monetized installment sale

24 Replies

I am considering a monetized installment sale and would be grateful to connect with anyone who has done one before.  This is a difficult transaction to get comfortable with and not a widely known strategy.

For those not familiar with it (including me), it is an alternative to the 1031 exchange and other tax planning strategies to defer the gain and depreciation recapture on the sale of a property or a business for 30 years (including a personal residence).  It involves selling the property to an intermediary/dealer under a 30 year interest only installment contract and the dealer sells the property to the normal buyer (seamless to the buyer).  The seller (me) monetizes that installment contract by getting a 30 year fixed rate interest only loan.  The interest payments on the installment contract and the loan are identical to one another and are administered by an escrow agent.  The loan proceeds are 93.5% of the installment sales proceeds (1.5% fee to the lender and 5% discount to the dealer).  Technically, the 5% discount does not occur until the dealer pays the principal on the loan in 30 years but the seller is short the 5% at inception.

I can't get comfortable with this transaction without help from some people who are not getting compensated from it and would love to hear from others who have done it (or researched it and shot it down).

I've never done one, but you might be well advised to know the government has an interest in closely scrutinizing these intermediary (midco) transactions under a number of different anti abuse regimes that come complete with onerous penalties and other sanctions. I obviously have not considered your specific fact pattern so I won't comment upon it, but care is generally warranted with these types of fabricated transactional vehicles.

I have sold a property with this program before, and the concept is simple.  As long as I receive my money and don't have to pay tax right away, I am good for it.  I am in the 4th year of the sale now, and the tax bill will not be coming for another 26 years.  Meanwhile, I can use the money to invest in others.

Originally posted by @Gabie Tylaman :

I have sold a property with this program before, and the concept is simple.  As long as I receive my money and don't have to pay tax right away, I am good for it.  I am in the 4th year of the sale now, and the tax bill will not be coming for another 26 years.  Meanwhile, I can use the money to invest in others.

Hey Gabie.  Thanks for responding.  I called the dealer and had a very poor call with him.  He was defensive, short, not helpful, and disinterested in speaking with me...not reassuring for someone I'd be partnering with for 30 years.  Sounds like your experience has been good so far.

Originally posted by @Gabie Tylaman :

A lady out in the west coast helped set me up with the dealer and attorney, she was informative and friendly.  If you would like to have her contact, PM me.  

Thanks Gabie.  I'm not concerned with the financial adviser...they just get a sales commission.  My concern is with the dealer...that's who we enter the 30 year installment contract with and I believe there is only one dealer in the country.  I'm leaving their name off this post in respect to advisers (and the dealer).  Hard to enter into a 30 year contract with someone who won't spend five minutes on the phone with me.

@Mike Dymski

I do not have any first-hand experience with this idea, so below are my general thoughts.

The lender essentially has to issue a 30-yr unsecured interest-only note. Unsecured, because the property has been transferred to the final buyer. His only security is the promise of the dealer. (That is assuming that you're not liable for this note in case the dealer stops paying - which should be the case.) I doubt that there're many lenders willing to lend under such risky terms. If they do, they have to charge sky-high interest, on top of 1.5% fee. 

Assuming that there is such lender, and he does charge high interest - how does it work for the dealer? He essentially borrows a lump sum at an above-market rate, for a very modest benefit of 5% commission. I struggle to see the attractiveness of this business model for the dealer.

That changes somewhat if the dealer and the lender are related, but even then the 5% haul is not exactly hitting the lottery. Also, I'm not sure if the dealer and the lender must be arms-length by the rules.

Finally, on your side, the interest payments from the dealer to you are taxable income. Whether or nor they can be cancelled out by your matching interest payments to the lender - depends. In other words, not guaranteed.

So, something does not quite add up for me on the dealer/lender side - which would give me a pause if you were my client and asked for my endorsement.

Also, you're trading deferral of capital gain tax for a 6.5% discount plus possibly income tax on the interest payments that are not yours to keep - phantom income. Another pause.

