1031 Exchanges are a great way to defer gains on the sale of real estate. But what if you don’t meet the requirements or don’t want to reinvest the proceeds in a like asset? You may be able to use a “monetized installment sale” instead.
Here’s the Cliffs Notes version of how a monetized installment sale typically works:
- The seller sells the property to an intermediary on a zero down, non-amortizing, interest-only 30-year installment contract.
- At the same time, the intermediary resells the asset to the final buyer, usually for cash. The cash is held in a special escrow account in the name of the seller. The intermediary never holds the deed; instead, it goes directly to the final buyer.
- A lender lends the original seller 95% of the cash the intermediary received for the property. The terms of this limited-recourse note match the terms of the installment contract with the intermediary. The 5% difference is a typical intermediary fee for setting up the transaction.
- The seller can invest the non-taxable loan proceeds however she sees fit.
- The interest-only payments from the intermediary to the lender go through the escrow account. The interest payments match the seller’s loan interest payments.
- Capital gains tax is paid at the end of the 30-year installment contract.
- Note that only the capital gains tax portion is deferred. If any part of the gain is ordinary due to depreciation recapture, that portion would be taxable in the year of sale.
In addition to real estate transactions, monetized installment sales can be used in transactions such as the sale of a business such as a partnership or LLC, the stock and assets of a business, a professional practice, contract rights, franchise agreements and art collections.
The Tax Cuts and Jobs Act of 2017 eliminated like-kind treatment of assets other than real estate, so other ways to defer tax, like monetized installment sales, will become increasingly important.
Convoluted? Yes. Effective? Could very well be, but please consult your tax advisor to discuss the risks before trying this.
Feel free to contact eric@ironrivervirtual.com if you have questions.
See: Section 453 of the Internal Revenue Code.