Pros and Cons of Structured Installment Sales
Carl E. Sera, CMT
August 25, 2023
When the correct combination of circumstances arises, there may be no easier way to defer or decrease long-term capital gains taxes when selling real estate, companies, or other valuable assets than a structured installment sale. Online searches for capital gains avoidance usually lead to a few common tactics, with the 1031 exchanges at the top of the list. Despite its history, structured installment sales (IRS Section 453) are rarely included in the same topic.
Structured installment sales, which are easier to implement than 1031 exchanges because there are no timing or like-kind requirements, allow a buyer to acquire a property, business, or certain other appreciated assets for cash, while the business seller can arrange for the sales proceeds to be distributed according to a planned schedule created to anticipate more favorable future income tax positions.
Unlike many other methods that primarily focus on tax deferral and, ultimately, elimination, a structured installment sale will not eliminate taxes on profits, even if the gain is considerable. Keep reading to discover the pros and cons of structured installment sales before deciding if it is the best option for your next tax deferral move.
Pros of Structured Installment Sales
Below are some of the advantages of structured installment sales:
Offering seller financing can make a property or business more marketable, especially when buyers may need help to obtain traditional financing or where there is limited financing available.
Higher selling price
A structured installment sale can allow the seller to sell their properties or businesses for a higher price than they would have received with an all-cash sale. This is because the seller can charge interest on the loan and spread out the payments over a more extended period of time.
Diversified investment portfolio
The seller can diversify their investment portfolio and generate steady income installments by accepting payments over time.
By spreading out the payments over time, the seller may reduce their tax liability, as they will only pay taxes on the portion of the sale they receive each year.
A structured installment sale can be structured to meet the needs of both the buyer and the seller. For example, the seller may negotiate a higher interest rate or a shorter payment term if they need the cash upfront. In comparison, the buyer may be able to negotiate a longer payment term or a lower interest rate if they need more time to pay off the loan.
Cons of Structured Installment Sales
While structured installment sales can have some potential benefits, there are also some potential downsides or cons to consider. Here are some of the most common cons of structured installment sales:
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 costly and time-consuming, resulting 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, limiting 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, resulting in the seller receiving less money than they would have with an all-cash sale.
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 consider these cons carefully and work with a financial advisor or attorney to determine whether a structured installment sale is the right choice for your situation.
Step Up in Basis
With a structured installment sale, you do not receive a step-up in basis upon death. You do pay the taxes as you receive the income.
A Worthwhile Approach
An installment sale is an approach worth exploring for anyone with high-value assets. It can play a key role in your estate plan and may help keep a family-owned company in the family.
Of course, this simple technique isn’t right for everyone. To determine whether an installment sale is the best path for you and your business — and to find out about other tax-smart options — please contact us at Sera Capital.