62 and Implementation of the Economic Substance Legislation; but comments in that letter would indicate use of such a trust would fall under application of the economic substance doctrine.
See http://taxprof.typepad.com/files/aba-notice-2010-62.pdf

(7) Whether the transaction involves a tax indifferent counter-party. Historically, the
presence of a tax-indifferent counter-party suggests a risk that the transaction may
create a disconnect between the economics and the tax reporting of the transaction.
The presence of this factor would support application of the codified rule.

Besides the challenges and risks of the economic substance doctrine being applicable, the issue of how and when distributions from the trust may or may not occur that will remain outside of the control of the beneficiary is important, as stated.

Just one man's thoughts, yours may vary significantly.

[jg]

After posting my prior comment it seemed as thought the trust would be subject to cpaital gain on the sale of the property to the buyer.

From the site:
The process starts with a property owner, transferring ownership of the property to a dedicated trust. The trust then sells the property, stock or other capital asset to the buyer. Next, the trust "pays" the client with a payment contract called an "installment sales contract." The contract promises to make installment payments to the owner or their trust and those payments can even be structured to continue to future generations with additional estate planning. There are zero taxes to the trust at the time of the sale since the trust "purchased" the property from the client for the sales amount.

Again, abbreviated:

The process starts with a property owner, transferring ownership of the property to a dedicated trust. ...There are zero taxes to the trust at the time of the sale since the trust "purchased" the property from the client for the sales amount.

How is that the trust basis of the property would be the sales amount ?
The general rule is that assets acquired by gift or trust receive transferred basis (also called carryover basis see IRC § 1015 ) In that case the trust would have gain on sale to the buyer.

Not sure what is being implied by "purchased" the property from the client for the sales amount; but how is that not a gain to the client when the trust "purchased" the property?

Perhaps it is just my lack of understanding of the language used on the site; but how is there no gain due on the sale to the buyer?

[Famspear]

After posting my prior comment it seemed as thought the trust would be subject to cpaital gain on the sale of the property to the buyer.

From the site:
The process starts with a property owner, transferring ownership of the property to a dedicated trust. The trust then sells the property, stock or other capital asset to the buyer. Next, the trust "pays" the client with a payment contract called an "installment sales contract." The contract promises to make installment payments to the owner or their trust and those payments can even be structured to continue to future generations with additional estate planning. There are zero taxes to the trust at the time of the sale since the trust "purchased" the property from the client for the sales amount.

Again, abbreviated:

The process starts with a property owner, transferring ownership of the property to a dedicated trust. ...There are zero taxes to the trust at the time of the sale since the trust "purchased" the property from the client for the sales amount.

How is that the trust basis of the property would be the sales amount ?
The general rule is that assets acquired by gift or trust receive transferred basis (also called carryover basis see IRC § 1015 ) In that case the trust would have gain on sale to the buyer.

Not sure what is being implied by "purchased" the property from the client for the sales amount; but how is that not a gain to the client when the trust "purchased" the property?

Perhaps it is just my lack of understanding of the language used on the site; but how is there no gain due on the sale to the buyer?

Because the web site refers to the installment sale rules, I'm assuming that this is, initially, a sale of the asset to the Trust, with the seller receiving an intangible asset such as a promissory note or an installment sales contract. This would be a sale, not a "transfer in trust." In effect, the Trust would receive the asset with a basis equal to the fair market value of the property transferred under section 1012 (plain vanilla purchase cost) and not the basis under section 1015(b). Under this approach, the transfer would not be a transfer "in trust" as that term is used in section 1015(b). Under this approach, the seller is not a "beneficiary" of the trust.

Of course, that might not be what they're doing. If they're setting it up so that the seller is indeed treated as a "beneficiary" of the Trust, then the section 1015(b) rule might indeed apply, and the Trust would take the property at the "grantor's" (i.e., the "seller's") carryover basis amount, but with the basis being increased by the amount of gain recognized by the "grantor."