Again, I don't have first-hand experience with this approach, so I may be missing something here. Would be interested to learn more.

ha! I’m not sure if there is only one dealer in the country, but the lady that was helping me handled everything, I never dealt with the dealer.  Everything was signed at the title company anyway, I didn’t care who the dealer was.  But yes, I am not surprised to see how dry a tax guy can be.  

Originally posted by @Michael Plaks :

@Mike Dymski

I do not have any first-hand experience with this idea, so below are my general thoughts.

The lender essentially has to issue a 30-yr unsecured interest-only note. Unsecured, because the property has been transferred to the final buyer. His only security is the promise of the dealer. (That is assuming that you're not liable for this note in case the dealer stops paying - which should be the case.) I doubt that there're many lenders willing to lend under such risky terms. If they do, they have to charge sky-high interest, on top of 1.5% fee. 

Assuming that there is such lender, and he does charge high interest - how does it work for the dealer? He essentially borrows a lump sum at an above-market rate, for a very modest benefit of 5% commission. I struggle to see the attractiveness of this business model for the dealer.

That changes somewhat if the dealer and the lender are related, but even then the 5% haul is not exactly hitting the lottery. Also, I'm not sure if the dealer and the lender must be arms-length by the rules.

Finally, on your side, the interest payments from the dealer to you are taxable income. Whether or nor they can be cancelled out by your matching interest payments to the lender - depends. In other words, not guaranteed.

So, something does not quite add up for me on the dealer/lender side - which would give me a pause if you were my client and asked for my endorsement.

Also, you're trading deferral of capital gain tax for a 6.5% discount plus possibly income tax on the interest payments that are not yours to keep - phantom income. Another pause.

Again, I don't have first-hand experience with this approach, so I may be missing something here. Would be interested to learn more.

Michael, great content.  MIS advisers will be able to respond better than I can but I will take a stab.

The interest paid by the seller to the lender on the loan is equal to the interest received by the seller from the dealer on the installment contract.  I don't have my notes with me but the interest rates for the loan and the installment contract were near normal market rates.  The rate on the loan was slightly higher than the rate on the installment contract to account for the discount.

The dealer gets access to the sales proceeds for 30 years, plus the 5% commission.  It's arbitrage (and a fee) and can be hugely profitable on eight figure deals for the sales of property and businesses.  Incidentally, a piece of the 5% goes to the adviser selling it...the dealer is behind the scenes (unless you call them like I did).

I had the same pause as you and I wanted comfort and to understand but did not get it from the dealer.  I'm sure an adviser could pitch the deal on me but that's not who the installment contract is with.  Who knows...maybe there is more than one dealer who does these things and they are not a conversational misfit.

Originally posted by @Gabie Tylaman :

ha! I’m not sure if there is only one dealer in the country, but the lady that was helping me handled everything, I never dealt with the dealer.  Everything was signed at the title company anyway, I didn’t care who the dealer was.  But yes, I am not surprised to see how dry a tax guy can be.  

The dealer is who your installment contract is with.  If they have any financial problems in the next 30 years, the payments you receive will stop but the loan payments that you owe will continue.  I understand that the contracts are structured in a way that is supposed to insulate you if that happens but contracts can be litigated and 30 years is a long time.  That's why I wanted to get comfortable with my partner (the dealer).  I don't care if he is dry...heck, I'm dry.  Thanks for taking the time to reply and offering your feedback to my post...good stuff.

@Mike Dymski

I don't believe in too good to be true. Again, from the lender's perspective. Why would I lend at market rate (or near market rate) when the loan is not secured by real property, if I can lend against a secured property instead? If the lender in this transaction charges market rate - something is off. Smells fishy to me.

The dealer does not just "have access" to the money, as you suggest. It's not free access. He has to pay you interest at the rate roughly equal to the interest charged by the lender. If that rate is market rate - it makes sense for the dealer. He gets an unsecured loan at a favorable rate plus 5%. But I still cannot understand how this transaction can operate on a market rate, from the lender's position.

