Recently we have talked to several advisors who have been pitched by promoters offering Deferred Sales Trusts – “DSTs” and Monetized Installment Sales – “MISTs.” Those are two names for basically the same scheme. The scheme (the IRS’ word, see below) is promoted as a tax deferral strategy.

California has banned the Deferred Sales Trust for years, and the IRS has now made its position clear. In September of last year, the IRS issued proposed regulations that would make DSTs and MISTs a listed transaction.

A listed transaction is an “abusive tax transaction that must be reported to the IRS.”

In January, the IRS went after one of the strategy’s promoters, Kaylor DST Services. The case is laid out in the January 2, 2024, filing United States v. Kaylor DST Services, LLC, No. 8:24-cv00003 (C.D. Cal.)

IRS Position

The IRS believes that the “Respondents promoted a potentially illegal tax shelter during the tax years 2015 to present.”  The IRS case focuses on the “transfer of real property to what has been referred to by Respondents as a Deferred Sales Trust (DST)”, which the IRS believes “improperly defer[s] the recognition of capital gains taxes.” The IRS appears to be considering imposing civil penalties on one or more of the parties involved.

IRS Description of DST or MIST

The following is a long excerpt from the September release.[1]

WASHINGTON — The Department of the Treasury and the Internal Revenue Service today issued proposed regulations identifying certain monetized installment sale transactions and substantially similar transactions as listed transactions – abusive tax transactions that must be reported to the IRS.

Material advisors and certain participants in these listed transactions are required to file disclosures with the IRS and are subject to penalties for failure to disclose these transactions.

The IRS listed monetized installment sales this year as part of the agency’s Dirty Dozen list of common tax scams and schemes.

Monetized installment sale transactions generally include the following elements:

• A seller of appreciated property, or a person acting on the seller’s behalf, identifies a buyer who is willing to purchase the property in exchange for cash or other property. 
   
• The seller enters into an agreement to sell the property to an intermediary in exchange for an installment obligation, which provides for interest payments from the intermediary to the seller. 
   
• The seller then purportedly transfers the property to the intermediary, although the intermediary never actually takes title or takes title to the property only briefly before transferring title to the buyer in exchange for the buyer’s cash or other property. 
   
• The seller also obtains a loan with an agreement that provides for interest payments from the seller to the lender that equal the amount of interest that the intermediary pays the seller under the installment obligation. 
   
• Both the installment agreement and the loan provide for interest due over the same periods, with principal due in a balloon payment at or near the end of the term of the installment agreement and loan. 
   
• The sales proceeds received by the intermediary from the buyer, reduced by certain fees, are provided to the lender to fund the loan to the seller or transferred to an escrow account of which the lender is a beneficiary. 
   
• The lender agrees to repay these amounts to the intermediary over the course of the term of the installment obligation.
   
• The seller then treats the sale as an installment sale under section 453 on a federal income tax return for the year of the purported sale and defers recognition of gain until the year in which the seller receives the principal balloon payment.

What to Do Instead?

We have heard from a growing number of advisors, including one of the biggest wire houses who used to do DSTs, that they will no longer participate.

There are several alternatives for clients seeking to sell appreciated capital assets, but not pay capital gains tax when the asset sells. Among these are a Stock Diversification Trust, a Real Estate Shelter Trust, and a Business Owner Trust. These are trusts that have been explicitly in the tax law for over fifty years.

If you have clients who have appreciated capital assets that they may want to sell but hesitate to do so because of the tax implications, or if you would like to learn more, click here to request our Advisor Guide to Selling a Business. Or, email [email protected], or call Connor Barth at 703 437 9720 to schedule a free consultation, or request.

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[1] https://www.irs.gov/newsroom/treasury-and-irs-issue-proposed-regulations-identifying-certain-monetized-installment-sales-as-listed-transactions#:~:text=Material%20advisors%20and%20certain%20participants,common%20tax%20scams%20and%20schemes.