FYE 34 | Deferred Sales Trust

 

You should never have to be forced to sell out your business out of fear or circumstance. Choose to sell your business when it’s at its prime and maximize your profit through a deferred sales trust. Joining host Michelle Seiler Tucker is Brett Swarts, founder of Capital Gains Tax Solutions. He helps his clients break out of the capital gains tax jail and make the most out of selling their business. Brett equips people with the tools necessary to successfully exit their business with minimal losses in revenue. He talks about upcoming potential changes in tax policies to succession planning and even how to move your funds out of your taxable estate. Curious to learn how he does it? Stay tuned for the episode and get incredible tips and tricks as he explains just how deferred sales trusts can work for you.

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Sell Your Business With Maximum Gains Via Deferred Sales Trust With Brett Swarts

I’m so excited to have Brett Swarts of Capital Gains Tax Solutions. What we are going to talk about is selling your business and keeping your money because it’s not what you can sell your business for, it’s what you walk away with. I truly have the best-kept secret that has been proven time and time again for years over thousands upon thousands of transactions. I have Brett Swarts to tell us how you can sell your business and keep your money. That’s what we are here to talk about.

You’ve got it, Michelle. It’s how to defer capital gains tax and keep more of it for you and your family versus paying it to the IRS and it’s gone forever.

Let’s talk about that because so many business owners are scared. I’m getting calls daily saying, “I’ve got to sell my business,” because of this new administration. They are extremely concerned that the taxes are going to be so high that they can’t afford to sell their business but it’s also not the best time for them to sell. I don’t like business owners selling out of fear. I want business owners to sell when their business is in its prime and doing the best it’s ever done.

FYE 34 | Deferred Sales Trust

Deferred Sales Trust: We can literally just sit and wait for an opportunity to come up. The money sits at a bank it’s protected. It doesn’t move without your approval or your signature.

 

I have other business owners that are saying, “No, we are not prime but we are going to hold on to it because of all the taxes we would have to pay.” The biggest issue that business owners face is how to sell their business and maximize value but most importantly, keep as much as you possibly can and walk away with as much as you possibly can. Why don’t you explain to us the deferred trust and how it all works? I have so many financial advisor friends and I try to talk to them about the strategy and they are not aware of it. This is great for financial advisors but most importantly, it’s good for business owners because they should sell when it’s right for them to sell not because they are paralyzed out of fear because of increased taxes.

I will start on this premise and then we will work through what’s called three perfect storms that are going on for every high net worth individual or business owner who’s considering selling. The premise that highest net worth, highly appreciated business owners struggle with is the capital gains tax and it’s somewhere between 30% and 50% of their gain. If Biden’s proposal goes through, it could be 50% to 70% when they go to sell or Michelle goes to help you sell that asset. We use a deferred sales trust to give them tax deferral, the ability to sell their assets, defer that capital gains tax, defer some income tax as well as move some of the funds outside of their taxable state so they can create and preserve more wealth.

Let’s dive into some of the challenges that individuals are facing now. There are three perfect storms. The first storm is what’s called the demographic perfect storm. This is according to the American Bankers Association. They did a study and they looked at the stats of all the wealth in America. They found that there’s one major group that has the majority of the wealth and that’s the Baby Boomers. In fact, this study found that there’s about $17 trillion to $20 trillion that’s going to pass from their generation to the next generation in the next twenty years or so. It’s known as the largest wealth transfer in the history of the planet.

In fact, about 10,000 Baby Boomers are turning 65 every day and there are about 77 million in the US alone. Three asset classes are the most highly appreciated. Private equity, which is businesses, commercial real estate and high-end primary homes. These illiquid assets want to sell, diversify and defer the tax but they feel trapped because a lot of old ways of doing things don’t fit what they are looking for, which is diversification, liquidity and the ability to go buy another business or to put the money into some liquid assets and some real estate assets.

Let’s focus on business. Let’s go ahead and get to that second storm.

The second storm is the political storm and we touched on a little bit about this. Biden is proposing some big changes. The first part of the political storm is the capital gains tax rate Federally going from potentially 20% to about 40%. Instead of paying 30% to 50% in capital gains tax and depreciation recapture, it could be as high as 50% to 70%. Could you imagine that? You start a business and you are in it for $1 million. Let’s imagine you are selling it for $10 million. It’s a $9 million gain and you have some depreciation recapture, 50% to 70% can be wiped out. That can be paralyzing for folks so they say, “It’s not even worth it. I’m not going to sell.”

Let’s say they have to sell and now the majority of their wealth that they have built with that business is paid in tax. Do we think it’s going to pass and be that high? Maybe or maybe not but it’s something to be prepared for. The second part of that storm is what’s called the elimination or the reduction of the 1031 exchange. By the way, business sales and M&A deals, typically, are not even qualifying for 1031s is not even relevant but that’s something to be aware of.

Real estate that’s in that business transaction could qualify as 1031 but your strategy is better than doing 1031.

The last part of the political storm is the elimination of potentially the stepped-up basis, which that single one is the biggest potential wealth transfer from the individual, families and the wealth in America to government that we might ever see in the history of the world. It’s because of the Baby Boomers and all of that. Do we think that’s going to pass? Maybe or maybe not but it’s something to be aware of because these are the things that are being looked at. We want to find a solution to that.

Sometimes it’s hard for people to learn something new that they hadn’t heard of.

The last one is an economic storm. Valuations and prices are sky-high. We believe it’s a great time to sell and we feel like we are in what’s called the eye of the hurricane. It was a wild COVID year and we weren’t sure where it was going to go and where things were at. Now it’s like this peaceful storm where we feel like things are calm again. We think there’s another storm potentially coming and valuations could change. I can’t predict those things but the stock market, real estate and perhaps even businesses that are all-time highs, it’s a perfect time to be a seller, gets safety, tax deferral and diversification. That’s where the deferred sales trust enters.

