What is a Structured Sale
When someone is selling a business, professional practice or real estate,
many individuals in these and similar financial situations would like to
liquidate their investment without having to recognize the entire profit
as taxable income in the year of the sale. Instead of taking a lump sum,
the seller can now design a stream of income to meet his or her individual
needs. By making the sale and having part of the proceeds payable over
time, the seller can use the payment proceeds as a source of income and
may be able to recognize the taxable gain as the installment payments
are received or deemed received.
What is an Installment Sale?
For a sale to be considered an installment sale, it must be a sale of qualified
property where the seller receives at least one payment after the tax year
of the sale. Each installment payment the seller receives will consist of the
following three components:
- nontaxable recovery of the investment (basis)
- taxable gain
- interest
What Should You Consider When Using
an Installment Sale?
Since a traditional installment sale permits the seller to receive the payment
from the buyer in future tax years, the seller could potentially be at risk
regarding the credit worthiness of a buyer. In order to minimize this risk of
the installment sale, the sale can be structured so that the periodic payments
will be funded with an annuity from a large, highly rated life insurer to provide
the assurance that the seller will receive future periodic payments.
How Can the Sale be Structured?
Assuming the assets being sold qualify for reporting on the installment
method, here's how the process would typically work:
-The seller enters into an installment sale
agreement under which the buyer promised to
make periodic payments for a stated number of
years.
-The buyer assigns his or her periodic payment
obligations to an assignment company.
-The assignment company funds the payment
obligation by purchasing an annuity from an
insurance company.
-The insurance company begins making the
payments to the seller as agreed to under the
terms of the sale and issues an agreement to pay
on the performance of the assignment company.
What are the Benefits of a Structured Sale?
Minimizing taxes often plays a major role in structuring and negotiating
a deal. Many promising deals have fallen through because the buyer and
seller couldn't agree on how to structure the deal to minimize taxes.
A Structured Sale is a new tool that can be used during negotiations to
help achieve a successful deal beneficial to both parties. The Structured
Sale process is simple, quick and costs nothing to implement. It is a new
answer to old problems. Some benefits to the parties are:
- Deferral of taxable gains providing potential tax
savings
- Guaranteed income streams designed to fit
individual needs
- Guaranteed rate of return minimizing investment
risk
- Free of ongoing management fees and expenses
- Security - the seller is not dependent on
the solvency or financial performance of the buyer
to make future payments like an installment sale
- Financial peace of mind
- Simple and clean, only involving signing a few
documents
Here's an Example of a Structured Sale.
Mr. Jones is a 55-year-old male who has spent the last 30 years building
his widget business and the business is his retirement fund. His advisors
inform him that deferring income from the sale will benefit him and he likes
the idea of a regular and predictable income stream. If he sells his business
for $7 million and structures $5 million, it could produce the following sample
income streams:
- $27,167 per month for 20 years guaranteed and life, producing
- over $7.4 million over his normal life expectancy.
- $385,097 annually for 20 years guaranteed producing over $7.7 million.
- $22,435 per month for 20 years guaranteed with 100% joint survivor,
- producing: Over $9.7 million during their normal life expectancies.
In any business sale, there's another party besides the buyer and seller with a
big financial stake in the transaction - the IRS.
There are two tax issues that all sellers must consider:
When income is taxed.Deferring income is a valuable strategy which
allows individuals to put the money to work making more money instead
of going to the government.
How income is taxed. By deferring income to the future and spreading it
out over time, you may be in a lower tax bracket which can reduce your tax
obligation.
These are some of the events that may be
appropriate for a Structured Sale:
- Sale of a business, real estate or farm
- §1031 exchange cash out in full or in part to provide
income
- Sale of professional practice such as dental, medical,
legal or accounting.
- Sale of a closely-held business.
Looking at these events separately:
The Sale of Real Estate
Very often, the IRC Section 1031 Exchange is described by others as the
only tax deferral solution for real estate owners. Unfortunately, it does
not work for someone who wants to get out of the real estate market.
The Challenges
Real Estate Investors are notoriously tax averse—there are a couple of
techniques they use to dispose of a property and defer tax:
- Code §1031 Exchange—This time tested approach often
works beautifully. But occasionally, an investor
when up against the 180 day deadline is forced is
close on an undesirable, over-inflated property,
simply to avoid paying capital gains taxes.
- Installment sale— A seller may get assets out of
the real estate market and spread out the tax
burden by entering into an installment sale. Often
that seller would prefer not to bear the risks
associated with carrying the paper. These risks
include the risk of default and the possibility of
repossessing a property in a falling market.
A New Solution
The Structured Sale is a technique that is built on the principles of the
installment sale, without the inherent risks. It utilizes reliable techniques,
which have proven effective over a number of years for producing win-win
advantages for all parties.
A Guaranteed installment sale OR a Code §1031 Rescue:
- Sell interest in real estate for a guaranteed stream
of payments that can be designed in almost any
way imaginable.
- Seller is taxed on gains they actually received
using the installment sale rules. In certain
circumstances, IRS regulations allow coordination
between Code §1031 and installment sale. This is
valuable when the Code §1031 fails.
The Sale of a BusinessOptions for the
seller of a closely-held business
A successful business owner, who might want to sell at retirement or sell
to an investor group at an earlier time, may hesitate when faced with the
single year tax liability of the cash transaction.
The Challenges
A business owner wishes to sell his interest and retire:
- But doesn’t want to risk repossessing the business
during his retirement years.
- Buyer and seller can’t agree on a cash price.
- A business owner suddenly dies and his widow
demands payment per terms of a buy-sell
agreement which wasn’t fully funded.
A New Solution
- The structured sale can bridge the gap between the
two parties.
- The structured sale can be used to assure her
future payments without forcing the business into
insolvency.
Lastly, you can read more about Structured Sales in a recent
article from the Journal of Financial Service Professionals and
an article by Robert W. Wood entitled Structured Sales:
Breathing New Life Into Installment Sales on this exciting topic.
Accountants, attorneys and other advanced individuals may
also wish to refer to:
- IRC 453
- Rev. Rule: 82-122
- Rev. Rule: 75-457
- IRS Publication 537
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If you are interested in learning more about this
method, please contact us for additional information
and assistance.
