One of the most common questions I get from clients is how they actually get their money once the trust is set up. After all, you've spent years building the value of your business or property. When you sell, you want to know how that wealth translates into your bank account.
The beauty of the Deferred Sales Trust (DST) is its flexibility. Unlike a standard sale where you take the cash and pay the tax, the DST allows you to customize your income stream to fit your life. This is all handled through a document called a Promissory Note.
Here is a breakdown of how those payments are structured and what that means for your taxes.
The Three Main Ways to Get Paid
When we sit down to design your note, we usually look at three primary paths. You aren't locked into just one forever, but this is how most of our clients at ECGS get started.
- Interest-Only Payments: This is the most popular choice for people looking for retirement income. The trust reinvests your sale proceeds, and you simply live off the interest generated by those investments. As long as you don't touch the original principal, you continue to defer 100% of your capital gains tax.
- Principal plus Interest: If you need a bit more cash flow, you can choose to receive a mix of both. In this scenario, you'll receive the interest plus a portion of the original sale proceeds. You only pay capital gains tax on the specific amount of principal you receive each year.
- Deferred Payments: Some clients don't need the money right away. Maybe you have other income sources and want the trust to grow as much as possible for a few years. You can structure the note so that payments don't start until a future date, allowing the full, untaxed amount to compound in the meantime.
How the Taxes Are Calculated
To understand the payment structure, you have to understand the math the IRS uses for installment sales. Each payment you receive is generally broken down into three "buckets":
- Return of Basis: This is the portion of the money you already paid taxes on (your original investment). This part is tax-free.
- Capital Gains: This is the profit from your sale. You only pay capital gains tax on this portion when it is actually distributed to you.
- Interest Income: This is the new money your investments earned inside the trust. This is taxed as ordinary income in the year you receive it.
By keeping the principal (the capital gains bucket) inside the trust, you keep that money working for you rather than handing it over to the government immediately.
Flexibility and the "Note Renewal"
A typical promissory note has a term, often ten years. However, you aren't forced to cash out at the end of that decade. Most DST notes are renewable.
If you reach the end of your term and decide you'd like to keep the tax deferral going, you can often renew the note for another term. This allows the DST to act as a long-term wealth-building engine that can even be passed down to your heirs.
Why This Structure Matters
Most people sell an asset, pay a 30% or 40% tax bill, and then invest the remaining 60%. By using the DST payment structure, you are essentially getting a 0% interest loan from the government for the amount of your tax bill. You get to earn interest on the full 100% of your proceeds for as long as you keep the principal in the trust. Over 10 or 20 years, that difference can be worth millions.
The Bottom Line
The payment structure of a DST is meant to be a tool, not a cage. Whether you need a steady monthly "paycheck" for retirement or you want to let your wealth grow for the next generation, we can engineer a note that matches those goals.