Business sales are at an all-time high if you are in the right type of business and category, meaning that there’s so much money out there, private equity money, strategic competitors and serial entrepreneurs. There are more buyers for good businesses and there are good businesses to buy. It’s really agnostic. It’s more about the EBITDA. When the EBITDA is over $1 million, we’ve got so many private equity groups that we are working with that are like, “Michelle, we already have twelve deals in a hopper. We will get to yours but we already have so many.” There’s so much activity in M&A and this is the perfect time to sell your business, especially if you have over that $9 million in EBITDA because that’s the sweet spot.

That’s where the deferred sales trust comes in, like, “What is this thing? Why haven’t I heard of it?”

It’s the best-kept secret. Nobody has heard of it. Why is that? Why don’t financial advisors, CPAs or business owners know about it?

First of all, we do have thousands of business partners across the US like strategic alliances, CPAs, national law firms, financial advisors, business brokers, commercial real estate brokers and luxury realtors but it’s such a specialized type of product. It’s the one law firm that does all the legal work. My role is as a trustee. By the way, there are just a few of us trustees. Some are closing deals versus those who know about it. It’s tough because it’s protected, yet it’s one law firm that’s doing it. It has been done for many years with thousands of closes and billions under management.

There’s also a level of skepticism because people have been with their CPA for a long time and even their M&A or their tax attorneys, and maybe they hadn’t heard of it. Sometimes, it’s hard for people to learn something new that they hadn’t heard of. I liken it to a Blockbuster versus Netflix. At a certain point, you didn’t know Netflix. You knew Blockbuster. It wasn’t until the adoption of it, more and more people were doing it, you saw and you knew, that you moved over but a lot of old ways of doing things and things are changing, we need to try to make it out.

I will give you two stories that helped build my confidence with this and it will help your readers as well. There’s a gentleman named Bill Gross. For those who don’t know Bill Gross, he’s a respected financial advisor in the industry. He worked with a gentleman named David Young and they work with a group called PIMCO and they put PIMCO from $80 billion to $1.2 trillion. They grew this to one of the most respected and great money management companies in the world. They are managing money for some of the top investors in the world.

They all retire and there are five of these guys that ran this thing. David Young, in particular, gets back and brings 4 of the 5. He gets approached with a deferred sales trust about a few years ago. Like most people, he’s in the financial advising industry and he thought he had seen just about everything. He thought it might have been too good to be true but he has an open mind and had his legal team look at it. He looked at it, talked with clients and everything. He went through it for two years. He did two-year due diligence. After two years, this is what he found, Michelle. A) That person who created this, Todd, is the smartest person we have ever met. B) We are all in and he’s an option to manage some of the money for this.

What I always say to folks is, “I know it seems too good to be true for you but if it’s good enough for David Young and his legal team who spent two years of due diligence, who think there has been an issue for 30 years, who ran with Bill Gross for over fifteen years, these are smart, sophisticated people and their legal teams, is it good enough for you?” We can put you on the phone with David. He’s happy to talk. He’s happy to tell a story. He has his whole story and he told it on my podcast and you can hear that. That would be my counter to that but we do not give our secrets away. We protect this thing because it’s special and we don’t want to mess it up for anyone else.

Can you give the high-level version of what it is without giving away any trade secrets so our readers will have a better idea of this if they think this could work for them?

The CPAs or financial advisors that are reading this might know it as a seller carryback. All the deferred sales trust is a manufactured installment sale and it’s based upon a Tax Code called IRC 453, which goes back to the 1920s. It states that if Michelle is going to sell a $10 million business and she has no basis and no debt, and Brett wanted to buy it, I could give Michelle a $1 down payment and she could carry back paper. She could become the lender. Michelle only pays tax on that $1 that she received and the other amount is in what’s called a tax deferral state. It’s like an IRA in a sense.

If you have money and the government is no stranger to tax deferral, they allow it for 401(k)s, IRAs and 1031 exchanges. It’s a study of macroeconomics, which states if we can keep the money flowing and deals happening, it grows the economy. Someone might have a $65 million business that they started from scratch. If they can unlock all of that capital, they could perhaps go invest in more businesses and create more jobs and tax revenue. It’s a win-win for everybody.

Essentially, what happens at the close of escrow is instead of selling a $10 million business to Brett on a $1 installment sale, we find a cash buyer for $10 million, all cash or they can get a loan, it doesn’t matter. We form what’s called a deferred sales trust with a third-party trustee, which is my role. We say, “Joe, why don’t you buy it for $10 million from Michelle but instead of putting the cash directly to Michelle and her revenue tax in all $10 million, why don’t you just cooperate with this trust?”

What happens is Michelle sells the $10 million business to the trust and the trust turns around and sells it to the cash buyer. Joe, the cash buyer, gets everything he bargained for so he’s gone. What’s left is Michelle owns what’s called a promissory note. She has lent the $10 million to the trust. Therefore, it’s in a tax deferral state. Let’s imagine it would have been a 40% tax. Instead of having $6 million, you get the full $10 million like an IRA. Instead of paying all the tax and not putting it into the IRA, you can put it into the IRA and you can defer the tax. Over time, you will get paid back. You became the lender typically structured around 8% on a ten-year term, which you can renew every ten years and you can pass it on to your kids.

FYE 34 | Deferred Sales Trust

Deferred Sales Trust: 1031 exchanges really only worked for investment real estate. They do not work for primary homes, for businesses, for cryptocurrency or highly appreciated public or private stock. Deferred sales trust works for all of these assets.

 

You are paying taxes when you take it out at the 8% level, correct?

Precisely.

A financial advisor is taking that $10 million and re-investing it.

