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Understanding Our Installment Strategy
What is an IST?
One of our Installment Strategies utilizes an Installment Sales Trust (“IST”) to defer Capital Gains tax utilizing Internal Revenue Code 453 which allows you to delay paying taxes when you sell certain types of assets. In short, the proceeds from the sale are paid to an IST, not to you. You, instead, receive a Promissory Note from the IST that pays you quarterly interest payments for the next 10 years. When the tax is deferred in this way you have the opportunity to earn up to 50% more income from the invested proceeds than if you had paid the capital gains tax. Only when you receive principal payments on the Note, which can be 10 years from now, will you be taxed on the capital gains.
Of course, you are not limited to putting the money into an account and drawing interest. An IST is extremely flexible, and you can invest the sale proceeds into a wide variety of investments, including but not limited to stocks, bonds, mutual funds, other property, investment accounts, real estate investments, and more. We are happy to help you find the best investment to suit your risk tolerance and anticipated return requirements.
The IST is a tax deferral strategy based on IRC Section 453, which allows Sellers of property (both real property and some types of personal property) to delay paying taxes on an installment sale when the installment(s) have not been paid during that tax year.
How To Use our Installment Sale strategy to Maximize Your Investments
Using an IST allows you to defer the payment of taxes to a later date, you can take advantage of this strategy to invest funds you otherwise would not have, resulting in higher returns. For example, when you sell a piece of property for $1,000,000, if you receive the money up front you will have to pay a capital gains tax on the sale.
While the capital gains tax rate can vary depending on a number of factors, the bottom line is that you will lose considerable money to the federal government (and possibly your state government as well). Federal taxes can be as much as 23.8% and state taxes, as much as 13.3%.
For purposes of our illustration, let’s say your capital gains tax rate is 30%. This means that, from the proceeds $1,000,000 property, you may net $700,000. You can invest that $700,000 in any way you choose; however, you will be starting with a lower initial investment.
If, instead, you use an IST to defer the receipt of the sales proceeds, you can invest the entire $1,000,000. In this instance, you would be earning returns on the extra $300,000 that you would otherwise have had to pay to the Federal and state government.
There are a number of ways the IST can be structured, and we are happy to have an Installment Sale strategy specialist give you more information on your options. For now, just be aware that you can delay paying taxes on your sales proceeds and by investing the deferred tax, you can make considerably more income.
Knowing the difference between an Installment Sale and our Installment Sale Trust (“IST”)
Simply put, the primary difference is one of control: in an Installment Sale, the Buyer is the one in control of when the Seller has to pay the capital gains tax. The Buyer can elect to pay off the balance of the principal at any point in time and the Seller will then need to pay the balance of the capital gains taxes owed. This is something out of the Seller’s control and essentially terminates the advantage the Seller had to earn a return on the deferred tax. With an IST, the Seller can defer collection of the principal for 10 years or more and this deferral can result in significant additional investment income for them.
Additionally, in the instance of an Installment Sale, should the Buyer default, the Seller would be left holding the “bag”; the property or business that was sold that would eventually be returned to the Seller, after taking the Buyer to court, may be in run down or depleted condition. With an IST, Seller sells the property to the IST for interest bearing Notes. The IST sells to the Buyer for cash and then invests the proceeds. There is no longer the risk of a default and the Seller gets to earn up to 50% more income than if they had sold and invested the after-tax proceeds. In an IST, there never is the fear of default as the Seller’s security for their Notes are in the Assets of the IST.
How Do I Know if this Installment Sale Trust is Right for me?
While an IST can be a valuable tool for building your wealth, there are some considerations you should be aware of. A proper understanding of the working of an IST will help you to determine whether you are comfortable with this strategy. Installment Sale strategy considerations include tight adherence to IRC 453, the possible differing treatment of certain classes of assets, and whether you are comfortable with having your assets managed by an investment advisor of your choosing.
First, an IST does have to meet some requirements. For example, the IST must own the assets at the time of the sale—you cannot sell your assets and then put the proceeds into the IST. Also, should you wish some but not all to the proceeds to go into the IST, the proceeds you retain will be taxed to you when received.
Second, there are limits to the ability of an IST to cause a sale to be considered as an installment sale. A full exploration of this is beyond the scope of this blog so be aware that some types of asset sales cannot take advantage of the installment sale treatment. If you are selling a business using an IST you will need to consult an accountant or other tax professional to ensure that you allocate the sales proceeds in such a manner so as to minimize the amount of tax, such as Depreciation Recapture that you may be required to pay.
Finally, while an IST can allow you to defer taxes, please be aware that the deferred tax will eventually have to be paid. To this end, you will still need to strategize when and how to pay the capital gains taxes when you finally receive the proceeds from your sale. Slowly receiving the proceeds over many years when you have less income or using life insurance to pay the tax owed by your beneficiaries are just two of the strategies available to you. Keep in mind that the capital gains tax rate you will pay will be those in effect at the time you receive the sales proceeds. If you anticipate the capital gains tax increasing for any reason, you may wish to consult with a tax professional to determine whether an IST is right for you.
Investment Property and IST
Tired of 1031s but afraid of the taxes if you sell?
Some Investors become weary of all the problems of being a Property Owner like those that arise from dealing with tenants, toilets, trash etc. An attractive alternative is an IST. With an IST all the capital gains taxes are delayed for 10 years or more allowing the Investor to earn up to 50% more income from the invested proceeds of their sale. It’s as simple as sell your property to the IST that is set up just for your transaction and receive a steady income from 100% of the taxable gain.
Can I use the Installment Sale Trust to sell my business?
Of course, many people have significant assets tied up in one or more businesses. If this is your situation, you may be wondering if an IST will work to help liquidate your business while delaying capital gains tax.
The short answer is yes: you may use an IST to sell some or all of your business assets, including the business itself. An installment sale of business assets by using an IST falls under IRC 453, meaning that you can defer capital gains taxes on the sale until such time as you actually receive the funds from the sale. In the meantime, you earn interest on all of the gain generated from the sale of your business rather that what would remain after paying the tax due on the sale which could be up to 37%.
When using our IST when selling your business, you earn up to 50% more income from the invested proceeds from your sale. Some Sellers will use an IST to permanently defer the payment of capital gains taxes and use things like life insurance to offset the capital gains taxes for their beneficiaries when they decide to liquidate the IST. Some Sellers will structure the IST so that the principal is strategically paid out during years when they anticipate lower than normal income from other sources. Remember that your capital gains tax rate can change depending on a number of factors and using an IST can help you keep your overall tax burden lower.
Finding The Right Advisor for my IST
Of course, finding an installment sale strategy specialist who fits your unique requirements is very important. After all, deferring the payment of the tax you owe needs be matched with a financial plan to take optimize advantage of this strategy. An IST advisor who works with various financial advisors is, therefore, very important to your comfort and peace of mind should you be interested in implementing an IST. And equally important is an advisor who understands how to safely implement an IST that helps you comply with IRC 453.
Here, at Installment Strategies, we have deep understanding of the tax law and how to make your IST comply with IRC 453. And we strive to understand our client and their needs. Each client has their own set of concerns and investment goals. We focus on creating unique solutions tailored to your financial needs and we want you to know that we see you as an individual, not just another client account.
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