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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
April 28, 2010
The situation: My wife and I own a large fruit-growing business, through a limited liability company we formed. We have received an offer of $60 million from someone who wants to buy the LLC. Our tax basis is $10 million, and we have no debt to speak of. I’m aware of the limit on tax deferral through installment sales, to $5 million of installment sales per taxpayer per year. Do you have something that would be applicable, to defer the tax on the entire $50 million gain?—Grower
Editor's Comment: Actually, there are a variety of ways in which to solve your tax problem. A very interesting one is to use a perpetual collateralized installment-sale contract. Here’s how it works: Sell the LLC to a collateralized installment sale dealer on a perpetual (that is, permanent) installment contract for $20 million, with $10 million paid to you immediately. With your wife and you as sellers and with $10 million paid up front, you can defer the entire tax on your $10 million gain.
The dealer will re-sell the LLC to the ultimate buyer for $60 million in cash. The dealer will pay $10 million of that to you immediately, and owe you $10 million on the installment contract, for which the dealer will place $50 million (ignoring transaction costs here) into a "collateral account" at a bank or financial services firm you approve, with the $50 million as security for the $10 million owed to you and your wife.
The term of the installment contract will be, say, 100 years (which counts as perpetual), which means that you personally will never be paid either the $10 million owed to you or the other $40 million in the collateral account—but you will receive income on $60 million (the $50 million perpetual investment portfolio backing the installment contract, plus your investment of the $10 million you receive up front), without ever having a capital gains tax to pay. And, by standard financial analysis, the right to perpetual income on $60 million is worth $60 million. You could say that enjoying the fruit of the tree forever is as good as owning the tree itself, and better, if there’s no capital gains tax.
So, you will receive the benefit of the full $60 million, with no capital gains tax, ever.
In contrast, if you were paid the $60 million now and you paid, say, 50% of that in tax (if you’re lucky), what would you do with the other $30 million? Invest it, of course, when instead you might have had the benefit of having invested all $60 million.
So, would you rather have $30 million invested or $60 million invested?
Here’s the clincher, though: Let’s suppose you decide sometime that you want to invest in something else, and you need the $50 million. Then you sell the income stream to someone else, and thereby collect the principal—when and if you choose to do so.—Stan Crow
P.S. The collateralized installment sale dealer will be taxed on a $40 million gain, if the dealer doesn’t have balancing deductions.
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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.