But if the doctrine of substance over form were to apply to recharacterize this transaction, then you're back to an installment sale (assuming that the seller has a realized gain, of course). In this case, the Trust takes the asset with a basis equal to fair market value under section 1012, and with the seller "recognizing" the realized gain on a year-by-year basis under section 453, as payments of principal are received from year to year. Under this scenario, each receipt could consist of up to three possible components: interest income (taxable as ordinary income), plus the two "principal" components: the pro-rata share of gain, and the pro-rata share of non-taxable recovery of basis.

I say "up to three" possible components since, under the scheme as described, in some years the seller might receive only interest and no principal. However, as I noted above, even the interest payments might be recharacterized (under the doctrine of substance over form, etc.) as being part interest and part principal.

[ejalquat]

do the documents provide you with any kind of security interest in the event the Trust has problems and cannot pay you? If so, in what asset? In the assets of the Trust?

Now, suppose you do retain a security interest in some asset or assets of the Deferred Sales Trust. Since you seem to be telling us that the Trust is under no contractual obligation to repay the principal to the seller at any particlar time, one question would be: Under this scenario, what exactly would be an example of a default event, anyway (other than, perhaps, a failure to pay interest on a timely basis)?

It is my understanding that the seller has the ability to specify that the funds be invested with Vanguard for instance (an example that was given to me) as well as having some influence over the 'aggressiveness' of the portfolio allocation (e.g. 100% bonds, 60/40 stock/bonds etc). Of course this doesn't mean the return cannot be negative, but you face the same issue with any investment.

[Famspear]

do the documents provide you with any kind of security interest in the event the Trust has problems and cannot pay you? If so, in what asset? In the assets of the Trust?

Now, suppose you do retain a security interest in some asset or assets of the Deferred Sales Trust. Since you seem to be telling us that the Trust is under no contractual obligation to repay the principal to the seller at any particlar time, one question would be: Under this scenario, what exactly would be an example of a default event, anyway (other than, perhaps, a failure to pay interest on a timely basis)?

It is my understanding that the seller has the ability to specify that the funds be invested with Vanguard for instance (an example that was given to me) as well as having some influence over the 'aggressiveness' of the portfolio allocation (e.g. 100% bonds, 60/40 stock/bonds etc). Of course this doesn't mean the return cannot be negative, but you face the same issue with any investment.

So, what you essentially have done is to dispose of an asset without retaining any security interest in that asset, or in some other asset, to protect you in the event that your return turns out to be "negative". Again, the web site falsely claims that under the scheme, "an asset that is otherwise liability prone is converted into a no risk asset." The installment sales contract right acquired by the seller is definitely not a "no risk asset."

To respond to jg's question earlier: If the transaction is indeed treated as a section 453 installment sale by the seller (so that the seller acquires rights under a sales contract and not a beneficial interest in the Trust), and as a straight purchase by the Trust, and if the Trust immediately turns around and sells the asset to a third party at a price equal to the fair market value on the date the Trust purchased the asset from the seller, then I suppose the Trust would not realize a gain or loss on the sale to the third party buyer -- under the theory that the Trust's basis in the asset was determined under section 1012, not section 1015(b).

[notorial dissent]

I will leave the quibbling over the various tax consequences to the tax professionals here, this is way out of my league and/or sphere of interest, but to my mind it looks like a sea of mines just waiting to go off at the slightest sneeze.

My main objection, is that I am supposed to transfer ownership of my property to a “trust” that I do not control, and have no control over, and apparently no oversight of, and then “trust’ them to complete the sale of said property, hang on to the funds for me, and then at no specified date dole out the interest payments to me or eventually the principal, at what appears to be their discretion???

Based on what assurances or what basis am I supposed to believe that any of this is ever going to happen??

I have to agree with Cathulhu, I don't believe the PLR exists, or if there is in fact one that it says what they claim, and the fact that they aren't showing it worries me all the more. You can claim anything you want, it is when it comes down to the proving of it that things start falling violently apart.

There is absolutely nothing about this that is in any way confidence giving, and quite frankly feels like it should be over in Diligizer.

[Trustnoone]

This sounds suspiciously like the Private Annuity Trust that was supposed to do pretty much the same thing. That didn't fly either.