Unraveling the Nuances: Delaware Statutory Trusts vs. Deferred Sales Trusts

Investors seeking to optimize their assets, defer taxes on large capital gains, and secure their financial future often explore various trust structures to achieve their objectives. Two popular options that have gained prominence in recent years are Delaware Statutory Trusts and Deferred Sales Trusts. While both share similarities in their tax-deferment capabilities, they are unique in their design and application. 

Breaking Down Delaware Statutory Trusts 

Primarily used for real estate investments, Delaware Statutory Trusts allow investors to pool their resources to invest in high-value, large-scale commercial properties. A legally recognized entity under Delaware state law, this structure offers an opportunity for portfolio diversification and acts as a tax vehicle for tax deferment on large capital gains, making them a popular choice among 1031 exchange investors. 

Delaware Statutory Trusts are generally applicable to real estate investors who are looking to execute a 1031 exchange — a tax-deferred exchange under Internal Revenue Code Section 1031 — and diversify their property holdings. However, this type of trust forgoes the Tenant in Common agreement commonly associated with 1031 exchanges. 

In a Delaware Statutory Trust, investors have limited control over the property since management decisions. Delaware Statutory Trusts are typically managed by professional asset managers or trustees, who handle property management and operational decisions on behalf of the investors. This means investors can enjoy passive income without having to bear direct responsibility for property management tasks. 

In addition, Delaware Statutory Trusts usually offer tax benefits through depreciation deductions and the ability to defer capital gains tax upon the sale of the property. However, when the property is eventually sold or the trust is dissolved, the accumulated taxes will most likely be due. 

Deferred Sales Trust 

A Deferred Sales Trust, on the other hand, is a specific tax strategy used to defer capital gains taxes on the sale of highly appreciated assets including real estate, businesses, and even stocks.  Classified as an installment sale under section 453 of the IRC code, this structure is not a distinct legal entity like a Delaware Statutory Trust but rather a contractual arrangement between the seller (taxpayer) and a third-party trust. 

The main goal of a Deferred Sales Trust is to defer capital gains taxes that would typically be incurred upon sale. Assets are not directly sold to a buyer for profit, but instead, are sold via an installment sale to the trust for a promissory note. By transferring the property or asset to the trust or completing an installment sale, the seller can defer taxes on the capital gains indefinitely and enjoy potential investment growth on the entire sale proceeds. Taxes are paid incrementally as the seller receives distributions from the trust, providing the opportunity for further tax deferral and potential tax savings. 

A Deferred Sales Trust can be utilized by any taxpayer looking to sell highly appreciated assets, including business owners, real estate investors, and shareholders of valuable stocks. It provides a viable option for individuals who do not qualify for or wish to pursue a 1031 exchange. In addition, the seller has more control over any investment decisions. Though the sale proceeds are transferred to the trust, the seller can direct the trust’s investments based on their risk tolerance and financial objectives. 

Both Delaware Statutory Trusts and Deferred Sales Trusts offer distinct advantages and cater to different financial objectives. Delaware Statutory Trusts are suitable for real estate investors seeking to diversify their holdings and achieve tax-deferred growth, while Deferred Sales Trusts are more versatile — allowing sellers of appreciated assets to defer taxes while maintaining control over their investments.  

Understanding these differences will empower you to make the right choice based on your unique financial goals and circumstances. As always, it is essential to consult with a qualified financial advisor or tax professional before making any significant financial decisions.