Next, you. Your risk is exactly as you stated. 30 years from now, you still owe the entire principal to the lender. That principal, in turn, is owed to you by the dealer. Neither debt is secured by real estate. 30 years from now it's supposed to resolve itself. Some parties will be dead / out of business / you name it. I dunno, but I don't feel safe about it.

What is also strange is that our discussion is so quiet. I'd expect bunch of sophisticated investors to chime in by now. 

Speaking from my case in particular, I signed a piece of paper saying that if the loan defaulted during the course of the 30 years, the lender cannot come after the seller.  The escrow company being used is one of the oldest one, and the escrow will actually be opened until the loan is finished.  So I feel quite safe about it.  For the 4th year now, all the interest-only payments are done through the escrow directly from the asset dealer to the lender, what I need to do is have my CPA to file the incoming and outgoing interest.  From my understanding, this is a very niche methodology, the dealer and the lender are affiliates of each other.  And when I was skeptical before finally agreeing to go with it, I did my research.  You can find online that there were many businesses being sold as monetized installment loans in much larger amounts, OfficeMax was one of the examples.  The lady that helped me can probably explain to both of you in a much better way, maybe you guys can have a chat.

@Mike Dymski

See - my hunch was on point! As @Gabie Tylaman just shared, the dealer and the lender ARE affiliates! 

That would make more sense. I hope their affiliation is not breaking the rules.

It still leaves a question mark. The combined dealer/lender entity then has nothing out of this transaction, other than 5% discount plus 1.5% fee. Like a Realtor, basically, plus 30 years of administrative hassle. Everything else cancels out. 

I can see their benefit on a huge commercial transaction. Not so much on a $500k residential.

interesting thread I'm actually looking into DST vs installment sale for bitcoin. Not a lot of objective info out there mostly just attorneys and accountanting firms shilling their product.

Mike, not sure if you already got the answers you are looking for.  There is a local company here in Seattle area who handles a large majority of these type of transactions.   The company is Fulcrum Wealth Advisors.   I would just google them and give them a call.   

Mike - Actually, there is a whole line of cases which include the Midco, Court Holdings, McDonalds of Illinois, McDonalds of Zion, Penrod, Associated Wholesale Grocers, Cal-Maine Foods, Estate of Christian, etc. which involve non-qualified intermediaries whose involvement was found to be for tax avoidance purposes.  For example in Mido, the Intermediary bought stock (taking title in the stock) in order to sale the highly appreciated corporate assets to the final purchaser.  When completed the newly formed intermediary ("Shell") corporation was merged out of existence.  The intermediary's fees were based on the tax savings resulting from the deal's structure.  The intermediary gave the seller a "bridge loan" which was "immediately repaid" from the proceeds the intermediary received from the final purchaser. The remainder of the proceeds went to the seller. When the intermediary ("Shell") corporation was merged out of existence, the obligations associated with the gains for the seller were gone.  The Seller did not report any gains.  The intermediary reported no gains. The final purchaser was able to depreciate the "highly appreciated assets" purchased from the intermediary. Provided the intermediary is qualified under the temporary intermediary installment sale regulations, this outcome is much more qualified.

In my experience, those who tend to like the DSTs, and this type of solution, tend to be those who are 75 or older without a spouse or significant heirs and who are just looking to postpone the taxes beyond their likely life expectancy (recognizing, however, that this is an ever increasing target in some instances).

One defect here is that you are totally out of control.   And I agree with of the tax professionals that these kind of strategies are risky at best.  Given that the transactions seems so utterly imprudent to many here that this only serves to reinforce the idea that it was motivated solely for tax avoidance.  As with the DSTs, it's a great deal for those receiving your money---but very marginal and conjectural for those selling out.

Why not a straight installment sale?  It's not perfect---you will realize recapture of depreciation taxes immediately even if the remainder is deferred.  But at least you can foreclose on the property if the buyer defaults so that you have SOME security.