July 2014

Planning Lessons

Do you know anyone who has a closely held business or other illiquid asset to sell to family or a third party? Is the prospective seller worried about taxes? Read our newsletter below for some tips and key messages about installment sales.

Mother sells the family vacation home worth $1,000,000 (with a cost basis of $100,000) to her son in return for his promise to pay her the value of that home in installments which includes interest on the unpaid balance over a 10-year period. Mother and Son agree to an interest rate of 3 percent.

Son agrees to send monthly payments of $9,656 to his mother for 120 months. The monthly payments are each partly a return of Mother's basis, partly payment of capital gains and partly interest.

This is an example of an installment sale, which can be a useful tool in solving a number of problems for our most successful clients:

1. Business continuation

2. Income tax deferral on the transfer of appreciated assets

3. Estate tax management

4. Gift tax management

In short, an installment sale is a seller-financed deferred-payment sale. Properly structured, an installment sale allows a deferral of the taxable gain realized by the seller.

What are some of the advantages?

  • Simplicity-An installment sale is so commonplace that the law in this area is relatively settled and easily understood.
  • Pro-rate capital gains-As the numeric example above shows, the seller can put off recognition of capital gains (and taxes) to future years.
  • Estate tax savings-Where the asset being sold to a family member is appreciating more rapidly than the interest rate used in the installment note, the strategy can help save estate taxes. In our example, Mother's estate is receiving 3% on the $1 Million. However, the vacation home may be appreciating by, for example, 6% of its $1 Million value. This difference can escape the 40% estate and gift tax.
  • Assure succession of a family business-An installment sale can help transfer a family business during lifetime-even if the buyer doesn't have ready cash on hand.