Instead of having $6 million, there’s $10 million so it’s a win-win for the client and the financial advisor. Also, it can help get deals done because some deals have two partners and have a certain number. In fact, in 1 of the 2nd stories, it was a financial advisor who worked for LPL advisors. He was selling his business, he’s one of the top advisors and this was years ago. He’s looking at the dollar amount that he needs post-tax, which means he needs to grow his EBITDA and revenue here. He can sell his business now because it’s pre-tax.

For him, the transformation was, “I can get ten years back in my life.” He had an ace in his pocket because he was also skeptical. He said, “I have been in business for 35 years. I thought I knew and had seen it all but I learned something new.” His ace in his pocket was his wife, who was even smarter than him who was a Treasury Attorney. She worked for the government. She’s smart and sophisticated. He goes, “I told you when we’ve got married that I would never do anything that you didn’t approve of but we might have something. I don’t know if it’s too good to be true but would you go back and research this with the resources that you have?” She said, “Sure, no problem.” He goes, “If it’s true, just so you know, I will sell my company and we can retire ten years earlier. We can move out of California and relocate.” She takes it.

I don’t know if you have seen that show, Suits. There are two power attorneys. On every big scene, you see the one walk in, they have a big stack of paper and they throw it on the table. They make the big exclamation point. He had given her a stack of paper to go check it all out. She comes back and he goes, “About 48 hours later, there are two words that changed my life.” She comes home from work and it’s like a slow-motion out of a movie. She has a stack of paper and she displaced it on the table. She says, “The two words, Brett, that changed our lives, it’s legit. That’s all I need to hear.” I go, “Can you come on my podcast and tell me that?” He’s like, “No, I don’t want to go on videos.” I’m like, “No problem.”

He was like, “Brett, this is what I want you to know. I was in the business for 35 years. She was working with a governor for over twenty years. Do you think we would put her legacy on something that we didn’t feel was 100% legal and legit? We would never do that. With tax? No way.” That was years ago. “You are welcome to call me. I only listen to voice messages. I don’t answer the phone. Leave a voice message and I will call you back.” These are the types of folks that we want to show you tangibly who have done the deals, who have closed the deals and are happy. Hopefully, that answers the question, Michelle.

You can take 8% out but you can also take money out when you want to invest in real estate and invest in other businesses. Are you penalized? Is that when you are paying taxes on whatever you check out? Explain how you can reinvest that money.

It’s super flexible but I want to let you know the difference between taking out and reallocating. Understand in this scenario, you are not the owner of the trust. You are the lender, which is also something that some people got to understand. You become the banker. What the trust does is owe you that 8% over a ten-year term. Typically, it’s paying you interest-only payments.

Is it always 8% over a ten-year term? Is it what you negotiate or whichever works best for you and your family?

It’s based upon your risk tolerance, your needs and your wants. You start with a risk tolerance questionnaire before anything goes anywhere. That’s going to be the constitution for how and where the funds are invested. You and your wife will fill that out. Generally speaking, most of our trust is restructured by 8%. Typically, people are taking interest-only payments somewhere between 4% and 7% payouts over ten years and the balloon is doing 10%, at which point they can renew it and keep the tax deferral going.

That being said, if their risk tolerance is lower, then it might be 6% or 7% but most of my clients are at 8%. Now we need to go make a return on that money. We are not guaranteeing the 8%. We’ve got to go invest the money. We, as a team with the financial advisor, would present an allocation based upon the risk tolerance and nothing gets invested without your approval. This is the part where it’s cool because you can go to stocks, bonds, mutual funds. You can go to insurance, hard money lending and real estate. You can go into new business ventures or existing business ventures in partnership with you.

I have a client, for example, who sold a $2.6 million business in Alabama and he was faced with $600,000 of liability. He had three partners so they bought him out. That’s another cool thing. The partners can just buy you out. Good to go and he went his separate way. His next business venture was to build multifamily complexes. He’s building tax-deferred in partnership with the trusted ground up 70 units of multifamily. All tax-deferred so he didn’t cash out, pay tax and then go do that. He just reallocated some of that $2.6 million to an LLC in partnership with him to do this. That’s the power of the deferred sales trust.

One of the biggest misconceptions is like, “I’m giving it to some financial advisor and I can’t do my next business. I can’t buy my next piece of real estate.” Here’s the cool thing versus 1031. There are no timing restrictions. If you are thinking like, “Brett, do we have to do this at a certain time?” No, we can just sit and wait for an opportunity to come up. The money sits at a bank, it’s protected and doesn’t move without your approval or your signature. It’s safe. Funds go to TD Ameritrade for the securities typically, depending on the financial advisor we are working with. They can go into real estate and business. Does that make sense, Michelle?

Yup. They can go into existing businesses, buy existing businesses, partner with business owners, buy a business and invest in real estate. Who makes the decision though on the allocation? If a client comes to you and says, “I’ve got this perfect business. I want to partner with Michelle,” who makes that final decision? Is it the one that’s lending to the trust or is it you, the trustee?

It ultimately is me, the trustee. It’s important to understand this. However, I can’t make decisions without them either. It’s a dual thing. Remember, I said ownership versus being a lender. If you were the owner and you sold this to somebody you knew or it wasn’t arm’s length, then essentially, that’s what’s called constructive. The tax is triggered. In this scenario, I’m a third-party, unrelated trustee. We want what you want and we want to be able to work with you based upon your risk tolerance and your income needs.

We like to say we are a part of your dream team. We will review the real estate investment and the suitability based upon the risk tolerance questionnaire. Ultimately, if it looks good and it lines up, then it’s a yes but it also takes them saying yes on those investments. Sometimes it’s the route for people that they have to get to know me and understand our track record, what we do and the type of investments. That’s part of the process of doing this. If I didn’t have that, it would be a sham trust. It wouldn’t work and you pay the tax.

