Answer
Aug 14, 2025 - 11:48 AM
I'm going to take a leap here and assume that maybe what you're referring to is a strategy that's out there floating around. One group has it trademarked as deferred sales trust. And the idea behind this strategy is someone who has highly appreciated real estate, who doesn't want to continue owning real estate, transfers that property to a trust in exchange for a 10-year promissory note, for example. That's the typical. And so, and then the trust now owns that real estate. The real estate then sells the property to a third party and then uses the proceeds of that sale to then make the annual installment notes that are owed back to the original taxpayer. And And when the death settles on that type of scenario, what you end up with as the investor is the income stream from a 10-year promissory note. And assuming no fraud, you will receive each of those payments. But you'll pay the taxes over that time. So you're merely deferring all the capital gains tax over a 10-year period. And as opposed to a 1031 exchange where you actually avoid the taxes altogether when you pass away. What happens in that scenario is then if you pass away before that installment note has paid out, then your heirs will inherit that promissory note. But unlike real estate where you get the step up in basis and the capital gains tax goes away, The capital gains tax does not go away on the note. And so whoever inherits that promissory note from you continues to make the capital gains tax payments that are owed with every payment from that note. So you haven't achieved any tax avoidance. You've just passed on the capital gains tax to your heirs. And secondly, to the extent that that pool of money that is now generating the income stream is the extent that it appreciates beyond the original sale price of the property, that additional appreciation does not get passed on to your heirs and you don't get that back and that just gets held by whoever you hired to put the trust together. So you lose the opportunity to receive or to bequeath that additional appreciation that, of course, you would completely continue to have a few 1031 exchange into a passive investment. So, you know, this strategy is a great strategy for financial investors who are looking for opportunities to convert their clients' rental properties into a pool of funds that they can manage and collect fees on. But from the taxpayer's perspective, it's really hard to rationalize why you would – go the route of a deferred sales trust type of strategy instead of just doing a 1031 exchange into passive real estate where you can continue to get depreciation benefit and where you get the full step up in basis when you pass away so the kids, neither you nor your heirs ever end up paying those capital gains taxes. And, yeah, Almost every time I sit down with somebody who's trying to figure all this out, once they just get an objective comparison of a 1031 passive replacement strategy versus a deferred trust strategy, it's not even close as far as what is more beneficial from a tax perspective. And if you're somebody who really just wants to avoid owning real estate altogether, you have to remember that when you invest in a passive real estate program, you are no longer involved in the operation of that real estate. So while your underlying asset, of course, is real estate, you are now no longer owning and operating that property directly. And if your goal is simply to just unburden yourself from the hassles of being a landlord, we can achieve that without you giving away your property to an irrevocable trust and then losing all the tax benefits of continuing to own that property. So anyhow... you are welcome to schedule a call with me. I'm happy to talk about the pros and cons of these strategies in the context that you described in your question. Excuse me.
