Deferring Capital Gains When Selling a Storage Facility

During our recent Gabfocus year-in-review episode, Matthew Roberts of Southern Storage mentioned that one of the biggest lessons they learned was to use a deferred sales trust. 

So what is that?

To put it simply, it’s a way to sell an asset without having to immediately pay capital gains taxes on it. Its use is a bit more complex than that, though, and it may not be the right choice for everyone.

Let’s take a look at how a deferred sales trust works and how it could benefit you (along with some of the risks).

What is a Deferred Sales Trust?

If you’re looking to offload a property, then you have a lot of options for how you can do it.

Three common methods include selling the property outright for a lump sum, selling the property in an installment sale, and using an exchange. 

Selling the property outright brings a lump sum of money but high taxes. Using an installment sale brings some risk, and you’re still paying capital gains taxes. Meanwhile, an exchange means you don’t get any upfront money at all, instead trading up to a different asset—but critically, the exchange means you’re not paying capital gains taxes (yet).

I know, I know. None of this is what you’re here to learn about. But their benefits and drawbacks are important to understand so that you know why you may want to use a deferred sales trust instead.

See, a deferred sales trust is kind of like a complicated installment sale.

Here’s how it would work for a self storage owner:

1. You sell your storage facility to the trust.
2. The trust promises to pay you back in future installments.
3. The trust sells the facility to another individual for a lump sum payment.
4. The lump sum is used to make investments and earn interest.

Right. There’s a bit of confusing business going on here that doesn’t make a lot of sense if you’re not well-versed in tax laws and financial strategy.

For everyone who isn’t an accountant, let’s break it down!

IMPORTANT: We aren’t lawyers or financial experts. Before you make any choices about selling your facility and how to do so, we ask that you please consult such experts. This article is only here to provide a basic understanding before you have these conversations.

What are the benefits of a Deferred Sales Trust?

At first glance that seems a little bit convoluted, right? I mean, why not just sell the property directly to the buyer and cut out the middleman?

But if smart business people are doing it, there’s got to be a benefit, right?

Remember how directly selling your storage facility for a lump sum payment means you get big capital gains taxes to pay? Well, it also jumps you up some tax brackets, increasing the taxes you’re paying overall.

And remember how being paid in installments brings some risk of not being paid back and also still requires you to pay capital gains?

Well, a deferred sales trust is designed to circumvent all of that.

Basically, you defer your capital gains taxes indefinitely. How? Well, by not being paid for your property.

You might be wondering how not being paid is a benefit. But most importantly, I never said you don’t get paid, only that you don’t get paid for the sale of your facility (immediately).

Let’s take a deeper look:

• Deferring capital gains. A deferred sales trust lets you defer capital gains indefinitely. It does this by not paying you immediately for the facility.
• Avoiding large tax bracket jumps. By receiving installments instead of a lump sum of money, you don’t go up as many tax brackets (if any at all).
• You get paid interest. The secret loophole in this plan is that you can get paid interest from the investments made by the trust using your future money.

Ahhh, there it is. A way to get paid without worrying about capital gains (yet).

Since you’re not being paid installments from the money the trust earned selling your facility, you don’t need to pay capital gains taxes for the payments you receive. You’ll only need to pay capital gains taxes once they start paying you installments from the initial sale rather than the investment interest.

Do Deferred Sales Trusts come with risk for storage operators?

If it’s such a sweet deal, why doesn’t everyone do it?

Well, there’s risk involved. It’s actually the same risk as the basic idea of an installment sale, only the source of the risk has shifted from the buyer to the trust.

The risk? A failure to pay.

That’s right. You have a legally binding agreement to be repaid by the trust, but what happens if they’re unable to do so? What if the trust is mismanaged, or if there is some financial crisis that leads to the trust being unable to repay you?

At worst, you’ve lost all of your money from selling your storage facility. At best, you might be able to somehow fight your way to some kind of compensation after a lot of time, effort, and probably additional money.

Should self storage owners use Deferred Sales Trusts?

There isn’t a black-and-white answer to this question, so I’m not going to give you one. Every situation is different, and every business owner is different.

There are definitely benefits, though. As Matthew Roberts said in the Gabfocus session earlier, “it’s been a game changer” for him and his team in allowing them to defer taxes while re-investing their capital.

You should definitely contact a legal and/or financial advisor to decide what to do when you sell your self storage business.

What I can say, though, is that there’s another reason to use a deferred sales trust OTHER than avoiding capital gains taxes:

Retirement.

If you’re ready to retire from the storage business and enjoy your golden years with some financial stability, one way to do so is to set up an installment plan by selling through a deferred
sales trust.

Experts suggest this method, sometimes, because it allows you to…

1. Avoid being kicked up a tax bracket and losing more of the sale to taxes
2. Earn a bit of interest from investments for additional retirement income

So while I can’t recommend whether or not you should use a deferred sales trust, I can recommend that you consider its possibilities beyond simply avoiding capital gains taxes.

In Summary

A deferred sales trust allows you to sell a property to a buyer with the trust acting as a middleman. The trust retains the sum paid for the property, and you don’t pay capital gains taxes on that money until you receive it.

By doing this, you can reinvest the capital, even earning interest off the investments without paying capital gains on the initial sale until you start receiving payments from the principal.

One major downside of this strategy is that should the worst happen, the trust may lose the money and be unable to pay you for the sale of your facility.

Here are some of my other favorite posts to check out!

• Are You Liable During Unplanned Gaps in Security?
• How to Limit Your Self Storage Liability 
• [LEGAL] What Does Climate-Controlled Actually Mean?

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