What documents does a structured installment sale need?

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

What does each document do?

Purchase agreement installment language, or an addendum. States that part of the price will be paid in installments on a set schedule rather than in cash at closing, and that the buyer's payment obligation will be assigned to an assignment company. If the purchase agreement is already signed, an addendum does the same job with the buyer's consent.

Assignment and assumption agreement. Signed by the buyer, you and the assignment company. The buyer pays the structured amount to the assignment company at closing, and the assignment company assumes the obligation to make your deferred payments. The schedule is written into this agreement and cannot be changed later.

Annuity application. The assignment company buys a fixed annuity from its affiliated insurer to fund your payments. The assignment company is the owner; you are the payee. You never own the annuity. You are an unsecured general creditor of the assignment company, and the payments depend on the claims-paying ability of the assignment company and the insurer behind it.

Escrow or closing instructions. Tell the escrow officer or closing attorney to split the buyer's funds: the structured amount to the assignment company, any cash portion to you.

Exact form names, and how many separate pages they come on, vary by insurer. Some combine documents; some add their own disclosure or suitability forms.

Who provides or signs what?

What does your CPA need, and why?

Your CPA uses four things to compute the gross profit ratio and the year-one tax:

• Basis records: original purchase price, improvements and prior adjustments. These set your adjusted basis.
• Depreciation schedules: total depreciation taken determines the §1245 recapture taxed in the year of sale (IRC §453(i)) and the unrecaptured §1250 gain that spreads with the payments (Treas. Reg. §1.453-12).
• The closing statement: contract price, selling expenses, any mortgage paid off from proceeds (which counts as cash received at closing), and any cash you received.
• The payment schedule: dates and amounts, so each year's gain and interest can be reported on Form 6252 and your return.

Illustrative: on a $1,000,000 sale with $400,000 adjusted basis and no selling expenses, gross profit is $600,000 and the gross profit ratio is 60%. Each dollar of principal you receive, at closing or later, carries 60 cents of gain. The CPA needs the basis and closing figures to get that ratio right; it then applies to every payment for the life of the contract (Temp. Treas. Reg. §15a.453-1(b)(2)).

Why does the beneficiary designation matter?

Payments run for a fixed term. If you die before the last payment, the remaining payments go to the beneficiary you named, or to your estate if you named none. They are income in respect of a decedent (IRC §691(a)(4)), so your heir reports the gain and interest as received, with no step-up in basis (§1014(c)). Name a beneficiary, and a contingent one, on the documents. See what happens at death.

What should you check before you sign?

• The assignment company's name and the insurer's name, both stated in the documents.
• The insurer's current A.M. Best rating (look for a highly rated life insurer, A or better by A.M. Best or equivalent).
• The payment schedule: amounts, start date, frequency, end date. It is fixed once funded.
• That nothing gives you a right to accelerate, commute, borrow against or cash out the payments. That right would put the deferral at risk.
• That your CPA or tax attorney has reviewed the full package. The installment method is settled law (IRC §453; IRS Pub 537), but this assignment structure has no published IRS ruling approving it.

Frequently asked

Q: Do I need a new purchase agreement? A: No. Installment language can go into your existing purchase agreement, or into an addendum if it is already signed.

Q: Who owns the annuity? A: The assignment company. You are the payee, not the owner, and you are an unsecured general creditor of the assignment company.

Q: Does the buyer sign anything beyond a normal sale? A: The installment language or addendum and the assignment agreement. The buyer pays the full price at closing and has no role after that.

Q: Do I get a copy of the annuity? A: You receive the documents that set your payment schedule. Ask which documents the insurer provides to the payee before closing.

What should you read or run next?

• When do I have to set it up?
• Can the buyer refuse a structured sale?
• What happens to the payments when I die?
• Is a structured installment sale legal?
• The assignment company explained
• How the deal works on closing day
• Gross profit percentage calculator
• All structured installment sale questions

Who wrote this?