Monetized Installment Sale
Capital Gain Tax Deferral
on Sale of Cannabis Business
We were recently contacted by a Registered Investment Adviser on behalf of his client, who owns several cannabis-related businesses. The client had been approached by a large company in the cannabis industry who was seeking to overcome the difficulty of obtaining a permit to operate in the client’s city. They wanted to buy their way into the market by acquiring an existing cannabis dispensary, or a share in one.
The client negotiated a deal with the buyer to sell a minority interest in the client’s existing cannabis dispensary business, in exchange for cash.
The original investment to set up the business was relatively small, and the cannabis industry has become increasingly attractive to outsiders, leading to a significant increase in cannabis business valuations. The client/seller learned from his accountant that he would be facing a large tax on the sizable anticipated gain on sale. So, the client asked his CPA and his financial adviser for ideas. The financial adviser found us on the web and contacted us to learn whether there might be a way for his client to defer or avoid capital gains tax on the sale of a cannabis business.
Facts and Circumstances
Sale price: $1,000,000
Cost Basis: $81,000
Gain on Sale: $919,000
Long-Term Capital Gains Tax + NIIT (CA - 37%): $349,030
We recommended a monetized installment sale of the cannabis dispensary shares. This strategy would allow the seller to avoid immediate capital gains tax. Instead, the seller would defer the capital gain, and the tax, for 30 years. At the same time the seller could obtain cash equal to most of the sales proceeds up front.
Our suggested solution, in brief, is as follows:
Seller already had the buyer lined up and had negotiated a purchase agreement.
We introduce the seller to a dealer who will buy the shares under a long-term (30 year) installment sale agreement, with interest-only payments and a balloon payment of principal. After the last payment (the principal amount) is received by the seller and the capital gains tax comes due.
The dealer will immediately resell the shares, for cash, to the end buyer, and all the terms and conditions that were agreed upon with the original seller remain in force.
Simultaneously, we introduce the seller to a private lender who will agree to make a cash loan to the seller in an amount equal to 93.5% of the net sales proceeds as stated in the installment sale agreement. The loan terms feature payments matched to those of the dealer’s installment sale contract: interest-only payments for 30 years and a balloon payment of principal.
Each payment on the installment sale contract from the dealer is used to make each payment from the seller to the lender, so that the dealer and lender payments essentially cancel each other out from the seller’s perspective.
The loan agreement stipulates that if the dealer fails to make payments to the seller, then the seller is not obligated to make payments to the lender.
The seller opted to avoid capital gains tax on sale of the cannabis business (at time of sale), using a monetized installment sale to defer the capital gain for 30 years.
The amount of deferred capital gains tax was $349,030 and the seller received cash at closing of $935,000, or 93.5% of the net sales proceeds. This is $284,030 more cash than would have been received under a conventional sale.