When the right set of circumstances presents itself, there may be no simpler way to defer, reduce, or completely eliminate long-term capital gains taxes when selling real estate than a structured installment sale.
Internet searches for capital gains avoidance usually leads the search to section 1031 of the Internal Revenue Code: Tax free exchanges. Structured installment sales are less frequently included in that same discussion despite the long availability of this money-saving option. Simpler to implement than 1031 exchanges because there are no timing or like-kind requirements, structured installment sales permit the seller to have the sales proceeds distributed according to a planned schedule created to anticipate more favorable future tax positions.
If planned properly, unlike many of the other options that focus mostly on tax deferral, a structured installment sale can eliminate taxes on gains altogether, even if the gain is significant.
Capital Gains Tax Efficiency
Since 2008, the lowest federal tax rate for long-term capital gains has been 0%, and even the maximum rate of 20% is approximately one-half of the highest federal income tax rates.
Long-term capital gains tax rates for the 2024 tax year
| FILING STATUS | 0% RATE | 15% RATE | 20% RATE |
| Single | Up to $47,025 | $47,026 – $518,900 | Over $518,900 |
| Married filing jointly | Up to $94,050 | $94,051 – $583,750 | Over $583,750 |
| Married filing separately | Up to $47,025 | $47,026 – $291,850 | Over $291,850 |
| Head of household | Up to $63,000 | $63,001 – $551,350 | Over $551,350 |
Source: Internal Revenue Service
This presents a tremendous opportunity for landowners seeking to “cash out” in a tax-efficient manner.
Background
Structured installment sales evolved as an outgrowth of IRC section 453, which governs the selling of qualifying appreciated assets using the installment method where sellers can spread out recognition of capital gains over several years according to an agreed-upon schedule.
Installment sales can be fraught with risk to sellers who, while retaining the rights to the future payments and title should the buyer default, could find themselves reacquiring the same business or property they chose to let go in the first place. But what if sellers could derive all the benefits of installment sale tax treatment without the downside risk of buyer default? And what if they could time those future installment payments in anticipation of reducing their capital gains taxes from 20% to 15% or 0%? It turns out—they can.
Enter the Structured Installment Sale
A derivative of installment sales, structured installment sales began as an outgrowth of the structured settlement industry, which aids the resolution of personal injury lawsuits. In that arena, laws permit a plaintiff to arrange for their injury settlement proceeds to be paid over a period of time on a tax-advantaged basis while earning interest on their recovery.
The Mechanics
Both buyer and seller will typically need to execute an acknowledgement statement and other disclosures as may be required by the provider of the structured installment sale product in advance of any deal moving forward, to ensure compliance with the issuer’s requirements for acceptance. Parties will then formalize their intent to enter into an installment arrangement, usually through an addendum to the sales contract, the terms of which will also be incorporated into the accompanying nonqualified assignment that serves as the formal document necessary to perfect the transaction. Much of this, including direct funding of the annuity, can be accomplished at close of escrow as an extension of the normal closing process.
The nonqualified assignment document is a crucial piece of the structured installment sales transaction. Because one of the keys to tax deferral hinges on being able to avoid constructive receipt of income in the year of the sale lest the seller be taxed on the entire gain all at once, this document outlines those sums that are going to be paid in the future. And because the present value of these future periodic payments is funded by the portion of the sales proceeds one elects to defer, the seller can avoid recognizing the income until it is actually received in the future. To the buyer, however, everything is the same as it would be for a cash sale.
All of the above must be coordinated by a licensed, experienced, and specially appointed structured installment sales expert who will make sure the desired payout schedule is properly implemented and will oversee compliance with all requisite paperwork necessary to conclude the structured installment sale. Because these experts are compensated directly by the life insurance companies accepting the structured sale, there is no cost to either buyer or seller for their services. The negotiated price of the property remains unchanged, and parties receive no invoices for fees or costs at close of escrow.
Although the structured sales expert will be responsible for proper implementation of the transaction, the parties should consult with their own independent tax advisor for tax guidance and to ensure the optimum income deferral strategy to minimize taxes.
Also, the feasibility and desirability of this tax deferral option will be driven by several other factors, including the size of the transaction, the current and projected future annual income levels anticipated by the seller, the potential for future changes to the tax code and tax brackets, and the seller’s overall goals. A thorough analysis of the taxpayer’s entire situation and a discussion of the risks versus rewards with a qualified tax advisor is always recommended.
