Selling Appreciated Assets: How the Tax Code Treats the Gain

If you own a business, commercial or other investment property, a high-end residence or other capital asset that you want to sell but are concerned about the taxes that a sale would trigger, take heart: tax law gives you some very viable planning alternatives to solve the tax issue. Here are some thoughts to keep in mind when you do sell:

The taxable amount is fixed and the taxes you owe are based upon the applicable tax rate for the tax year the taxes are paid.

The timing of payment is still flexible depending on how you structure the sale of the asset.

The IRS measures your income on a cash basis. Until you actually receive the funds, the sale proceeds are not considered to be income or taxable.

Deferring taxes is one of the planning alternatives you may want to consider. It is allowed by tax law and can be a very viable way to sell the asset, effectively manage the taxes and gain a greater amount at escrow closing than you might expect.

Doing so, however, in the traditional way by the seller taking back a note (seller carryback financing), does come with some business risk. The buyer, for example, could fail to honor the payments for a number of reasons. The business they bought could fail, the property loses value or, as occurred for many during the Great Recession, the buyers’ cash flow dried up and they simply were unable to sustain making payments on the note.

Any of these events could also trigger a costly legal battle. Most sellers of assets would prefer to completely sever their ties with the business or property sold for these reasons.

A better way by which a seller can sell the asset and not be concerned about these kinds of business risk is to consider doing what the Chief Counsel of the Internal Revenue Service says is a permissible way to sell capital assets: couple a monetization loan with an installment sale.

Although this planning method is not widely known, it nevertheless has been in tax law since 1918 when the IRS enacted the installment sale reporting rules (ratified by Congress in 1921). It was further enhanced in 1980 when the IRS codified provisions to state clearly that sellers may obtain monetization loans and still defer the tax on the sale with installment reporting. Adding to this history is a 2012 Memorandum issued by the Chief Counsel of the IRS which supports implementing this type of transaction.

And as an added assurance that the IRS is not likely to try to nullify the transaction sometime in the future, the Chief Counsel states in his Memorandum that the IRS should not assert the step transaction doctrine or the substance over form doctrine to disallow a taxpayer’s deferral of gain recognition on the sale of an asset implementing this planning approach.

The benefits a seller receives by implementing this planning approach are compelling:

• The seller receives a tax-free lump sum at close of escrow that is a near equivalent amount of the sales proceeds.
• If the seller does not receive installment payments as promised, to that extent the seller cannot be required to repay the monetization loan.
• The taxes are deferred for many years into the future
• The buyer pays full price for the asset and owns it outright, with no strings attached to the seller.

Covering the details of this structure would take more space than this column allows, but if you have an asset you are hesitating to sell because you think the taxes would be too much to pay, TaxWealth can analyze the different outcomes.