Has there ever been a situation where that lender of the trust doesn’t like the trustee or doesn’t trust the trustee? Has there ever been a situation where the trustee walks away and you replace that trustee?

A couple of things. If I get hit by a bus, we have a succession plan for another trustee. If that person were in the same bus that was hit, they can be assigned to another trustee.

Deferred Sales Trust is a nice, elegant way to lower your overall income tax, right and slowly pay tax along the way.

What if they just don’t like the trustee?

I have never been fired by a client and I might at some point. I had never been in a lawsuit. I always say if it doesn’t work out and as long as it’s approved with the tax attorney and it’s all still aboveboard, if not a related party, a team member, college roommate or the best man in your wedding, all that stuff, if we don’t sacrifice the integrity of what we have built, then they can go to another trustee.

It can be a family member, a college friend or anybody like that and that’s got to be approved trustee, correct?

Exactly. It’s certified and it’s approved. It’s a proprietary structure, which you will quickly know, learn and maybe you have been learning it. It’s not just like setting up an LLC and transferring. It’s a team of professionals that are experts at playing their role. I liken it to a Roman legion with all shields. There’s the tax attorney who is the creator and he’s the brain surgeon. He’s got his little spear and a shield. The client is in the middle and I’m over here as the trustee with my spear and my shield. We are separate necessarily to make the structure work then there’s the financial advisor who’s separate as well. All of us are the balance of power.

You’ve got the rock star M&A advisor to sell it for the highest possible price and then potentially find new business opportunities for you to invest back into. Honestly, for most of our clients, what they learn and how they built their wealth is how and where they want their wealth invested. They don’t necessarily want to be active or have so much on their shoulders. They want to be able to sell to that big M&A group to take off a lot of the stuff they don’t want to do anymore. They still have some ownership that we can structure as slow payouts. We are closing a deal, he’s getting a big chunk up front, and then he’s going to get some earnout along the way. We can keep rolling those earnouts into the trust we structured into the deal, which by the way, it’s important for timing aspects. We want to make sure you set this thing up early. If the deal has gone by too far, we cannot help you.

It’s my understanding that it has to be set up before the letter of intent is signed.

Ideally, we like to be as early as possible. Let’s give you the drop-dead date so this is clear. The drop-dead dates on the deferred sales trust are if and when the buyer has removed all contingencies. You might have 100-day escrow and 50-day due diligence. Upon day 51, they have removed all contingencies except for the financing contingency or the exception of something else. There are at least some exceptions there. We can absolutely, based upon the specific deal, insert or create the trust and be a part of the deal.

If you say, “Brett, it’s closing next week. It’s closing in twenty days. All contingencies have been removed. They are just waiting for funding but they are going to move forward,” I’m going to say, “I’m so sorry. It’s too late.” Unless they are in a 1031 exchange. If they were in a 1031 exchange, the funds haven’t been constructively received yet by that particular person and they are sending out a qualified intermediary, then we can save a failed 1031 exchange. Again, that’s only for that.

Remember, 1031 exchange only works for investment in real estate. They do not work for primary homes, businesses, cryptocurrency, highly appreciated public or private stock, whereas the deferred sales trust works for all of these assets. It works for LLCs, LPs, partnerships, S corps, and C corps. It can work for multiple partners, which is also another question. Someone says, “I get ten partners. What if four of them don’t want to do it and six of them do?” “No problem.” “Are the funds commingled?” “No, they are not. The funds are individual trust that only does business with that particular person.” “What if I want to put half of my money in and pay the other tax?” “No problem.” These are all flexible things.

Let’s say you are selling a company for $25 million and there’s $5 million of debt. You sell for $25 million, pay off that $5 million debt, then the $20 million goes into the trust, correct?

Precisely.

Let’s talk about my case study. I have a client that we are working with selling the business between $60 million to $70 million. They have been in business for decades. They weren’t interested in moving forward because they didn’t understand the program. That’s when I said, “Brett, you’ve got to do a comparison. You’ve got to show them what they will be paying in capital gains. You’ve got to do that comparison to show them a side-by-side example.” Let’s talk about that a little bit. Before we do, S corps or C corps, does it make a difference?

It does a little bit. C corps do take a little bit more cooperation with the partners. S corps are depending on how many partners are there, are typically a little bit simpler. Every deal is deal-specific and that’s where the legal brain surgeon, Todd, comes in and deciphers this. By the way, we work on a conditional basis as well. We will look at the deal and review the deal. You don’t pay a dime unless we perform and you use the trust. There’s no cost, no obligation to get with us early but that’s the key, get with us early.

I thought that was a great benefit because I have been on numerous calls with the team, especially the attorney out of California and I like the fact that he architects the entire deal. Somebody’s deals can get complicated. Especially when you’ve got kids, marriages, partners and everything else, it can become complicated. It doesn’t charge you anything until the money has the trust. Let’s talk about that case study without naming names.

Zero bases is an amazing story of perseverance, ingenuity and teamwork of a family. They are looking to sell and they feel trapped. He had even said before, “We would love to sell but I’m not going to pay this tax. I’m not going to sell until I figure that out.” It has been on hold. It got frozen until we came up with it and started talking. We are looking at several things. A huge capital gains tax as well as this family going their separate ways so this can be two family groups. What’s unique about it is on the 65, one has children and one doesn’t, each trust is going to be customized specifically for each family based upon their needs and their family unit.

The funds are not commingled. They are separate. They could go back into business together if they wanted to with the trust later on but they don’t have to. It’s flexible. That’s the first thing. We are going to defer the capital gains tax, which was a big number. The second thing is they are high-income earners. That might even be staying on for a couple of years during this and they are going to be paid a big amount from the group that’s acquiring them. What’s unique about the trust is that we can delay payments for some time. It’s not only capital gains tax deferral but also income tax deferral.

