Structured Installment Sales for Tax Efficiency

Written by Posted On Friday, 07 February 2020 16:03
Structured Installment Sales to Defer Taxes Structured Installment Sales to Defer Taxes Photo by Kelly Sikkema on Unsplash

You found a buyer for that appreciated investment property you’ve decided to sell. Everything about the transaction is looking great. You got the price you wanted, the buyer is pre-qualified, and everything is looking positive for a successful closing.

Then you see the projected tax bill.

Because capital gains taxes, net investment income tax, and state income taxes can reduce your anticipated profit significantly, smart sellers always look for more tax-efficient methods of selling qualifying appreciated assets.

Enter Structured Installment Sales

As a simple-to-implement alternative to traditional real estate transactions, structured installment sales permit the parties to settle for the same price they originally negotiated but changes the method of proceeds distribution to bring about a more tax-friendly outcome for the seller at no detriment to the buyer or cost to either party.

Tax Authority for Implementation

Taking advantage of 26 U.S. Code § 453 and assorted Revenue Rulings, the buyer and seller craft a sales agreement obligating the buyer to make payments to the seller over time. But because neither the buyer nor seller wishes to rely on the buyer to make these future payments, the parties arrange for specially licensed and appointed structured installment sale professional to walk them through a process designed to help them achieve the desired outcome.

Not all transactions qualify. Clients should review IRS Publication 537 to ensure the transaction is eligible for installment sale tax treatment.

Tax Cuts and Jobs Act Brings Added Incentive

By spreading the proceeds out over time using this method, taxpayers can defer, reduce or possibly eliminate the exorbitant taxes they’d otherwise owe.

The passage of the Tax Cuts and Jobs Act (TCJA) provided some added incentive to consider deferring sales proceeds. While the tax rates themselves remain the same as before the passage of the 2018 law (0%, 15%, and 20%), they are tied to different brackets. Additionally, the TCJA retains the net investment income tax (NIIT) at 3.8% for those in the higher income tax brackets.

At a minimum, taxpayers can frequently reduce their capital gains taxes from 20% to 15% and eliminate the 3.8% NIIT if they arrange their structured installment sale properly and fall into the right future tax bracket. Some taxpayers have been known to completely eliminate their capital gains taxes. Every situation is unique.

Secure Financial Future

While the appeal of tax efficiency is certainly understandable, the desire for future financial security is another reason to consider a structured installment sale.

Because of the way structured installment sales are crafted, deferred funds are paid not directly to the seller, but to a financial institution that agrees to make future payments, which may include accumulated tax-deferred interest, to the seller according to a pre-determined schedule.

Since future payments are backed by major financial institutions or U.S. Treasuries, the seller benefits not only from tax deferral but from the peace of mind in knowing their future is more secure. One such company, MetLife, recently began offering structured installment sales and is poised to garner significant market share in the niche market.

Follow the Right Steps to Financial Security and Tax Efficiency

Although the concept itself is rather straightforward – receive sales proceeds over time for future security and tax efficiency – it’s crucial to follow the correct implementation steps to avoid any inadvertent slipups which could derail the structured installment sale.

Step 1: Consult an expert on Structured Installment Sales BEFORE finalizing any transaction to avoid constructive receipt of funds which will jeopardize the tax deferral;

Step 2: Determine the amount you wish to defer and choose a payout pattern;

Step 3: Execute the structured installment sale paperwork along with any other required closing documents;

Step 4: Escrow officer funds the structured installment sale contract directly and dispenses other funds as agreed.

Parties should always seek independent tax advice before entering into any agreement, but this tax deferral strategy is a viable option for those seeking tax efficacy and future income security.

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Dan Finn

Dan Finn, the owner of Finn Financial Group, LLC in Newport Beach, CA, placed his first structured installment sale in 2006 and has been a leading advocate for this unique tax deferral strategy since then. Licensed throughout the United States, Dan is available to consult on transactions across the country at no cost to the buyer or seller.

Dan can be reached at (949) 999-3322.

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