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176. Does an Installment Sale Defer the Tax on Recapture of Accelerated Depreciation? No. Can the Tax on Recapture of Accelerated Depreciation Nevertheless Be Deferred When an Installment Sale Occurs? Yes.
162. Transfer a Family Business to the Next Generation During the Parent's Lifetime, Retain an Asset for Income, Give the Transferee a Stepped-up Basis, Defer the Gain on Sale, Support the Parent with Deductible Rent, and Finance the Transaction, Too
May 21, 2015
(Please note: On this Website the reader will see countless references to “collateralized installment sale” transactions, and to “C453”, for short. Because the IRS has used the term, “monetized installment sale”, we’re changing our terminology accordingly, without any change in the content of the deal. So, wherever on this Website you see the phrase, “collateralized installment sale”, think “Monetized Installment Sale” instead, and wherever you see “C453”, think “M453” instead. Regardless of the name change, the structure of the deal remains as it has been since 2011.)
I’ve frequently been asked whether the ultimate purchaser can purchase on an installment contract from S.Crow Collateral Corp., when S.Crow Collateral Corp. purchases from a seller in a tax-deferred Monetized Installment Sale (M453) transaction. My answers have not always appeared to be consistent, and I’ll try to clear up that seeming inconsistency now, with this post.
First, the rationale: For the lender to be willing to fund the monetization loan to the seller, the lender requires assurance that S.Crow Collateral Corp. has deployed the resale proceeds in such a way that the lender can be reasonably confident that S.Crow Collateral Corp. will have the funds with which to fulfill its obligation to pay the agreed interest and principal to the seller, so that the seller will have the funds to repay the monetization loan. That means, then, that S.Crow Collateral Corp. must actually receive the resale proceeds and not have to rely on the ultimate buyer’s making time payments of the resale proceeds to S.Crow Collateral Corp. So, in general, S.Crow Collateral Corp. will not agree to “carry the paper” for the ultimate buyer; the ultimate buyer must come in with cash. (The cash can be money which the ultimate buyer has borrowed elsewhere, in whole or in part, but it must be cash.)
Second, a partial exception: When the agreement between the seller and the ultimate buyer calls for the ultimate buyer to pay, at closing, approximately one-half or more of the purchase price and to pay the remainder soon, such as in one or two or three lump sums, it’s possible to use an M453 but to have the monetization loan be funded in one to three steps, each in relation to the portion of the resale price paid at that time by the ultimate buyer to S.Crow Collateral Corp. (That often happens when a business is sold and a “holdback” is put into place for part of the resale price, to await certain post-closing results.)
Third, not an exception but a work-around: In circumstances in which the seller wishes to “carry the paper” for the ultimate buyer so that the ultimate buyer need not obtain as much outside financing as would otherwise be required—or maybe the ultimate buyer is unable to obtain as much outside financing as would be necessary—there is a work-around.
An example: Seller’s price for the asset is $3 million. The ultimate buyer can obtain outside financing in the amount of $2 million, and the ultimate buyer can bring $400,000 in other cash to the table, from other funds of the ultimate buyer. That leaves the ultimate buyer $600,000 short of having enough to pay the $3 million required by the seller.
So, the seller, who has strong confidence in the ultimate buyer, agrees to lend $600,000 to the ultimate buyer at closing, to be repaid over five years. The seller’s source for that $600,000 is the monetization loan which is funded at closing. Thereafter, the ultimate buyer makes payments of interest and principal to the seller (not to S.Crow Collateral Corp.) over the five years.
The ultimate buyer comes to the closing with $2 million from an outside lender, $400,000 from the ultimate buyer’s other cash, and $600,000 from the seller’s loan to the ultimate buyer. Therefore, at the closing, S.Crow Collateral Corp. receives the full $3 million resale proceeds (ignoring, for this example, closing costs and the broker’s commission).
Assume here that the monetization lender lends $2.85 million to the seller up front as a monetization loan, of which the seller uses $600,000 for a loan to the ultimate buyer. The seller has a $3 million installment sale to S.Crow Collateral Corp., and the seller has (ignoring transaction costs, for this example) $2.25 million remaining from the monetization loan proceeds to invest elsewhere. Neither the monetization lender nor S.Crow Collateral Corp. has any connection with, or involvement in, the seller’s $600,000 loan to the ultimate buyer or the seller’s investment of the other $2.25 million.
Advantage to the seller: The seller defers for 30 years the tax on the gain on the entire $3 million sale. If the seller had “carried the paper” for a $600,000 partial installment sale to the ultimate buyer and had sold the remainder to S.Crow Collateral Corp. on a 30-year installment contract , the seller would have been taxed over just five years on the $600,000 and would have deferred the tax on only $2.4 million for 30 years. This way, the $600,000 is a loan to the ultimate buyer, not a five-year installment contract, and the seller defers the tax for 30 years on the whole $3 million installment sale.
Overall result: Each party gets the deal it wanted.—Stan Crow
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The Latest Installment addresses situations, questions and issues which are brought to us in the course of the consideration, negotiation or execution of transactions. We don't use the real names of parties to transactions, and we may edit the statement of the question to try to tell the story better. Please feel free to comment, or to take issue, or to raise your own question or situation. If you do the latter, please do not relate any confidential information.
The Latest Installment blog is edited by Stanley D. Crow, who is president of S.Crow Collateral Corp.