No one likes to pay taxes, but it can be an especially hard pill to swallow when you’re selling a highly appreciated asset, like real estate, stock, or a business. Being pushed into the highest tax brackets and watching so much of what you worked hard to build over time going to the government can be disheartening.
Luckily, there are other ways of disposing of an asset without getting slammed by a huge, one-time tax bill. One of those ways is to do an intermediated installment sale using a deferred sales trust.
What Is An Intermediated Installment Sale?
An intermediated installment sale is when you sell an asset to a trust and receive the payments for it over time. Because the income is spread out over the life of the installment note, you pay taxes little by little as you receive them instead of in one lump sum as in a direct sales transaction. As such, transferring assets to a deferred sales trust in an installment sale allows you to defer the payment of capital gains taxes while generating an income stream. An intermediated installment sale is an alternative to a 1031 exchange or a direct sale and can simultaneously increase your gains and lower your tax liability.
Intermediated Installment Sale Benefits
There are a number of benefits to an intermediated installment sale. Some of them are:
- Since taxes are not taken out first, investors have more funds to allocate to their portfolio than they would with a direct sale.
- With more funds invested, a larger income stream may result.
- It eliminates the risks associated with “carrying a note” for a buyer.
- It allows investors to diversify their portfolio, which can lower the risk and increase stability.
- Having the asset in the deferred sales trust provides asset protection against creditors and lawsuits.
- It replaces income lost when selling a business or real estate.
- It spreads out capital gains taxes and can defer them for up to 20 years.
Intermediated Installment Sale FAQS
When deciding whether or not to utilize an intermediated installment sale, there are many factors to take into account. Here are the answers to some of the most common questions that arise as people think through the issue:
Are taxes due when I sell the asset to the trust?
No. When properly structured, there is no taxable gain at the time of the sale.
If I don’t owe taxes when I sell the asset to the trust or when the trust sells it, when do I incur taxes in an intermediated installment sale transaction?
Income is reported and taxed as it is received from the trust.
How are the payments taxed?
Part of each payment is returned to you tax-free as a return of your basis. The remainder of each payment is taxed partially as capital gains and partially as ordinary income. Some depreciation recapture may have to be accounted for as well, depending on the type of asset sold.
Can I defer collecting payments until my retirement?
The installment note may be drafted to provide for almost any type of payment structure and term, as long as it is commercially reasonable.
Will the assets be included in my estate for Medicare?
Once in the deferred sales trust, the assets will not be included in the seller’s estate for Medicare purposes. However, the installment note will most likely be included.
Is this a loophole that will be closed by the IRS?
This is not a loophole. Tax code IRC 453 allows for installment sales. The tax code has had a provision for installment sales for many years.
Can the transfer of assets be challenged under fraudulent conveyance laws?
As long as the property is sold for fair market value, the transfer should not be overturned under the fraudulent conveyance laws.
What if the IRS changes the rules?
The tax code is changed by Congress, not the IRS. U.S. tax law changes are very rarely made retroactively. Therefore, any change in the law will likely not affect intermediated installment sales that have already begun.
Will I be more likely to be audited if I do an installment sale?
There is nothing in the transaction that should cause an audit flag. However, a properly structured intermediated installment sale conforms to current tax regulations and law and therefore should not be a problem in the case of an audit.
Once established, can additional property be sold to a deferred sales trust?
Yes, additional property can be sold in an installment sale to the trust after it has been established.
What happens if I die?
The contents of the deferred sales trust have no effect on your estate taxes. It can, however, reduce or eliminate estate taxes when used in conjunction with other estate planning tools.
Can an intermediated installment sale be canceled?
The deferred sales trust can be dissolved under certain circumstances, such as default of payments. If that happens, any capital gains will be owed for the remaining balance at that time.
Is there a limit to the amount of property that can be sold in an intermediated installment sale without causing tax to be recognized?
The limit is 5 million dollars per year, per person.
Are the assets safe from creditors?
The assets of the trust are protected from your creditors. The laws of many states provide an exemption for some portion of the payments as well. However, creditors may be able to attach to your right to receive payment from the trust.
How To Execute An Intermediated Installment Sale
Intermediated installment sales are not complicated. This is how they work:
First, you will want to find an experienced advisor and tax attorney to work with. Our advisors at 1on1 Financial have been trained in executing installment sales and working with deferred sales trusts. We can serve as your main liaison during the setup, implementation, investment, and distribution of your trust. We will also help you identify and retain an attorney to handle the setup of your deferred sales trust.
Once you have the trust set up, you can sell your property to it. This sale effectively transfers the asset to the trust. After that, the trust will turn around and sell the property. The resulting assets from the sale are held within the trust and the taxes are deferred until they are passed on to you.
Next, you have the opportunity to invest the assets that are being held within the trust for growth. We at 1on1 Financial can help you identify suitable investments based on your income goals, risk tolerance, and time horizon. The trust then pays you according to the terms of the installment sale.
As you can see, an intermediated installment sale is a prudent way to dispose of a highly appreciated asset without surrendering a large portion of the proceeds in taxes. It also creates a dependable income stream, the source of which is protected from creditors.
If you have been thinking about selling an asset or property, you should consider how you may be able to benefit from an intermediated installment sale. Call our office today at 909-981-1720 or simply click here to schedule a free 15-minute introductory phone call and we can answer your questions and help you analyze your options to determine the best course of action for your unique situation.
About 1on1 Financial
1on1 Financial is an independent financial advisory firm specializing in guiding working and retired professionals, executives, and business owners along the path to financial well-being. Founded in 1990, we use a team approach to help our clients accumulate wealth, generate income, preserve their life savings, and strategically plan for the distribution of their estate. With more than 50 years of combined experience in the financial services industry, we remain true to our fundamental mission: to provide personalized guidance, treatment, care, and service so our clients can gain control of their future and feel confident in their financial life.