On a $65 million deal, to give you rough numbers here, let’s say it’s at the 8%. That’s about $5.2 million a year. Let’s imagine they were planning on taking out half of that, which is $2.6 million and lending the other half compound in there. That’s $2.6 million, plus whatever else they are making. Let’s say they are making another $1 million to be running in the company, there is a $3.6 million tax bracket but they are only going to be there for a couple of years until they fully get out of the deal. In this scenario, we can delay the income from the trust instead of taking that $2.6 million or any of that amount, they can say, “Let’s delay that for a couple of years while I’m still working and making high income. In a couple of years, when my income drops to $0, now let’s start pulling from it.”

You are saying that your $1 million salaries can go into that trust, too?

Not the $1 million salary. Imagine they are making a $1 million salary. Instead of having to take income from the trust, we can delay the income. Therefore, it can delay the overall tax bracket or where they are paying. Let’s say they might even move out of the state they are in into a new state and establish residency there and then start pulling income from the trust. It’s a nice, elegant way to lower your overall income tax and slowly pay tax along the way. Number one is capital gains tax. Number two is the income tax.

Here’s number three, which is powerful, the ability to move the funds outside of their taxable estate. It doesn’t matter what size of the deal. This is a great way we can do that. That can say 40%. I will give you an idea of what that is. By the way, it has nothing to do with a stepped-up basis or capital gains tax. It has everything to do with the entire estate at the time of death based upon how much is inside of the taxable state.

I will do an example. $22 million is exempt. If you are married and let’s say you are worth $52 million, the first $22 million is exempt and that leaves $30 million that’s not exempt times 40%. That’s $12 million estate death tax if, at the time of death, your $52 million was inside of your taxable estate. The intent is to get it outside the taxable estate. The challenge is most clients before they meet us, can’t get it out fast enough. They can’t give it enough. They don’t want to give it to charity. They don’t want to buy a ton of life insurance.

The solution is the deferred sales trust and that needs to be at the close of escrow. It has to be a legitimate sale. Let’s imagine it was a $30 million asset. We can sell that $30 million and simultaneously move it outside the taxable estate. Your clients, by the way, are still relatively young. That $65 million between the two of them can easily grow to $120 million. This is the cool part. With our strategy, we can grow outside the taxable state. It’s powerful and proven. By the way, you are probably wondering now, “How about the audits?”

You have told us all the positives. Tell us the negatives. Tell us about auditing.

Let’s start with audits, then we will get into fees and maybe some of the other challenges that people want to know about. There have been over a dozen no change IRS audits and there have been thousands that have closed over the 25-year track record. What’s unique about this is all of these audits have been no change successful audits, zero changes. I want to give an analogy. If Michelle and I were to get an audit, we probably keep clean books and report everything as best we can but there might be a receipt missing or there might be something that was off. What are the odds that we are not going to get even a single change on an audit? I would probably say one in a million that you and I are going to get a single change.

In every single one of these deferred sales trust audits for individual clients that were not triggered by the deferred sales trust, by the way, there were no changes. In fact, one of the biggest ones was in Southern California. It was a $125 million deal. It was a no-change successful audit. “That’s cool, Brett. What else has been tested by the IRS?” There has been a couple of formal audits. What I mean by that is they are looking at the entire structure. They are sitting down and saying, “There’s not a particular deal but you guys are getting so big. We want to find out, is there any trapdoor? Is there anything there that we need to be concerned about? You can hurt a lot of people.”

FYE 34 | Deferred Sales Trust

Deferred Sales Trust: Each trust is going to be designed customized specifically for each family based upon their needs, based upon their family unit.

 

We are like, “Here’s everything. Here’s it all. One happened in ’08 and another one happened in 2019. Both of these are successful, no change IRS. This has never been on an IRS watchlist. It has never been on a dirty dozen.” There’s also what’s called a private letter ruling on form and substance for the structure. It was approved. It’s a perfect track record, Michelle. There has been more scrutiny on a few other strategies than ours but it’s proprietary and protected. It’s one law firm versus a 1031 exchange.

There are 5,000 exchange companies all out there educating and talking about it, whereas there’s one law firm that’s there that does all of them. There are thousands of folks that are talking about it but they are not dedicated companies. That’s except for mine and a couple of others. Hopefully, that answers the question there on the legal part. Any other questions or thoughts?

How many attorneys are in that one law firm? When I hear one law firm, that scares me. What happens if something happens to that lawyer?

We have had the succession plans in place and there are multiple attorneys but also, there’s audit defense. It’s another thing I want to touch on. If you close the deal, you pay the one-time fee to the tax attorneys but there’s a lifetime audit defense. If anyone ever approaches you with a tax deferral strategy, especially for your $65 million, you should ask a couple of things. One of the first things you should ask is, “What happens if I get audited by the IRS? That’s great you have a perfect track record but what happens to me when they audit my $65 million deal? Who’s going to pay for all that legal stuff?” “That’s 100% covered by the law firm that has the perfect track record.”

The second question you want to ask is, “What is your track record? You have done all these surgeries. How many of these patients have you lost at the operating table? How many have gone to jail?” “None of them have died and none of them have gone to jail for us,” so it’s perfect. The next question to ask is, “How many of you close thousands, billions under management?” They are professionals, which we are happy to do once they sign the NDA. Most of them end up joining us and referring to our business. Hopefully, that answers the legal part. Anything else on the legal part?

No, I don’t think so other than what triggers an audit?

There are different levels when you can be triggered on an audit based upon how you are reporting on your taxes and the companies are running, all these different things. What’s unique about the deferred sales trust is it’s one of the lowest audit risk triggers. It’s a small percentage. We don’t think it’s an audit trigger. By the way, what you are saying to the IRS is you are telling them, “I owe you all this capital gains tax. It’s just in a deferral state.” It’s not like we are hiding anything. There’s nothing offshore. We are saying, “We sold for $65 million. Our basis was $0. This is the tax we owe you. We have taken it on an installment sale over time and we are going to slowly pay tax over time.”

