A structured installment sale, also known as a seller-financed sale or a seller carryback, is a type of financing arrangement where the seller of a property or business (or both) agrees to receive payment in installments over time instead of receiving the full amount upfront. In a structured installment sale, the buyer typically makes a down payment and then pays the seller in regular installment payments over months or years, with interest.
The terms of a structured installment sale can be negotiated between the buyer and seller and can include factors such as the purchase price, the interest rate, the length of the payment term, and the down payment amount. The seller may also retain some ownership interest in the property or business until the final payment is made, acting as collateral for the seller. We see this often.
When businesses and partnerships want to liquidate their holdings and benefit from tax deferral, the structured installment sale can be an excellent way to defer taxation. When you examine the history of tax deferrals, you’ll find that they are primarily sold in the form of a guaranteed annuity through a big insurance company. Rather than receiving the funds directly, the funds go to a qualified assignment company which then pays the client a stream of income over a predetermined time agreed and an agreed upon purchase price. The significant advantage is that you can defer those payments for 10-20+ years with a structured installment sale. Another advantage is that you can receive the lump-sum that you receive and spread payments out over a lifetime.
While most of our articles speak to both the advantages and disadvantages, this one only speaks to the disadvantages. Keep reading to find out some of the disadvantages of structured installment sales.
7 Disadvantages Of Structured Installment Sale
Here are some potential disadvantages or risks of doing a structured installment sale:
Risk of default
If the buyer cannot make the payments on the loan, the seller may be forced to foreclose on the property or business and take legal action to recover the outstanding balance. This can be a costly and time-consuming process that can result in the seller losing money.
Interest rate risk
If interest rates rise during the payment term, the seller may be stuck with a lower interest rate than the current market rate, which could lead to lost income.
Structured installment sales can tie up a significant amount of capital, which could limit the seller’s ability to invest in other opportunities or meet their financial obligations.
The value of the property or business could decline during the payment term, which could result in the seller receiving less money than they would have with an all-cash sale.
Suppose the buyer cannot obtain traditional financing to refinance the loan when it comes due. In that case, the seller may be forced to extend the payment term or foreclose on the property or business.
Structured installment sales require the seller to manage the loan and collect payments, which can be a time-consuming and administrative burden.
Legal and tax implications
Structured installment sales can be complex and involve legal and tax implications, such as the need to comply with state and federal lending laws and the potential for tax consequences.
It’s important to carefully consider these risks and downsides of using a structured installment sale and work with a financial advisor or attorney to determine whether it is the right choice for your situation. Other factors to consider might include the creditworthiness of the buyer, the overall market conditions, and the potential for interest rate fluctuations over time, among others.
Thinking of doing a 1031 Exchange, DST, or Structured Installment Sale? Sera Capital helps clients by acting as a fee-only fiduciary focusing on tax-efficient exit planning. We offer DST 1031 exchange services through special situations where investors could put 1031 real estate into a securitized property while deferring potentially large capital gains taxes. While 1031s make sense for real estate, structured installment sales usually work better with businesses or goodwill.