Tax Research – Is A Monetized Installment Sale Approved By The IRS?

The short explanation of this technique is that instead of selling property from person S to person B directly and incurring capital gains, instead S would sell to intermediary company C. In return S would receive a balloon installment note paying interest only with principal deferred for up to 30 years. S would pay no capital gains tax until the principal payment is received. C then immediately turns around and sells the property to B. Lastly S and C arrange with finance company D, so that D provides S with a loan for close to the sale price of the property. The loan payments to D are made with the installment proceeds that S is receiving from C.  Using this method the seller is deferring capital gains for up to 30 years, but yet has most of his money from the sale up front. 

This is how a sale usually looks:

The important thing to remember, is that usually, ANY cash you receive as the SELLER, will be taxable at that time. Like many other “tax strategies” Loan Monetization attempts to get the SELLER 100% of the money they are owed, but NOT pay any tax on it for 30 years. So, you may ask, “If they are technically getting the full proceeds from the sale, why do they think they should not pay any taxes for 30 years?” That is the exact question the IRS asks.

So let’s look at how the Loan Monetization “strategy” chart looks. You will see that the seller winds up in the same cash position, although the “professionals” pushing this strategy tell their clients to invest those proceeds immediately into a new venture, as if that “Loan” was unrelated to the sale of their assets. But no matter what, for a moment, they were given cash that can easily be considered as the proceeds from the sale of their assets. Is it just a coincidence that loan proceeds received by the SELLER are almost exactly the sales price of what they sold?

Remember, that this SELLER is put in touch with the Unrelated Financing Company D by Unrelated Company C, further strengthening the clear argument that this is merely a shell game, with players inserted to obfuscate what the underlying facts are of the transaction.

This “Loan Monetization” is an interesting idea, but another thing to consider besides my notes above, is that any installment sale that is over five million dollars that is not personal property or farm property incurs interest to the IRS at the current Applicable Federal Rate.  Interest is owed on the installment principal outstanding in excess of $5 million. This can significantly reduce the overall tax savings on any transaction.

Next to consider is that this is not yet settled law, and the IRS is aware of this and still looking at it. Generally a monetized loan received on an installment note is considered a principal payment.  This particular arrangement gets around that because the intermediary purchaser and the lender in this case are completely unrelated. A few cases have been won using this technique, but in particular it was noted that the seller had a bona fide business reason to take out a loan. But are these truly unrelated transactions? Is the loan that the Unrelated Financing Company D is making to the SELLER collateralized by the Loan that the SELLER is holding from Unrelated Company C? 

In my opinion, it is very difficult to make these transactions seem unrelated. I hope you can see why, based on my analysis, I came to this conclusion.

In one case the seller invested the proceeds directly back into his business. Some intermediary companies require an investment in new property with the loan proceeds in order to skirt this rule. So, you can’t just pocket the money from the loan proceeds.

In the end however the IRS is still looking at the substance over form doctrine with respect to this type of transaction. 

So, it may be a worthwhile option for some, I still feel it can be somewhat of a gamble until final regulations are issued regarding this specific type of transaction.

When in doubt, we prepare a request for a Private Letter Ruling, which is a direct request for IRS guidance about complex scenarios.

If you are approached by what seems to be a professional and seasoned team, with any “strategy” that looks like this, I urge you to contact me so I can help you analyze the real underlying tax issues and potential consequences. If this “team” doesn’t have Private Letter Rulings, and instead give you an IRS memorandum, this is a good indication that they themselves do not have confidence in what they are suggesting you do.

Remember, your tax returns are your responsibility, and these “seasoned professional teams” have no responsibility. A few years down the line, when you are audited, and possibly assessed heavy taxes, fines and penalties, they usually will not take your call. They have long since been paid. 

One last piece of advice, be sure that these professionals, sign an agreement to be responsible for any interest or penalties you may incur due to taking their advice.

Questions? Concerns? Call me on (732) 673-0510.

Please reach out to me without hesitation with any tax, business or

accounting question, and to schedule a consultation.

Tax Laws are complex.

It is very easy to make mistakes that can incur penalties.

Do you have a Tax, Accounting or Business Question?

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“If We Aren’t Working For You, Then You Aren’t Working At Your Best”

Chris Whalen, CPA
(732) 673-0510
81 Oak Hill Road
Red Bank, NJ 07701
www.chriswhalencpa.com

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