How Does a Structured Installment Sale Work?
Instead of receiving one lump sum, all parties agree to periodic payments for a stated number of years as a condition of the property sale. The periodic payment obligation is then transferred to the Assignment Company by the Buyer, who pays the full premium to cover the payments. The Assignment Company takes the Buyer’s premium check for the periodic payments and purchases an annuity from the Structured Settlement Annuity company. The Structured Settlement Annuity Company then issues the scheduled payments to the Seller. Both entities are A+ rated U.S. life insurance entities, and, as such provide great confidence for all parties.
A Case Example:
In 2021, Marge sold an investment property that she had owned for the last 20 years. The sale price was $1,500,000; the adjusted basis of the property was $900,000, the property wasn’t subject to a mortgage and the selling expenses associated with this transaction were $50,000.
During the sale, Marge consulted with her legal and tax advisors who helped her determine that a Structured Installment Sale would be beneficial. This financial tool would provide periodic payments to help supplement her retirement and would also defer capital gain taxes on the property beyond the year of the sale. Per the Purchase and Sale agreement, the $1,500,000 purchase would be payable as follows: upfront cash of $500,000 in this year with the remaining $1,000,000 payable in 10 equal amounts beginning next year.
If Marge had received the proceeds in full at the time of the sale, she would have to pay just over $68,000 in federal capital gain taxes. A 3.8% net investment income tax (NIIT) would also apply to a portion of the gain resulting in an additional $11,400 of taxes. Total federal taxes would be about $79,400 ($68,000 + $11,400).
But, if she uses the Structured Installment Sale she will pay approximately $11,600 of federal capital gains taxes in the year of the sale due to the 15% and 0% capital gains rates, and $0 each year for the next 10 years due to the 0% capital gains rate* Additionally, none of the proceeds would be subject to the 3.8% NIIT. This results in a tax savings of about $67,800. Under the tax rules applicable to installment sales, a portion of each payment will comprise interest and thus, will be taxed as ordinary income.
Ultimately, by using a Structured Installment Sale, Marge’s capital gains and NIIT tax bill will be reduced thus preserving more of the sales proceeds and she will have peace of mind of a guaranteed1 income stream.
How was Marge’s Capital Gain Calculated?
The capital gain taxes were computed by first determining the amount of gross profit (none of which is subject to depreciation recapture rules): Selling price of $1,500,000 less adjusted basis (including expenses of the sale) of $950,000 equals a gross profit of $550,000. The gross profit factor is 36.67% ($550,000 gross profit divided by $1,500,000 contract price).
In the year of the sale and using an installment sale, Marge received only the down payment of $500,000. In applying the gross profit factor of 36.67%, Marge must report $183,350 of capital gain income resulting in about $27,502.50 of capital gains taxes ($183,350 x 15%). For the ten years following the year of the sale, Marge receives $100,000 per year. In applying the gross profit factor of 36.68%, Marge must report $36,670 of capital gain income resulting in about $0 of capital gain taxes annually during this period ($36,670 x 0%).
Tax computations assume: Marge’s filing status is married filing joint; the applicable standard deduction is $25,100; Marge has no other taxable income; 2021 federal capital gains rates apply for the duration of the installment sale. State taxes may apply and are not reflected in the computations.
*This example is hypothetical in nature and actual results will vary. For further information about the federal tax treatment of installment sales, see IRS publication 537 at www.irs.gov.