Monetized Installment Sale Definition
Updated: Apr 12, 2020
When someone mentions the phrase “a monetized installment sale” in conversation, it’s not unusual for the listener to reply with “a what?”
This unusual linking of the word “monetized” with the term “installment sale” is seldom heard except among financial literati, some investment bankers, and sellers of assets that were fortunate enough to learn about this topic so they could apply it to their advantage.
My Monetized Installment Sale Definition
A monetized installment sale is a way of structuring the sale of an asset to achieve a combination of tax deferral and liquidity that would not be possible in a regular sale.
In a regular sale, the asset is sold for cash (either all cash from the buyer or a combination of cash from the buyer and cash in the form of financing from a lender). As soon as the transaction closes, the seller has obtained receipt of the sales proceeds. If there is a gain on the sale (the definition of which is beyond the scope of this post) then the gain is taxable as ordinary income if the asset has been held for one year or less. Otherwise, the gain is subject to long-term capital gains taxes, which generally are lower than ordinary income tax rates.
Although capital gains tax rates may be lower than ordinary income tax rates, they can still be significant burden for sellers, so a means to mitigate that burden is desirable.
A monetized installment sale is a tax strategy that employs two separate transactions to:
Mitigate the capital gains tax; and
Provide liquidity to the seller in an amount sufficient to satisfy the seller’s desire for liquidity, which normally will be less than 100% of the sales proceeds.
The two separate transactions that comprise the monetized installment sale are:
An installment sale, which under Sec. 453 of the Internal Revenue Code, enables deferral of capital gains tax for as long as the seller has not yet received the sales proceeds; and
A loan from a third-party lender, who agrees to provide a loan to the seller representing a high proportion of the seller’s net selling price under the installment sale.
Together, these two transactions provide tax deferral and liquidity.
The payments on the installment sale loan to the buyer are equal to the payments the seller makes on the payments to the lender. The duration of the contracts are usually lengthy (up to 30 years) which can make the deferral of gain for the seller quite valuable due to the time value of money.
The payments on each loan are interest-only with final balloon payments of principal due at the end of each loan’s terms. At the end of the loan terms the seller receives the sales proceeds, which are used to pay the balloon payment on the monetization lender’s loan. Having received the sales proceeds, the capital gains tax then becomes due.
The net effect of the two transactions on the seller is to defer capital gains tax for a long period while receiving immediate liquidity via the separate loan transaction.
Check out my "how it works" post to learn more about the effects of the transaction on the installment sale buyer and the lender.
Wikipedia Definition of Monetized Installment Sale
The Simplest Definition
Perhaps the simplest definition of a monetized installment sale is to think of it as a pair of loans:
The seller loans the purchase price to the buyer of the asset, on an installment contract.
The seller separately arranges to borrow money from a lender in an amount that provides a high degree of liquidity relative to the amount of the installment sale price.
While the two loans are entirely separate transactions, if properly structured these two loans can accomplish the dual objectives of tax deferral and liquidity for the seller.
Synonyms for Monetized Installment Sales
Other names sometimes associated with the term “monetized installment sale” are:
M453 (for “monetized” and Section 453 of the Internal Revenue Code, which governs installment sales)
M.I.S. (abbreviation for “monetized installment sale”)
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