Monetized Installment Sale - IRS Dirty Dozen
Carl E. Sera, CMT
April 27, 2023
Every year, the IRS publishes its "Dirty Dozen," a list of transactions and arrangements taxpayers should avoid.
In a recent report, the agency emphasized four potentially abusive transactions/arrangements likely to result in "additional agency compliance activities." In other words, if you have participated in any of these, you may expect an IRS auditor to show up at your door in the not-too-distant future.
Nevertheless, in this article, we'll focus on one of the four, Monetized Installment Sale, and go into greater detail about what it entails.
What is a Monetized Installment Sale?
A Monetized Installment Sale (MIS) arrangement allows sellers of highly appreciated assets (stocks, real estate, enterprises) to benefit from tax deferral while still offering liquidity and access to funds for ongoing company or personal requirements.
In this transaction, an intermediary purchases the appreciated asset through an installment sale under IRC 453 and resells it to the ultimate buyer. Meanwhile, a third-party lender makes a loan to the asset's seller for 95% of the asset's worth.
While dozens of large corporations have used this type of transaction, the IRS has recently deemed it abusive due to the improper application of the installment sale requirements under Section 453.
How Does A Monetized Installment Sales Work?
At its simplest, the monetized installment sale transaction works as follows:
• Seller wants to sell a Property to Buyer, immediately receive cash in an amount equal to Property’s fair market value, and defer the recognition of any gain realized from the sale under the installment method;
• Seller sells Property to Intermediary in exchange for Intermediary’s unsecured installment obligation in an amount equal to Property’s fair market value; the loan provides for interest only over a fairly long term, followed by a balloon payment of principal, at which point the Seller’s gain from the sale would be recognized;
• Intermediary immediately sells Property to Buyer for cash; Intermediary does not realize any gain on this sale;
• Seller obtains a loan from Lender, the terms of which “match” the terms of Intermediary’s installment obligation held by Seller; Seller does not pledge Intermediary’s installment obligation as security for the loan; escrow agent accounts are established to which Intermediary will make interest payments, and from which the interest owed by Seller will be automatically remitted to Lender;
• Seller has the non-taxable loan proceeds, which they may use currently; Seller will typically invest the proceeds in another business or investment, at least initially, to demonstrate a “business purpose” for the business loan;
• Seller will report the gain on the sale of Property only as Intermediary makes payments to Seller under its installment obligation; in the case of a balloon payment, the gain will be reported and taxed when the obligation matures;
• Seller will use the payment(s) to repay the loan from Lender.
Flaws of Monetized Installment Sales
MIS advocates sometimes cite an IRS Office of Chief Counsel Memorandum dated July 12, 2012 (the "2012 IRS Memorandum") as evidence of IRS acceptance of the MIS transaction structure. Sadly, the 2012 IRS Memorandum states nothing of the sort, but that does not stop MIS advocates from citing it as supporting guidance.
On May 7, 2021, the IRS Office of Chief Counsel released a memorandum directly, albeit briefly, addressing flaws in the MIS transactions (the “2021 IRS Memorandum”). Some of the flaws include the following:
• First, Section 453A(d) of the Code includes a notable exception to the general installment sale rule when there is a related pledge. Specifically, since the Seller Loan is secured by the right of the Seller to receive payment from the Intermediary, there is a deemed payment under the pledging rule whereby the loan proceeds are treated as payment of the installment note (which unwinds the intended tax deferral).
• The Office of Chief Counsel also clarifies that the 2012 IRS Memorandum is distinguishable from the typical MIS transaction. The 2012 IRS Memorandum was premised on an exception to the pledging rule for sales of farm property. Unless Seller’s business assets qualify as farm property, the 2012 IRS Memorandum does not support the typical MIS transaction.
Like most things in life, anything that seems "too good to be true" most often is. Taxpayers should think twice before including these questionable arrangements on their tax returns. Taxpayers are legally responsible for what's on their return, not a promoter making promises and charging high fees. As a taxpayer, you can help stop these arrangements by relying on reputable tax deferral professionals you can trust and never engage in a Monetized Installment Sale.
Sera Capital is a wealth management consulting firm specializing in all aspects and all available tax-efficient exit options for business owners, real estate investors, and developers. Our team works with you and your advisors to examine all available solutions, including 1031 Exchanges, Delaware Statutory Trusts, 721 UPREITS, Opportunity Zone Funds, and Section 453 Installment Sales, including Deferred Sales Trusts and Structured Installment Sales. We have two mottos. The first is “We help landlords and business owners exit tax efficiently,” and our second is “When you want out, call us in.”
If you want to explore your options, make a no-obligation appointment with us today. Discover the possibilities.
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