Monetized Installment Sales

Monetized Installment Sales (M453 Transactions) also known as “collateralized installment sales” or “C453 transactions" are based on Section 453 of the IRS Code.  This planning approach uses a third-party dealer in capital assets to defer sale proceeds (and the tax on those proceeds) for lengthy periods of time.  Because it does no good to defer taxes if you do not have access to the funds, this strategy includes a monetizing loan to provide liquidity during the installment period.  

 

This strategy works for sales of assets that are eligible for installment sale treatment under IRS Code §453. These include privately-held business entities and assets, business and investment real estate of all kinds (business, investment, personal residences, fractional interests), as well as tangible assets like collectibles, yachts, and airplanes. However, they don’t include sales of business inventory except as part of the sale of the entire business, and they don’t include “dealer” assets which you buy for resale in the ordinary course of your trade or business, or publicly-traded securities.

How does a monetized installment sale work?

There are four key participants involved in a monetized installment sale:

  1. Seller
  2. Buyer
  3. Dealer
  4. Lender

 

After a Seller finds a Buyer for the sale of the property, a Dealer is inserted between the two parties to facilitate the monetized installment sale. Like a traditional installment sale, the Seller sells the property to a third-party Dealer in return for a 30-year, interest only installment contract.

Dealer sells property to Buyer at no mark-up, the Dealer sells the property to the Buyer in an all-cash, fee-simple interest sale. An unaffiliated lender provides the seller with an unsecured loan in the amount of the sale price (not including fees).  The loan has special characteristics that protect the seller from the bank.

  1. Single Source Provision: The Lender cannot compel the Seller to pay more on the loan than the monies deposited into the Seller's escrow from the Dealer
  2. Loan Guarantee: Guarantee to the Seller that the Seller will not have to repay the loans from monies other than those from the Dealer deposited into the Seller's escrow
  3. The Lender cannot report any non-payment to a credit reporting agency.

Monetized Installment Sales are low maintenance. A series of escrows setup at inception automates the loan payment process.

Are monetized installment sales legal?

In short - Yes.

During the 1980s, high interest rates had brought institutional lending for the buying and selling of real estate and other capital assets nearly to a halt.  Part of Congress’ response was the codification of what came to be termed the monetized installment sale provisions in the tax code.  Congress saw installment sales as a potentially substantial contribution to economic recovery, because a particular seller who could “carry the paper” on a sale and a particular buyer who needed financing to be able to buy could agree on any interest rate they might choose, regardless what market interest rates were at banks and other financial institutions.

To encourage sellers to be willing to carry the paper so that someone could afford to buy, Congress added provisions which allow sellers to sell on installment contracts but receive borrowed money in hand at the same time, without losing the tax deferral that typically accompanies an installment sale.  Under these new provisions, sellers could defer the tax on the sale but have liquidity at the same time.

The rules which Congress put into place allow sellers of agricultural properties and homes to sell on installment contracts and at the same time borrow money, with the loan being secured by the installment contract.  In the case of installment sales of business or investment property, Congress said that the installment seller could enjoy tax deferral and still borrow money elsewhere at the same time, as long as the loan which the seller takes out is not “directly secured” by the installment contract or the lender does not take the installment obligation in satisfaction of part or all of the loan to the seller.

Additionally, the IRS Office of the Chief Counsel issued a memorandum (memo number 20123401F ) on Monetized Installment Sales in 2012, blessing this structure.

How does a monetized installment sale differ from a 1031 exchange?

Disposition of Appreciated Assets on Tax Deferred Installment Sale are often easier and more flexible then 1031 Exchanges which have numerous limitations.  Benefits include:

  • No 45 day & 180 Day time period limitations
  • No “Like Kind” reinvestment limitation
  • No Replacement Investment – thus a true exit strategy
  • No Limitation on the nature or scope of what is re-invested into if one so chooses to re-invest
  • No Limitation on “used in business for profit” you can installment sale personal homes and personal property – collectables – No limitation to business or investment property
  • No maintenance of debt requirement
  • No need to delay disposition because you need to line up new financing or wait to find a replacement investment
  • No limitation to carry over basis – No loss or recapture of depreciation deduction
  • No over paying for replacement property to delay taxation

Congress has reiterated, again and again, the high importance which it places on installment sales, their many benefits, and their role in promoting economic growth.  Those factors are as true today as they were in 1980.

It is likely that a properly structured monetized installment sale can in many circumstances defer entirely (and thereby materially reduce) the capital-gains tax on the sale of an appreciated asset.  For  that  reason  and  because  every  seller  should  exercise  due  diligence  about  the  matter  before engaging in a monetized installment sale, it is important that the seller seek his or her own legal, tax and investment advice.   

The Steburg Law Firm, P.C. can advise the seller and the seller’s advisers to determine whether proceeding with a monetized installment sale would be in the seller’s best interest in his or her particular circumstances. No transaction, including a monetized installment sale, is without risk of some kind.  With the benefit of the legal and tax  advice from the Steburg Law Firm, P.C., the risks associated with a monetized installment sale can be minimized.  Each seller who considers entering into a monetized installment sale should contact the Steburg Law Firm, P.C. to identify, evaluate, quantify and compare the risks and the benefits of of the transaction.

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