Monetized Installment Sale
Tax-Deferred Sale of Real Estate
An elderly married couple wanted to sell their portfolio of several apartment buildings to obtain relief from the burdens of active management and reduce their exposure to real estate market risk. They had owned the properties for two to three decades, and appreciation that had occurred during that period left them with a staggering capital gain, and capital gains tax to be paid if they sold.
Since a 1031 exchange was out of the question (they wanted to cash out and reinvest in low-risk securities) they sought a way to exit with as much cash as possible.
Facts and Circumstances
Sale price: $25,000,000
Cost Basis: $13,000,000
Gain on Sale: $12,000,000
Long-Term Capital Gains Tax + NIIT (CA - 37%): $4,440,000
After talking with the seller's CPA and attorney, we suggested a monetized installment sale as a way for the sellers to maximize the immediate cash obtainable from exiting their investment.
This involved setting up an installment sale through a dealer and a separate "monetization loan" from a third-party private lender.
The dealer would buy the properties on a 30-year installment note, with interest only payments and a final balloon payment of principal. Immediately upon closing the dealer would resell the properties to the originally-intended end-buyer, for cash. The dealer would invest that cash and use the investment income to make monthly payments of interest to the seller. At the same time, the seller would use those monthly payments to repay the monetization loan provider, whose loan terms mirror those of the dealer's installment note -- interest only payments for 30 years, followed by a final balloon payment of principal.
The installment sale would defer capital gains tax for the 30 year duration of the contract, and the monetization loan would provide an amount of cash up front equivalent to 93.5% of the net sales proceeds of the sale transaction to the dealer. Thus the sellers can defer their tax (under Sec. 453 of the tax code) for 30 years, while exiting with most of their net sales proceeds in cash up front.
The loan agreement would stipulate that in the event that the dealer stopped making payments to the seller, the seller would no longer be obligated to make payments to the lender.
The sellers elected to proceed with a monetized installment sale, deferring approximately $4.4 million in capital gains tax.
Instead of netting $12 million - $4 million (tax) they netted $12 million x 93.5%, amounting to $11.4 million in loan proceeds. The monetized installment sale provided the sellers with $3.4 million more than they would have received if they had engaged in a standard cash sale. The capital gains tax has been deferred for 30 years.
How to Defer Capital Gains Tax for 30 Years
Simultaneously Obtain Cash
Equal to 93.5% of Your Net Sales Proceeds