How is a structured installment sale different from seller financing?

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

What do the two have in common?

The tax side is the same law. An installment sale is any sale where at least one payment is received after the close of the tax year of the sale (§453(b)(1)). Whether the payments come from the buyer or from an assignment company, you:

• Report the sale on Form 6252 in the year of sale and each year you receive a payment (IRS Pub 537).
• Apply one gross profit ratio (gross profit divided by contract price) to every payment, including cash at closing (Temp. Treas. Reg. §15a.453-1(b)(2)).
• Pay tax on §1245 recapture in the year of sale, in full, even with no cash received (§453(i)). Unrecaptured §1250 gain spreads with the payments and comes out first (Treas. Reg. §1.453-12).
• Treat interest on the payments as ordinary income.

So the choice between them is not about tax. It is about who stands behind the payments for the next 10 or 20 years.

Where do they differ?

The buyer usually prefers the structured sale too. They close like any cash buyer, through their own lender or funds, and owe you nothing afterward.

What can go wrong with a buyer's note?

Over a 10 to 25 year note, the buyer can die, divorce, get sued, file bankruptcy, lose the business, or simply stop paying. A bankruptcy filing stops collection. A foreclosure costs legal fees and months of time, and hands you back a property the buyer may have under-maintained, often in a weak market, since that is when buyers default. If the buyer was depreciating the property, you are now the owner again with a fresh sale to run.

Repossession also has its own tax rules. Getting real property back under §1038 triggers gain recognition on some of the cash you already collected, and your CPA has to recompute basis. None of that is a reason seller financing never works. It works well when the buyer is strong, the down payment is large and the term is short. It is a reason to price the risk honestly.

See the longer list at why not just take payments from the buyer.

What does it look like with real numbers?

Illustrative: you sell a building for $2,000,000 and want income over 10 years.

• Seller financing: the buyer puts $400,000 down and signs a $1,600,000 note. Your $1,600,000 depends on that buyer for a decade, secured by the building.
• Structured installment sale: the buyer pays $2,000,000 at closing. You take, say, $400,000 in cash and have $1,600,000 paid to the assignment company, which buys a fixed annuity to fund your 10 years of payments. The buyer's credit stops mattering the day escrow closes.

In both cases the gain is spread the same way under §453. The interest rate will differ: a note rate is whatever you negotiate, while the structured rate comes from the insurer's pricing at closing. Your CPA should confirm the stated interest is adequate under §§483 and 1274 in either case.

When is seller financing still the better fit?

• You want a higher rate than an insurer will pay, and you will accept buyer risk for it.
• The amount is below the insurer's minimum for a structure.
• You may want to renegotiate, take the property back, or sell the note later (selling or pledging it has tax consequences under §453B and §453A(d)).
• The buyer cannot get financing to pay all cash at closing. A structured sale needs the full price at closing.

Have your CPA review your facts before you pick either route.

Frequently asked

Q: Is the tax treatment the same for both? A: Yes. Both use the installment method under §453 and Form 6252. The gross profit ratio, recapture rules and interest treatment are the same.

Q: Can I convert my existing seller-financed note into a structured sale? A: No. A structured installment sale must be set up before closing. Selling or transferring an existing note is a disposition that can trigger the deferred gain under §453B.

Q: Does the buyer pay more in a structured sale? A: No. The buyer's cost is the same as an all-cash purchase. The commission is built into the annuity pricing, not added to the price.

Q: Do I get a lien on anything in a structured sale? A: No. You are an unsecured general creditor of the assignment company. The payments depend on the claims-paying ability of the assignment company and the insurer behind it.

What should you read or run next?

• What if the buyer defaults?
• Is a structured installment sale safe?
• Should I just pay the capital gains tax instead?
• What interest rate does it pay?
• Why not just take payments from the buyer?
• Seller financing tax implications
• Seller financing calculator
• All structured installment sale questions

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