Monetized Installment Sale
with Tax Deferral & Liquidity
An investor with a portfolio of single-family residential rental properties for sale contacted us regarding capital gains tax. The properties had been owned for twenty years or more, and most had appreciated substantially in value. His intent was to take his profits, exit the real estate sector, and reinvest in other asset types.
He wondered if there was a way to structure the sale of these properties to provide both long-term tax deferral and liquidity. Since he did not want to reinvest in other real estate, a 1031 tax-deferred exchange was out of the question. He had heard of monetized installment sales as a way to achieve his objectives, so he put the question to us: could he sell a portfolio of small properties using a monetized installment sale to defer tax and obtain cash at closing?
Unless they are luxury properties, normally single-family homes are priced at a level that preclude use of a monetized installment sale, due to minimum deal size requirements and the likelihood that the costs could outweigh the benefits.
Factors that mitigate against these concerns are
the properties have a low cost basis compared to sales price, so the tax benefit to be achieved is substantial, and;
some method of aggregating multiple properties into a packaged transaction can be found so that the transaction costs are spread over a larger base.
Facts and Circumstances
The property portfolio consisted of eighteen single family homes, ranging in market value from $325,000 to $600,000.
Altogether, the gross selling prices would amount to roughly $8.3 million.
The cost basis of the portfolio was about $1.9 million.
Capital gain: $6.4 million
Estimated federal and state (CA) capital gains tax and Net Investment Income Tax (37%): $2.37 million
The owner anticipated selling each property individually over a period of 12-18 months.
With input from the seller’s CPA and attorney, we suggested that a structure sale of the properties be done in such a way that the properties could be individually sold on flow basis yet aggregated into a single installment sale contract, custom-designed with open end provisions allowing for multiple properties to be sold over time under a master agreement.
As described elsewhere in our case studies, this “monetized installment sale” includes the following features:
Seller receives an installment sale contract from a dealer, who buys the properties with an interest-only contract with a balloon payment of principal at the end of 30 years
The dealer immediately resells the property for cash to an end buyer, lined up by the seller in the usual way, with all terms and conditions in the original purchase agreement sustained.
The dealer makes interest payments to the seller for 30 years
The seller is introduced to a lender that, at time of sale, makes a cash loan to the seller in an amount equivalent to 93.5% of the net sales proceeds.
The loan terms are essentially the same as those contained within the installment sale agreement: interest-only payments and a 30-year term with a balloon payment of principal.
At the end of the 30-year terms of the installment sale and loan agreements, the two balloon payments cancel each other out. All that’s left is for the seller to pay the capital gains tax, which has been triggered by the final balloon payment of principal to the seller from the dealer.
Meanwhile, the seller has had the use of the cash from the monetization loan for 30 years.
In this situation, the installment sale and loan agreements are customized to support inclusion of additional sale and loan proceeds into each agreement as each additional property is sold.
The investor accepted this proposal, enabling him to market his properties with confidence that, upon concluding each sale, he would be netting considerably more cash than if he sold the properties in the conventional fashion, and deferring the capital gains tax on each sale for three decades.
Cash from regular sale: $5.9 million
Cash from monetized installment sale: $7.8 million
Extra cash at closing from monetized installment sale: $1.9 million