How a Monetized Installment Sale Works
Updated: Apr 12, 2020
OK, you’ve heard of Monetized Installment Sales, possibly by reading my definition post, and you’re curious. You want to know how a monetized installment sale works.
Before I take you through an example of a monetized installment sale, let me introduce you to the participants:
Seller: this is the person or business entity that has an asset to sell, and due to the large capital gains tax they are facing if they sell, they choose to engage in a monetized installment sale to defer the tax while obtaining a high degree of liquidity.
Buyer: this person or entity has been identified in advance as the ultimate purchaser of the asset. They are willing to pay cash (which may be a combination of cash and loan proceeds that they line up to finance the acquisition).
Dealer: this entity serves as an intermediary between the Seller and the ultimate Buyer. The Dealer provides two functions to the Seller:
Purchases the asset on a long-term installment contract from the Seller, providing deferral of capital gains tax;
Introduces the Seller to the Lender, who will provide liquidity in the form of a loan that closes immediately after the installment sale to the Dealer
Lender: this entity is typically a non-bank provider of financing, able to provide a limited-recourse personal loan to the Seller equivalent to 95% of the Seller’s net sales proceeds.
Monetized Installment Sale Example
The Seller sells their property to the Dealer on a long-term installment sale contract, with interest-only payments, typically for a term of 30 years, with a final balloon payment of principal. The Seller receives an installment sale contract and promissory note from the Dealer.
The Dealer immediately resells the property to the originally-intended end Buyer for cash, for the same price and terms originally envisioned by the Seller and Buyer. The Buyer’s cash goes into escrow, Buyer takes possession of the property and exits the picture.
The Dealer will have introduced the Seller to the Lender (a third-party not involved in the installment sale transaction). The Lender provides cash to the Seller in the form of an unsecured, limited recourse loan (with some Seller protections included, as explained further below). The Seller agrees to pay the Lender interest-only monthly payments for 30 years, with a final balloon payment of the principal balance, typically 95% of the Seller’s net sales proceeds.
After closing, the Dealer’s payments to the Seller are automatically passed through a long-term escrow account, which then automatically forwards payments in the same amount to the Lender on behalf of the Seller (who now is also a Borrower). The Dealer’s payments fully fund the Seller/Borrower’s payments to the Lender, including all monthly payments of interest and the final balloon payments occurring at the end of the 30-year loan terms.
The loan agreement between the Seller and the Lender includes several features that protect the Seller from what would otherwise seem to be significant repayment risks of monetized installment sales:
The Lender may not compel the Seller/Borrower to pay any more on the loan than the Dealer pays on the installment contract. In other words, the Lender looks to the interest income received by the Seller from the Dealer as the sole source of repayment.
Likewise, the Lender agrees that in the event that the Dealer does not make payments to the Seller, the Seller is not required to repay the loan from funds other than those paid by the Dealer. The Lender may not pursue other assets of the Seller for repayment.
The Lender also agrees that the arrangement is a private loan and will not report any non-payment to a credit reporting agency.
Numerical Example of a Monetized Installment Sale
John owns real estate with a large capital gain and engages in a monetized installment sale. As seen in the table below, with a $1 million sale price, a $200,000 cost basis, and taxes typical in California, he will come out ahead by $229,000 in the year of sale due to the deferral of the tax.
There’s a lot more detail that could be added to this description, but we tend to keep things short here in this blog. The best way to fully explore how a monetized installment sale works, and to learn about the legal foundation, is to attend our monetized installment sale webinar replay.
WANT TO LEARN MORE?
How to Defer Capital Gains Tax for 30 Years and
Simultaneously Obtain Cash Equal to 93.5% of Your Net Sales Proceeds