Intermediary Sales Installments

INTERMEDIARY SALES INSTALLMENTS

An Intermediary Sales Installment (ISI) is a financial strategy used to defer (but not avoid) capital gains taxes when selling highly appreciated assets such as businesses or stocks. Unlike a 1031 exchange, which is limited to real estate, an ISI can be used for a broader range of assets and provides greater flexibility in how and when the proceeds are reinvested.

HOW IT WORKS

  1. Pre-Sale Transfer: Before a sale occurs, the seller transfers the appreciated asset to the intermediary (the ISI).

  2. Intermediary Sells Asset: The ISI then sells the asset to the intended buyer. Because the intermediary, not the original owner, executes the sale, the capital gains tax is not immediately triggered.

  3. Installment Note Issued: In exchange for the asset, the seller receives an installment note (also known as a promissory note) from the intermediary, promising to pay the seller over time.

  4. Tax Deferral: Payments to the seller are structured over a period of years, and taxes are only due as principal is received. This spreads out the tax liability and allows the invested proceeds to potentially grow before taxes are paid.

KEY BENEFITS

  1. Capital Gains Tax Deferral: By receiving installment payments rather than a lump sum, the seller can delay the recognition of capital gains, potentially for many years.

  2. Diversification and Liquidity: Unlike a 1031 exchange, which requires reinvestment in “like-kind” real estate, ISI proceeds can be reinvested in a diversified portfolio including stocks, bonds, mutual funds, or even real estate investment trusts (REITs).

  3. Estate Planning Tool: ISIs can be integrated with estate planning strategies, reducing estate tax exposure and offering a way to pass on wealth with more favorable tax treatment.

  4. Flexibility: The payment terms, investment strategies, and intermediary structure can be customized to suit the seller’s risk tolerance, income needs, and tax objectives.

USE CASES

  • Business owners selling a closely held business.

  • Real estate investors looking to exit property holdings without engaging in a 1031 exchange.

  • Individuals selling highly appreciated stocks or collectibles.

  • Retirees looking to generate a predictable income stream from a sale.

LIMITATIONS & CONSIDERATIONS

  • IRS Scrutiny: Although the ISI strategy relies on established tax principles (especially IRC Section 453 regarding installment sales), it is less directly codified than a 1031 exchange, and improper setup may risk IRS challenge.

  • Setup and Maintenance Costs: Establishing an ISI involves legal, intermediary, and advisory fees, and ongoing administration costs. It is typically only cost-effective for gains exceeding $500,000.

  • Intermediary Role: The ISI must be administered by an independent third-party intermediary, and the seller cannot have control over the assets to maintain the tax-deferral benefit.

  • No Immediate Access to Funds: The seller gives up ownership of the sale proceeds in exchange for a promissory note, and cannot demand immediate access to the full amount.

There are risks associated with the Deferred Sales TrustTM including, but not limited to non-deferral of excess accelerated depreciation; less liquidity than some other strategies; and the capital gain offset on the sale of a personal residence up to $250K per husband/wife and spouse cannot be take up front with the DST strategy but rather becomes a balloon credit against taxes owed, if any, at the end of the investments contract. A Deferred Sales TrustTM may have somewhat higher set-up fees than other investment strategies.