Remember, this is good for the IRS because the IRS says, “That’s great.” What’s the reverse of that? You don’t sell it for $65 million. There’s not a big commission paid to Michelle. There’s not a big lender. There’s not that money getting infused into the economy to create more jobs. Remember, stocks, bonds, mutual funds, new businesses, new developments and real estate investments, all of that spurs revenue tax than someone sitting on this big pile of money and being like, “I don’t want to sell.” I want to dispense that false belief that this is a good thing for everyone. It’s a win-win for everyone.

Let’s say we sold my client’s business for $65 million and they invest the money. Who handles the tax returns and all of that going forward?

That would be their personal. Let’s talk about how that works. We are not wanting to take over all their stuff. They stay with their CPA. They receive 1099 based on the income they received. Let’s say they receive $500,000 of payments in a year. They will get a 1099 and say, “You received $500,000.” Let’s say they will pay capital gains tax and then they dip into principal. Some people take the principal and interest payments, and essentially 1099. You report that to your CPA. It’s simple on that side.

Is there a timeframe when you have to take that principal out?

There’s no timeframe on the principal and no dollar limit there. It’s a nice piece. There’s no minimum required distribution like an IRA would have. You can keep that principal in there and you can live off the interest. If you dip into principal, you will pay tax there as well.

I have been in the industry for years. I personally have sold several companies. My firm has sold even more than that. I have heard about different programs but I have also heard of scams. Who’s your competition? Who else out there has joined this?

There have been some copycats that have popped up. What’s interesting is they don’t have the IRS track record. We always say don’t do this at home, on your own or with someone who hasn’t been through it. Some of them will say, “We have never been tested by the IRS. We are clean.” That’s not what you want. You want those who have gone through the fire of the IRS on multiple occasions with multiple deals over multiple years. Some copycats maybe have tried to reverse engineer what we do but I wouldn’t go with those surgeons. I would make sure you get with the best, who has a perfect track record. The other competitions would be like a Delaware Statutory Trust but that’s only worked for 1031 or a charitable remainder trust, which is great, by the way if you are 100% charitable essentially.

What’s unique about the deferred sales trust is that it’s one of the lowest audit risk triggers.

We talked to one of those charitable trusts and it was so complicated. In fact, my same client has a $65 million transaction and at the end, they are like, “We have to give all our money to charity.”

It’s inflexible with how and where you can invest the funds. Most of the business professionals, owners and commercial real estate people we work with know, like and trust the things they made wealth in and they don’t want to be restricted to a lot of things that they are not comfortable with. By being able to go back and do those things, it gives the option. Not all of them want to do that. Some of them want to completely retire but who knows? The market may crash and you’ve got a deal and you might want to buy your business back.

In fact, there was a deal in 2006 and a gentleman sold a $20 million commercial real estate asset. Five years later, that property was foreclosed on and the funds were sitting in the trust. The bank calls up and says, “Do you know that property you sold to that 1031 buyer?” “Yeah.” “We foreclosed on it. We are curious if you want to buy it back.” He says, “Maybe. What’s the price?” They are like, “$0.60 on the dollar.” He was able to reallocate with the trustees’ approval to put it into an LLC, all tax-deferred. He bought it back for $0.60 on the dollar and you go, “Really? You can do that?” “Yeah, it’s all legal. It’s all above board. It’s all fair market value. It’s a legit JV partnership with the trust.” We have already proven it. We stay within the rulebook. We don’t deviate. When we do that, we all win.

What happens when I and a trustee don’t agree? I want to do a certain investment and my trustee is telling me no. I’m like, “It’s a great deal. I have been around business forever. I have been a long-term entrepreneur.”

There are two options. I will give you the extreme. I have had people ask me, “Brett, can I put it on cryptocurrency?” It’s a legit question. They are throwing these hypotheticals like, “I will put it on a Bitcoin.” First of all, you filled out a risk tolerance questionnaire and you told us that your risk was here. What you are saying is to the moon risk. It’s not matching up. A couple of options. “How about if we pay you back all your money, go pay your tax and then go put it into Bitcoin? By the way, we hope it goes to the moon and then you come back, and do a DST on that with us. That’s cool.” That’s the extreme scenario.

Let’s talk about the practical level. You send me a business venture that you know, like and trust with partners that you know, like and trust. You are like, “Brett, this is the numbers. Here’s the deal and this is the return based upon the market research.” There’s no reason that a large percentage of the trust, let’s say it’s $10 million up to about 80% is allowed to go what’s called outside deals. We do keep some reserves of about 20%. It’s still your money and you are still earning. Typically, investment-grade securities, that’s where that’s at. That other 80% can be used for a down payment to purchase that business to do that deal. You can buy it all cash or you can get financing. That’s great. You form that LLC, you are running that LLC, and it’s wonderful.

Honestly, it’s not that often that we would say no to something. If you say, “I’m running some random hotel in Brazil ground development. I don’t know any of these people.” Most of the people we are working with our sophisticated and smart, Michelle. They were smart in this tax deferral part of it. We are going to guide them there but they are smart about making money. They don’t necessarily need our help in doing that.

Go back to you, retain 20%.

The trust maintains 20% liquidity. It’s like a bank. If a bank said, “Michelle, we will give you a loan for $2 million but you’ve got to keep $200,000 at our bank. It’s still your money and it’s still earning interest. It’s just a reserve account.” This isn’t a reserve but it’s still invested. It could sit in the bank for a while but typically, we are putting it in investment-grade securities. It’s protected. Conservative stuff, that’s based upon the risk tolerance that you approve.

