Jun 11 in General discussion
Deferred Sales Trust (Installment Sale)
Hello Everyone,
Last year I was introduced to a tax-saving strategy that appeared promising at first sight. Nevertheless, upon closer scrutiny and extensive research, I have found some pitfalls which I consider worth sharing here.
Well then, what is this strategy about?
Indeed, it is about disposing of an asset that has had significant growth to a third-party trustee who is unrelated to the seller (grantor). The seller in return receives a promissory note while the asset within the trust transfers ownership from its owner’s hands by way of stepping up its basis. Later on, this asset can be sold by the trustee to another person at no tax cost since the selling price equals cost basis. The trustee may reinvest these funds for the benefit of the grantor or use them to repay the loan with interest.
Now let’s consider the following cons:
The trustee and client/grantor should be totally separate entities. This means that you cannot have a person whom you know well controlling the money. They will have full control over the assets or funds in the trust and no legal ability to influence the decisions that develop in the process.
Sale Control: It is imperative that the trustee be in charge of disposing of assets, without any agreement on this issue being done beforehand. Evidence indicating preset arrangements may render an entire trust "sham" bringing about requirement of paying all owed amounts relating thereto inclusive of penalties and interests by the grantor due to the finding of tax audits and other legal sanctions like constructive receipt and lack of substance over form by IRS.
Wealth Manager: On request, the trustee hires a wealth manager should this be necessary. The wealth manger can't be someone the client/grantor had a relation with before setting up the trust. We all know a good relationship is hard to come by, especially with wealth managers. At this stage, youre either trusting the trustee to find you one or you would have to connect your Trustee with a new wealth manger, which is again risky as it will show you have control over the trustee (something the IRS doesnt like)
Fees: Trustee fees usually represent 1-1.5% of the trust’s value with additional charges for employing a wealth manager. Therefore you end up paying a fee on your whole wealth rather than profit tax alone which at times lead to tremendous losses especially during bearish market conditions.
Tax Obligations: The promissory note does not defer taxes indefinitely but rather brings them forth when due. Subsequently, one is liable to also pay taxes aside from trust fees made on note amounts.
Who is this structure for?
It is my opinion that this method can be useful for those who do not have appropriate knowledge of finance and investing matters. If someone had made a successful investment based on advice from other people, but do not know how to reinvest received monies, it could be worthwhile entrusting these funds management in favor of living off interest thereof, and not needing to call back the promissory note.
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Deferred Sales Trust (Installment Sale)
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