Why Is A 1031 Exchange Better Than A Monetized Installment Sale?

Written By
Carl E. Sera, CMT
Published On
June 23, 2021

house key in lockOne of the beneficial aspects to investing in real estate is the tax advantages it offers. Investors are now fully aware that they can defer the payment of capital gain taxes, write off depreciation recapture taxes, and other operating expenditures by simply following the available tax deferral strategies made available by the Internal Revenue Service.

In this article, we will focus on two of the major tax deference strategies known as the 1031 exchange and the Monetized Installment Sale. Also, we will give you several reasons why you should consider doing a 1031 exchange over a Monetized Installment Sale.

Let’s get started!

What is a 1031 Exchange?

The 1031 Exchange is named after the IRS tax code to which it pertains. According to this rule, an investor who has made a profit from a real estate investment or taken depreciation tax credits can defer the tax on both if:

  • they purchase another property of equal or greater value
  • it has to be a property of like kind
  • all is completed within the specific time limits that are attached to a 1031 exchange

This is an incredibly effective tool for many real estate investors, especially when they’re trying to leverage their rental properties. If you find yourself wanting to sell but resisting the urge because you don’t want to incur those tax burdens, this program might be exactly what you need. It allows you to unlock the equity and the profits that you have in your current property and move that money into other properties with more growth potential or diverse investment benefits.

What is a Monetized Installment Sale?

The Monetized Installment Sale or m453 exchange is a unique tax deferral strategy that allows the seller of “property” to defer capital gains taxes for 30+ years while receiving sale proceeds today. So, in an m453 transaction, the investor uses a third-party dealer in a capital asset to defer the sale proceeds and the associated tax for a defined period usually up to 30 years.

This tax deferral strategy works for sales of assets that qualify for installment sale treatment under the m452 IRS tax code. These include privately-held business entities and assets, business and investment real estate of all kinds (business, investment, personal residences, fractional interests), and tangible assets like artwork and other collectibles, boats, 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. A typical monetized installment sale process is structured in the following manner:

  • You sell your asset to the Dealer in exchange for an installment sale contract with lump-sum payment of the purchase price payable after a pre-determined time period.
  • At the same time, a third-party private lender extends to you an investment-business loan, typically equivalent to 95% of the sale price. (Note: From this amount, a loan cost of 1% and up to .5% for set-up costs are taken by the lender, leaving net loan proceeds paid to you typically equal to 93.5 %.)
  • The Dealer simultaneously sells the asset to your Buyer in exchange for your agreed-upon price.
  • At the expiration of the installment sale contract, the Dealer pays the agreed-upon sale price which is used to repay the loan in its entirety. You pay the capital gains tax for that tax year with greatly discounted dollars because of the impact of inflation.

Why Is A 1031 Exchange Better Than A Monetized Installment Sale?

One of the major problems associated with the monetized installment sale as a tax deferral strategy is its huge cost. The 6.7% of the net sales price is often a large dollar figure. Under the monetized installment sale strategy, you will need to pay off the capital gains tax at the end of the 30 years tax break. If the law changes before an installment sale is completed and the tax rate rises, you'll end up paying more tax than expected on a portion of your profit.

However, with a 1031 exchange, you have the opportunity to swap until you drop. You can simply continue to defer the payment of capital gains and other taxes as long as you exchange it for another like-kind property without receiving the gains or sales proceed.

Final Thoughts

This is a complex procedure and your situation is likely different from the next person. You should endeavor to reach out to a qualified tax advisor for proper assistance. This article is only for educational purpose and doesn’t in anyway replace the advice of a professional tax advisor.

Learn more about Delaware Statutory Trusts and 1031 Exchanges and Delaware Statutory Trust Fees and Commissions.

If you want to see current DST offerings and DST properties and you’re an accredited investor, Schedule Your Call Today.

Carl E. Sera, CMT

Carl E. Sera, CMT

Managing Principal, Sera Capital
Carl Sera is a Chartered Market Technician and the Managing Principal at Sera Capital Management, LLC. He has over 16 years of experience in the financial services industry with a focus on investment management.

Secure Your Free 30-min
Consultation Today

Schedule Consultation