Let’s talk about the financial advisory part of the business. I have been on several calls and you have a financial advisor that you recommend to work on my clients’ deals but we can bring our own financial advisor to the table.

Two things. We’ve got to make sure that the advisor gets to us first and then the advisor is bringing their client. The order of that must be in the correct order because it can be construed as constructive. Remember, I said too much control, knowing the trustee, your team member, your best man in your wedding or whatever. We don’t want to even touch the line that that person is running the deal. They are calling all the shots. We like to keep that separate from the trustee and the financial advisor. If the financial advisor gets educated, gets signed up, signs the NDA, gets everything in order on our side and then absolutely has a client that he brings to the table, no problem, he can be the financial advisor.

The financial advisor has to be signed up with you first. If I have a client that loves and trusts our financial advisor, we can refer to the financial advisor. They sign up with you, and then they can represent their client versus going with one of the financial advisors.

That sounds like a good order. We want the advisor to come in. Let’s talk about that. Some of these big house advisors are like the old Wells Fargo bank. They never want to do business with things that are new, different or not something that they created. We work with a lot of independent folks. We work with small boxes. I will give you a story. He worked for Morgan Stanley for many years. Part of why he left and went independent is because he couldn’t offer the deferred sales trust. He saw the value in offering this tool more than the value of holding on to Morgan Stanley.

Among other things, this is one of the reasons he left. They were a great firm for him but he’s like, “My clients need this,” so he moved. We also work with financial advisors if they are looking for alternatives to be able to offer this, the answer is to get with us early, talk with us, get everything in order and then we are happy to work with you.

You are telling us all the positives. Tell us some of the negatives.

The biggest things that we come up against are, what are the fees? Once your deal is at least $1 million of net proceeds and $1 million gain, we think it’s a home run for anybody out there. If the deal and the tax are too small, then it’s not worth our fees so we don’t want to do the deal.

What’s a good sweet spot?

It’s different than if you have a $3 million sale but you have $2.5 million in debt. It’s not a good deal. The minimum is a $1 million net proceeds and at least $1 million gain. If you are selling for $3 million but you bought it for $2.2 million, it doesn’t sound great. Ideally, I want a low basis, which by the way, for most of the business owners we work with, there is zero basis anyways. They are selling for $3 million, $5 million, $10 million, $25 million. The biggest is $125 million. I have done lots of big deals. I’m working on one that’s a $50 million sale out of Minnesota. There need to be lots of gains to justify our fees. What are our fees? About 1.5% of the gross sales price is typically the one-time fee to the tax turn. Let’s use simple math. On $1 million gross sales price, $15,000 to the tax attorney paid at the close of escrow.

One and a half percent no matter the price of the business.

If it goes higher, then we get a little break. They typically charge 1.25%. Let’s say it’s a $2 million deal. You have $15,000 on that first $1 million, and then $12,500 on that second $1 million. That’s the general fee structure. We will keep it simple there. Second is the ongoing fees and that’s including myself as a trustee as well as the financial advisor. It’s generally between give or take 1.5% to 2%, depending on how and where the funds are invested, depending on what actual amount hits the trust because they might sell for $65 million. Let’s imagine they owe $30 million. They might sell for $6 million but they owe $3 million. Depending on the amount that hits, that’s generally ongoing.

It’s important to understand that a trustee by themselves like me by myself or a corporate trustee can sometimes be as high as 1% to 1.25%. Financial advisors by themselves can be as high as 1% to 1.5%, depending on the deal size and everything else. We do try to keep it institutional and keep it low. That’s the general fees there. The last thing I will touch on is wherever you go with the funds. Some people say, “What if I want to run 80% of it into my own business deal or real estate deal, do I still pay fees?” Yes, you do. No matter where and how the funds are invested, it’s always about 1.5% to 2% on an ongoing basis.

You outearn that 1.5% to 2%.

We are trying to earn 8%. Let’s talk about the promissory note. Not guaranteed but we are trying to, as a team, everyone together, earn about 9.5% to 10% to net compounding 8% over a ten-year term on average. If you do the Rule of 72, which states if I can earn 7% compounding over ten years, at the end of ten years, that amount doubles. Let’s say you would have paid $4 million of tax on a $10 million sale. You put it all into the trust. Let’s imagine you took no payments for ten years so it netted 7% net of the fees. That $10 million will now be $20 million. That’s where we figure out that math.

They also deliver state tax. We are going to move those funds outside of the taxable state. This is the legacy play here, especially for these ultra-high net worth individuals who are selling huge things. You’ve got to look post-death. If that $65 million that we do on that deal, let’s say they would have paid $20 million, now they have $65 million, gross to $120 million, we can say 40% on that $120 million. Those exclusion amounts, by the way, the $22 million married are set to go back to $12 million married in 2025. Potentially even $7 million married, $3.5 million single. Even crazier, I have even heard just $1 million per married couple or it would be $2 million total.

Think about that. You grew something to $100 million to have 40% of it upon your death because it’s inside of your taxable estate to be completely wiped out. This is important to understand. It’s a compelling reason to sell now and not just hold on for the stepped-up basis because the stepped-up basis doesn’t move it outside your taxable estate. Connecting these dots is no longer about cashflow. It’s about tax flow because capital gains tax, estate tax, everything goes up. How are you managing that? It’s preservation using proven tax deferral strategies, proven estate tax strategies to maintain the family legacy and wealth. That’s why we are doing what we are doing.

FYE 34 | Deferred Sales Trust

Deferred Sales Trust: If anyone ever approaches you with a tax deferral strategy, you should ask a couple of things: what happens if you get audited by the IRS and what is your track record?

