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Guidelines for the Deferred Sales Trust to Qualify

Trust Structure: In order for a Deferred Sales Trust to qualify for capital gains tax deferral, it must be considered a bona fide, third- party trust with a legitimate, third-party trustee.


Independent Trustee: The Deferred Sales Trust must employ a trustee that is truly independent from the owner/beneficiary of the trust. If there is not real trustee independence from the owner, the IRS considers this to be a sham trust, set up for the sole purpose of creating layers of legal documents to avoid taxation. The independent trustee is responsible for managing the trust according to the laws that govern trusts, according to the installment contract, and according to the investor's risk tolerance and investment objectives.


Asset Transfer: In order for the Deferred Sales Trust to shield the owner from capital gains taxes, the owner must not take constructive receipt of any sales proceeds from the disposition of an asset. The trust created on behalf of the investor must take legal title to sale proceeds directly from the disposition of an asset or from a third-party qualified intermediary that is holding the sale proceeds on behalf of the investor in order to qualify for capital gains tax deferral.


Asset Ownership: Asset ownership must be legitimately transferred to the trust prior to a sale for the sale proceeds to be sheltered from capital gains tax. If the owner did not transfer practical ownership over to the trust and still retains all of the benefits of direct ownership, the IRS disallows the owner from enjoying the tax-advantaged benefits afforded by the trust's ownership. In other words, the property must be legitimately transferred to the trust or it will be taxed as if it were not.


Assets Must Remain in Estate: The owner cannot use the trust to transfer any economic interest to a third party without due compensation. The IRS does not allow this type of transaction because it allows people to pass assets out of their estate without bearing capital gains, gift, income, or estate taxes.

Trust Restrictions and Law: The owner/beneficiary of the trust must be subject to the restrictions imposed by a trust agreement or the law as it applies to trusts and transferred assets. If the owner enjoys unrestricted use and control over the assets of the trust without fiduciary limitations, the IRS considers this to be a sham trust that does not qualify for capital gains tax deferral.

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