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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 26, 2010
The situation: Now that I’m ever-so-slightly older and thinking more about my retirement, I’m becoming quite concerned about my investments. If I were to sustain a big investment loss now, I wouldn’t have time to recoup, and I wouldn’t have employment earnings to help me to do so. The state of the economy seems very agitated right now. What can you tell me to ease my concerns?
Editor's Comment: I can give you a solid footing on which to minimize your risk of investment loss. What’s more, I can do so without even giving you any advice about the investments themselves.
Here it is: Invest with dollars that haven’t been taxed yet, to increase substantially your margin against investment loss.
Let’s assume that you have the opportunity to sell a capital asset for $1 million, that your tax basis is zero, and that the combined state and federal capital gains tax rate is 30%. Let’s compare selling for cash at the end of 2010 vs. selling with a collateralized installment sale at the end of 2010. Let’s assume that either way the sale proceeds are invested (directly by you, in the case of a cash sale, and via a collateral account if it’s a collateralized installment sale) in January, 2011, in something that immediately loses $200,000. Let’s assume, further, that either way the new investment is sold right after the loss occurs. You then receive what’s left, either directly or because the collateral account is closed and the installment contract is paid. (Ignore transaction costs either way.)
Why do you get $60,000 more with a collateralized installment sale? If you begin with a cash sale for $1,000,000, that amount is immediately taxed, at a cost to you of $300,000, and when you lose $200,000 on the next investment you never get back any of the tax on the $1,000,000. With a collateralized installment sale, however, the government bears 30% of the loss for you, because the $200,000 you lost was never taxed as income to you in the first place. With a collateralized installment sale, you never receive $1,000,000 to be taxed; you receive $800,000, and the tax on that is $240,000 instead of $300,000, and the government absorbs the other $60,000.
It gets even better, though, if instead of immediately terminating the collateral account after the $200,000 loss you delay payment of the tax on the $1,000,000 collateralized installment sale for 30 years, as follows:
You improve your position by $670,000 just by choosing a collateralized installment sale: a very substantial buffer for possible investment losses! (Some contingencies are not addressed here, of course.)—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.