 

If you want to give to some charity, by all means, it’s your money. Do what you want. Control that income stream with your family, and then funnel that to the charities that you believe in because the charities’ leadership can change. You could go, “Mom and dad supported $100 million for this charity but they would never support what happened 10 or 20 years later after their death.” If you can keep those values with your kids, you can tell, “Kids, we are going to go to the deferred sales trust. We are going to get the same amount on cashflow to them. If their values change, stop that and go to someone else that we support the value.” That’s the real big thing with the CRT. I love charities but I don’t love it if leadership changes. I’m not supporting something that is not supporting my values.

It’s great information. What else do we need to know?

Be early.

What I love about is the sellers will call me up all the time and say, “Michelle, I need to start my business.” I always take their temperature by asking them, “What do you want?” I always cringe because I know it’s unrealistic. They are like, “Michelle, I want $20 million.” They are even as maybe $200,000 or $1 million. You are not going to get $20 million. When we drill down, they don’t need $20 million to live on because when you figure out tax-deferred, we can say, “Save more taxes, lifespan, how much do you need a month or a year to live on, etc.” Maybe they need $7 million. This is a great tool and program for that.

Let me add to that, too, Michelle. Separate the emotion of the exit plan versus selling your baby, your blood, sweat and tears for years.

I have been a Psychologist-Psychiatrist in M&A. The number one thing we’ve got to do is get them to change their mindset. Your business is not your baby. It’s your most valuable asset.

This is important to understand because when it is your baby, you are selling your $65 million assets and you are bringing in Brett Swarts, deferred sales trust, these tax attorneys and all of these big promises, it can be overwhelming. Separate the two, laser focus on the exit plan and your vision for your wealth, family and legacy, and check that box off. Once that’s checked off, breathe, relax, list the business with Michelle and let her go get a rock-solid price so you are not having to co-mingle, rush around, and make last-minute decisions that are going to affect your family and legacy for generations to come. Separate those two. Do yourself a favor and take action. Get with Michelle and get with me. Get no cost, no obligation consultation. Let’s plan that out. Let’s architect that and then sell it.

Do you ever see anything changing in the IRS or regulations change that will completely change for a program?

It absolutely could. They are taking away the 1031 exchange and IRC 453. Let me give you why we think that’s not as probable. Part of the 1031 exchange from the IRS is the government’s perspective because the IRS just enforces the law and the Congress makes the law. From Congress’s perspective, people are doing this thing called swap until you drop. They are doing 1031 exchanges dying a stepped-up basis. We are never getting paid on the tax. We are not getting our fair share in their minds.

Even worse, in the 2008 crash, they are running up all of these 1031s overpaying for these properties just to see them lose half or all of it and all of a sudden, we are not getting paid again. They are going, “This isn’t great for us but what could be cool for us is on the deferred sales trust.” Remember, by the definition of it, we are diversifying and we are giving back time, which also means we are diversifying the chances for the government to get the tax revenue. Would the government rather have you be in one single asset class, all of your capital, all of your money, 1031-ing or even in a business for that matter?

You are a $65 million business. Who knows? Something could crash and they could change in the world and you are $65 million business can go in the half. Something could happen, depending on the business you are in or they rather have you sell it and give you the incentive to sell it, and then infuse it into all these other businesses and companies that spur economic growth. We believe that’s why it’s a winner for everybody and why they wouldn’t go away.

The second thing is during the depression, part of the challenges was lending. They want to be able to incentivize the American people to be the bank if they need to be. If the government tries to take over all the banks, they don’t want to be in the business of banking. Everything comes to a grinding halt. When we can incentivize commerce to happen, this is the essence of IRC 453, which is the ability to become the bank and have an incentive to do that. That’s why we think it will not be taken away but we don’t know for sure. There’s some crazy stuff on the table. As the laws stand, it’s good. If it was taken away, do we think they had grandfathered you in? Yes, but we were not the Congress or the president.

If you can continue to extend the terms on the principal, then they are not getting paid either, it’s like the 1031s are there.

They are because that business was sold for $65 million. That new company that came in has probably grown that to $200 million within ten years with new employees, innovation and tax. The $65 million is invested into the stock market, which is growing those companies and other business ventures. They are getting the tax revenue. They are not getting the capital gains tax but that’s okay for them. They are looking at that and saying, “Our ROI on this if we don’t allow certain things.” Out of that $65 million, give me that $20 million. It’s short-sighted to go, “Why don’t we just help them to make this thing create way more wealth, which creates way more tax revenue than a short-term $20 million?”

Separate the emotion of the exit plan versus selling your baby or your blood, sweat, and tears.

It has been around forever.

The IRC 453 is 1921 so that’s the foundation of the structure. How we apply the law is where the secret sauce is. Everyone knows 453. All the CPAs know it. Their secret sauce is how we apply the law and that has been around for over 25 years.

Any thoughts or anything else that you feel like our readers should know? This is a wealth of information. It’s a tremendous tool. I always tell business owners, “You don’t determine when to sell because of what the tax law is. You determine when to sell when your business is doing well and it’s in its prime and doing the best.”

You can find me at CapitalGainsTaxSolutions.com. Reach out to Michelle and we will work together to get you on a free consultation call. We have a free eBook as well. You can search on YouTube, Capital Gains Tax Solutions. I have had Michelle on my own podcast. We are coming out with a book and she will be a part of one of those chapters. Perhaps that one deal will be closed with the client that you brought by then, and then we can even share some details there as well. All that being said, thanks, Michelle, for having me on the show. It has been more than a pleasure.

Thank you, Brett. It was a wealth of information and thanks to all my readers at Exit Rich. Remember, go out and get my book Exit Rich at ExitRichBook.com. Brett, you are reading my book, right?

I’m 1/3 of the way through and I will make the Amazon review for you because it’s an amazing book.

Make sure you connect with Brett on social media. Make sure you reach out to me and him. We are a team now. We are working together. Thanks again to all of my followers. Thanks again for reading this episode with Brett from Capital Gains Tax, the best solution to defer capital gains. Thank you.

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