Comparing Testamentary and Family Trusts with a 453 Trust

Trusts are a versatile way to help you manage your wealth. A variety of options can shape your strategy, including testamentary trusts, family trusts, and 453 trusts. Each type of trust operates differently, allowing them to potentially serve various objectives, such as asset protection, tax management, or the distribution of family wealth.

Learning the differences between these legal tools can help you select the right option for your family’s financial needs and goals. However, structuring a trust is a complex process that requires the expertise of experienced legal professionals. Call 453 Trust Powered by Pennington Law today for a free consultation.

What Are Testamentary Trusts, Family Trusts, and Deferred Sales Trusts?

A trust is a legal arrangement in which a person (the grantor) places assets under the management of a trustee for the benefit of designated beneficiaries. Testamentary trusts, family trusts, and deferred sales trusts are three kinds of trusts used in financial and estate planning:

• A testamentary trust is established in a will and takes effect after the person dies. The will specifies which assets are placed into the trust and who will benefit.
• A family trust is created to manage assets for the benefit of named family members. A trustee oversees and distributes the assets according to the instructions in the trust document.
• A deferred sales trust (DST), or 453 trust, uses IRS installment sale rules to help defer capital gains taxes when selling an appreciated asset, such as real estate. The property owner transfers the asset to the trust, which then sells it and receives the proceeds. The trustee distributes the proceeds to the seller in accordance with the terms of the trust’s installment agreement. The seller pays capital gains tax only on the portion of the proceeds received in each tax year, allowing tax deferral over time.

Key Differences Between Testamentary, Family, and 453 Trusts

The significant differences between testamentary, family, and deferred sales trusts include:

• Purpose: A person may create a testamentary trust in their will to manage and distribute inheritances to beneficiaries after the person’s death. Conversely, families typically use family trusts for asset management and wealth transfers. Finally, deferred sales trusts allow asset owners to manage the capital gains tax owed on the sale of an appreciated asset.
• Creation: A testamentary trust can be established only in a will and takes effect upon the testator’s death. A family trust, by contrast, can be created during the grantor’s lifetime as a living trust. A deferred sales trust must be created before the sale of the asset or before the seller receives the proceeds — either actually or constructively — to qualify for installment-sale tax deferral.
• Control: Although a grantor can amend the will that creates a testamentary trust during their lifetime, the trust itself becomes irrevocable upon taking effect after death. Individuals and families can retain control over family trusts by structuring them as revocable trusts. Finally, an asset owner has no control over the management of assets in a deferred sales trust, as distributions are dictated by the terms of the installment agreement.

When a Deferred Sales Trust May Be the Right Choice

A deferred sales trust (DST) can be helpful when you want to sell a high-value asset while deferring the immediate capital gains tax. By using a DST, the sale proceeds are transferred to the trust, which can reinvest them, potentially allowing your wealth to continue growing. Capital gains taxes are generally paid only as proceeds are distributed over multiple years, which may help manage your tax liability by taking advantage of losses or lower tax rates in different years. A DST may be an appropriate strategy for individuals who do not need immediate liquidity and want to maximize the potential growth of their assets through reinvestment and diversification. 

How Tax and Market Conditions May Affect Your Trust Strategy

Changing tax laws and market conditions may affect your chosen legal strategy over time. For example, higher income in a given tax year or updates to tax laws may prompt a review of your trust strategy to help manage your tax liability. Similarly, market downturns may encourage strategies focused on preserving assets rather than pursuing aggressive growth through investments.

Common Mistakes to Avoid When Establishing a Trust

Retaining experienced legal counsel when setting up a trust is crucial to reducing the risk of errors or oversights that could undermine your goals. Some common mistakes include:

• Choosing the wrong type of trust for your objectives
• Assuming that a trust automatically provides asset protection or tax benefits
• Selecting an unsuitable trustee
• Failing to fund the trust with assets properly
• Not executing trust documents in compliance with state and federal laws
• Using vague, ambiguous, or conflicting terms in the trust document

Schedule a Free Consultation to Explore Your Trust Options Today

If you have questions about how a deferred sales trust can help you meet your financial and tax goals, the experienced attorneys at 453 Trust Powered by Pennington Law can help. Our firm is comprised of attorneys and professionals with in-depth knowledge of trust law, estate planning, financial planning, asset protection, wealth management, and tax law. With a nationwide client base and top ratings and accolades from legal and financial organizations, our law firm can assist in structuring DSTs that comply with IRS rules, helping clients safeguard their assets and plan for tax deferral. Call or contact us today for a free consultation.