Does it Qualify as Installment Sale If Another Prop. Mortgaged

Question

Instead of doing a 1031 exchange can I carry back financing on two properties (the property for sale and another property)----or will the IRS somehow think that involving another property does NOT somehow qualify as a seller finance of the original property?

Lawrence S. · Answer

Thanks for your contribution.  But I don't think that I can postpone the depreciation recapture unless I do a full fledged 1031---an installment sale alone pursuant to IRC 453 will NOT help with that IMHO.

The other question concerns the status of (1) "monetized installment sale" or (2) "structured installment sale" or the like.  I have talked to some CPAs who are not 100% sure that the IRS approves of them.

Do you know otherwise?

I DO know that there is an entity called a "deferred sales trust"---that is flogged by one organization in particular----that is one I would AVOID.

Lawrence S. · Answer

I have another scenario.  Can the carryback financing be pulled off where the buyer buys an annuity that will fulfill the financing promise to the seller?  What is the advantage of this?  The problem with a seller carryback is what if the buyer decides to sell or refinance?   Yes, you can try to make your financing attractive to the buyer but you probably can't necessarily stop this from happening.  And if either occurs (sale or refinance), then the seller would be forced to pay taxes at that point.  (If the buyer were more sophisticated, maybe you could walk the mortgage, but let's assume most buyers won't, or maybe they don't have another property that would make sense).  My question: So long as the annuity continues to pay, the seller finance has accomplished its goal of postponing taxes pursuant to IRC 453.

Lawrence S. · Answer

Thanks for your post, in any case.  Maybe I misunderstood, actually.

I think your point is that if the loan payments are interest only (not fully amortized), then depreciation recapture would be postponed.

Actually, I never thought of that distinction----I don't know whether that would affect the outcome or not.  It's an interesting idea---Thanks for posting that.

Thomas Rutkowski · Answer

You might want to talk to a tax attorney, not a CPA. I'm not a "tax-advisor", but I'm pretty sure that the reason that the seller in a monetized installment sale is not in constructive receipt of the sales proceeds is that the transaction is completed via a qualified intermediary. There is no depreciation recapture for the exact same reason as there is no depreciation recapture in a 1031 exchange.

I'm no fan of DST. But that is mainly because I believe an irrevocable trust should be independent. I've heard the promoters tell their clients they can change the terms of the contract, withdrawal rates etc. If they have a flaw, I think its the lack of arms-length separation.

Thomas Rutkowski · Answer

You are on the right track. If you sold property A on a 30-year, interest-only sales contract, you could defer the taxes and depreciation recapture for 30 years. Since that sale has no relationship whatsoever to the purchase of another property other than using the money from one to pay for the other's loan payments, you have two completely separate transactions. The key is that you are not pledging one property as collateral for the loan on the other. Each loan is secured by the underlying real estate.

Rather than go to all this trouble, though, you could just do a monetized installment sale. This is a way to structure your deal so that you get cash at closing and you can defer the capital gains tax and depreciation recapture for 30 years. This would avoid your concern of an early payoff--which would trigger the taxes.

This would also let you sit on the sidelines while you take your time to find your next deal. And you would be able to go into your next deal with an all new basis and fresh depreciation.

You could find a buyer the old-fashioned way.

Lawrence S. · Answer

These 2 notes do NOT need to last forever----only to get me above the hump of the next market crash.

After the market crashes, maybe I can trade both notes to buy another property---at least, there will be properties for sale for more reasonable prices.

Lawrence S. · Answer

Basically, what I am seeking to do is to exit the market WITHOUT doing a 1031 exchange---and WITHOUT paying alot of taxes.

Lawrence S. · Answer

Another question is---is this one transaction?  I think it is, but some of whom I have asked the question want to somehow break it down into 2 transactions.

Lawrence S. · Answer

The beauty of this scenario is that I can rely on someone I already trust for the 40% LTV---I am creating value for them by a refinance of their property which wouldn't be easy for them to do---and not at an attractive rate.

But there is a complication----what if the Third Party ever wants to sell their property or wants a refinance of more than 40% (or whatever low LTV)?

But I think I can live with that----I suppose I could ask the buyer to mortgage a free and clear property that they already own--but the problem is that I have no track record for this new buyer and what they are going to do.   The truth is that even if I set up this kind of low LTV on 2 different properties, I'm not sure how I could prevent the buyer from selling this other property.

But I would want an accountant to sanctify this as a transaction that qualifies under IRC Section 453.

Lawrence S. · Answer

It's kind of convoluted, but I wanted to start the transaction with someone other than the ultimate buyer but someone else that I knew and trusted (but not a family member)---let's call him the Third Party.

1. This other property  has a free and clear property that they can't refinance easily because they are self-employed and the rate they would receive, even if they could refinance it, would not be nearly as attractive.

2. So, instead of receiving a large down payment from a buyer (for which I would be required to pay taxes), I am going to receive a low LTV note on this other property and the buyer is going to make this large cash down payment to the Third Party.

3. This way I have 2 notes---one on the original sale property that is assumed by the new buyer---and one on the free and clear property owned by the Third Party.    And the cash down payment is going to be received by the Third Party---and not myself.

4. But the virtue of the transaction is that the buyer has "skin in the game"---but without me being forced to pay taxes on the down payment.

5. The question I am not 100% sure about----is this going to qualify as an installment sale (IRC 453) of the original property that I have for sale.

I think it will, but I just thought I would post the scenario.