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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
July 16, 2015
I am a persuaded advocate of Monetized Installment Sales (M453) transactions, and I believe that the legal and factual reasons and precedents in support of them are far, far stronger than whatever arguments one could make against them. Let’s put all of that aside for now, though, and consider how one may develop a financial analysis of the prospects for and against M453.
How can a seller or a seller’s adviser put a number on the risk of a tax audit and of a possible decision adverse to tax deferral with M453? How can a seller intelligently financially calculate whether the risk is worth taking?
Calculating the Probability-weighted 30-year Benefit
1. Estimate the probability, expressed as a percentage, that the M453 will continue as planned for 30 years. 90%? 75%? 50%? 25%?
2. Project the amount of after-tax return over that 30-year period, on the net proceeds of the monetization loan.
3. Multiply #1 by #2.
4. Add the net proceeds of the monetization loan, because the seller will retain this amount.
5. Subtract the net sale proceeds, because the seller will not receive this amount. (The seller will receive this amount at the end of 30 years, but then the money will go to repay the monetization loan.)
6. Subtract the estimated eventual tax cost on the sale, and the resulting figure is the projected benefit if the M453 is undertaken and proceeds as planned.
Calculate the Probability-weighted Cost of an Adverse Tax Decision
7. Estimate the probability, expressed as a percentage, that the seller will undergo a tax audit and that the M453 transaction will be challenged in that audit.
8. Estimate the probability, expressed as a percentage, that the outcome of the tax audit will be adverse to M453.
9. Multiply #7 by #8.
10. Estimate the tax that will be required to be paid in that event. Multiply that number by #9.
11. Add the expected amount of interest that will be required to be paid in that event, and add that to #10.
12. From #11, subtract the estimated after-tax earnings on the net loan proceeds for the period of time until the tax will have to be paid.
13. Subtract #12 from #6. The resulting number will be the probability-weighted benefit of proceeding with M453, taking tax risk into account.
14. If #13 is a positive number, it makes sense to proceed with M453, because the probability-weighted benefit exceeds the probability-weighted cost.
This analysis does not compare M453 with other transaction and tax strategies. (Hint: M453 competes very well against whatever alternatives a seller might consider.) This analysis helps a seller to determine whether it makes financial sense to proceed with M453, with tax risk taken into account.
This, I believe, is the way the analysis should be done, and when it is done, the financial value of M453, as compared with the financial risk, is likely to be very high.—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.