Can I speed up or borrow against structured sale payments?

Hans Goldstein structures installment sales for sellers and works alongside their CPAs. Email hans@goldsteinco.net or call 213-340-2018.

Why can't the payments be sped up?

Under Treas. Reg. §1.451-2(a), money that is set apart for you or made available so you could draw on it at any time is taxed as if you received it. If the structured sale contract let you call for the balance, the whole balance would be available to you, and the deferral would collapse into the year you gained that right. The locked schedule is the substantial restriction that keeps each payment taxable only when paid.

So the contract has no acceleration, commutation or cash-out feature, and the assignment company has no obligation to pay early. The payment schedule is set in the contract at closing, and the payments depend on the claims-paying ability of the assignment company and the insurer behind it.

What happens if I borrow against the payments?

IRC §453A(d) is the pledge rule. If an installment obligation from a sale over $150,000 secures a loan, the net loan proceeds are treated as a payment on the obligation, received on the later of the date the loan is secured or the date you get the proceeds. Gain is recognized at your gross profit ratio. An arrangement that lets you satisfy the loan by handing over the obligation counts as a pledge too (§453A(d)(4)). Personal-use property sold by an individual and farm property are outside §453A (§453A(b)(3)).

Later payments are not taxed again until they exceed the amount already treated as paid (§453A(d)(3)). The pledge does not create extra gain; it pulls future gain into the loan year.

Illustrative numbers. A seller structured $2,500,000 of a $3,000,000 sale; gross profit ratio 61.67%. In year four, right after that year's scheduled payment, with $1,750,000 of principal still to come, the seller pledges the payment rights to secure a $600,000 bank loan.

The seller has $600,000 of borrowed cash, owes interest on the loan, and pays tax on $370,000 of gain up to two and a half years early, often in a higher bracket and possibly over the 3.8% NIIT threshold. Structured sale contracts also generally restrict assigning or encumbering the payments, so a lender may not accept them as collateral in the first place.

Can I sell or give away the payments?

Yes, technically, and it ends the deferral. Under §453B(a), a sale, exchange, gift or cancellation of an installment obligation is a disposition:

Selling future payments to a factoring company usually means a steep discount on top of the accelerated tax. If you think you might need the money, the time to solve it is before closing.

What can I do before closing instead?

Every liquidity choice is made when you set the schedule, before closing. After closing the schedule is fixed.

• Keep more cash at closing. Cash at closing is taxed at your gross profit ratio in the year of sale, and it is yours to spend. Many sellers keep enough to pay the year-one tax plus a reserve.
• Choose a shorter term. A 5-year schedule gets the money to you faster than a 15-year one, with less deferral.
• Schedule lump sums at set dates. A balloon in year 3 for a known expense, or every few years, is allowed if it is in the contract from day one.
• Step-ups. Payments that rise over time can match expected costs.
• Split the structure. Different pieces with different terms can create a ladder, if each piece clears its insurer's minimum.

After closing, the one thing you can usually change is the beneficiary, under the contract's procedure.

Frequently asked

Q: Can I ask the insurer to pay out the balance in an emergency? A: No. The contract does not allow commutation or acceleration. A right to do so would make the balance taxable under the constructive receipt rule.

Q: Can I use the payments as collateral for a loan? A: Contracts generally restrict it, and if it happens, IRC §453A(d) treats the loan proceeds as a payment, so the gain is taxed in the loan year.

Q: Can I give the payments to my children? A: A gift is a disposition under §453B(a). You would recognize gain equal to the obligation's fair market value minus your basis in it. A transfer to your spouse is not a disposition (§453B(g)).

Q: Can I change the schedule later? A: No. The schedule is chosen before closing and fixed in the contract. Build in cash at closing, a shorter term or scheduled lump sums if you may need money sooner.

What should you read or run next?

• What payment schedules can I choose?
• Can I structure only part of my sale?
• What is constructive receipt?
• What happens to the payments when I die?
• §453A interest charge and pledge rule and why a monetized installment sale is a warning sign
• Installment sale calculator
• All structured installment sale questions

Who wrote this?