Ask Dealburt
about Collateralized Installment Sales
(Frequently Asked Questions)
The Sale Transaction
Qualifying Properties
Tax Treatment
Collateral, Investment and Substitution
The Installment Contract
Section 1031 Exchanges
Independent Third Party (“Collateral Holder”)
S.Crow Collateral Corp.
The Sale Transaction:
Q. Does my sale to S.Crow Collateral Corp. on a collateralized installment contract have to occur simultaneously with the re-sale by S.Crow Collateral Corp.?
Dealburt: No, but no payments on the installment contract will be made, and no interest will accrue, until the re-sale by S.Crow Collateral Corp. occurs.
Q. What are the first steps to take toward entering into a collateralized installment sale?
Dealburt: You should seek the advice and assistance of your legal, tax and investment advisors, and if the asset you wish to sell is listed with a broker, you should cooperate with that broker and seek that broker’s advice and assistance as well. That done, you will disclose to S.Crow Collateral Corp. full information about what it is you are selling, and what your desired transaction is. Then, in appropriate circumstances, S.Crow Collateral Corp. and you will negotiate the terms and conditions of the collateralized installment sale contract.
Qualifying Properties and Assets:
Q. What assets qualify for a collateralized installment sale?
Dealburt: All assets can be sold on an installment contract, but two kinds of assets cannot be sold directly on a tax-deferred basis: inventory, and “stock or securities which are traded on an established securities market.” For reasons of statutory interpretation, we believe that “stock or securities which are traded on an established securities market” refers to an installment sale of particular shares, particular bonds, or particular other instruments through an exchange, rather than to an installment sale of securities which could have been sold through an exchange. To say it another way, we believe that installment reporting is not available for particular securities that are marketed through an exchange but is available for particular securities which are marketable through an exchange but are not sold in that way. Generally, though, taxpayers will find advantages in a collateralized installment sale of privately held stock, business and investment real estate, partnership and other ownership interests, contract rights, high-value personal residences, professional practices, art or antique collections, classic automobiles, yachts, aircraft—just about anything which has appreciated in value.
Q. Isn’t there already an exclusion from tax liability for gain on the sale of a personal residence?
Dealburt: Yes, but the exclusion has not kept pace with the rate of increase in the values of homes. For many such homes, the exclusion is so comparatively small that the homeowner can face a large and immediate tax liability upon sale. A collateralized installment sale solves that problem.
Tax Treatment:
Q. What is it that allows a seller in a collateralized installment sale transaction to defer taxation of the gain on the sale for federal income tax purposes?
Dealburt: Section 453 of the Internal Revenue Code provides for the “installment method” of reporting the taxable gain on sale. Under that method, the taxpayer recognizes for any taxable year that proportion of the principal payments received in that year which the gross profit bears to the total contract price.
Q: Are there any kinds of assets which are ineligible for the installment method of reporting the gain on sale?
Dealburt: Installment reporting may not be used for an asset which is held by the taxpayer for sale to customers in the ordinary course of the taxpayer’s trade or business. That means, then, that a sale of an asset that constitutes business inventory in the hands of that taxpayer will not qualify for that taxpayer to use the installment method of reporting the gain on sale. See Qualifying Properties, above, about marketed or marketable securities.
Q. Are there any limitations in the Internal Revenue Code as to dollar amount?
Dealburt: There is no limitation, but under Section 453A of the Internal Revenue Code if the total amount of installment obligations entered into by a taxpayer in any one year exceeds $5 million, the Internal Revenue Service can collect interest on the deferred tax related to that portion of the obligations which is in excess of the $5 million. Note that the interest is only on the tax, it is only on a portion of the tax, it is not on the gain or on the principal amount, and it is applicable only to the extent that one taxpayer enters into more than $5 million in installment sales in any one year.
Q: Is there a way a taxpayer can defer the capital gains tax on a transaction that is in excess of $5 million?
Dealburt: Yes. Contact us for full details.
Q. I’m acquainted with use of the installment method of reporting, in circumstances in which I sell an asset on an installment contract and retain a lien on the asset I sell. Why is the installment method of reporting available when the asset is conveyed free and clear, with no retained lien?
Dealburt: Section 453 says almost nothing about collateral. Indeed, it doesn’t require that there be any collateral at all. Its concern is when the payments are made, not what the collateral is or isn’t.
Q. S.Crow Collateral Corp.’s., collateralized installment obligation is non-recourse other than to the collateral and the earnings and proceeds of the collateral. Does a non-recourse installment contract qualify for the installment method of reporting?
Dealburt: Again, Section 453’s concern is not the collateral, security for the obligation, or whether all of the buyer’s resources, besides the collateral, may be reachable in an action to collect the debt. The installment method of reporting concerns the timing of the installment payments, not the security which is or is not behind the obligation. It is essential, however, for the taxpayer-seller to qualify for installment reporting, that the installment obligation be the obligation of the buyer, not of someone else.
Q. S.Crow Collateral Corp. re-sells for cash each asset it acquires on an installment contract. Because of that, is there any risk that my installment sale to S.Crow Collateral Corp. would be disregarded for tax purposes, and that your subsequent re-sale of the asset would be treated for tax purposes as if it were a cash sale by me?
Dealburt: We believe that the substance of the transaction and its form coincide precisely, as an installment sale by you to S.Crow Collateral Corp. The transactions are what they say they are, and we believe the transaction will be treated for tax purposes as what it is. In Section 453, Congress explicitly considered the role of a dealer and determined that sales by a dealer are an exception to the definition of an installment sale, but left sales to a dealer within the definition. So, our role as a dealer which purchases with installment contracts is not some unforeseen or out-of-bounds application of the statute. It is what Congress intended, for many good reasons. Here is just one: Section 453 explicitly contemplates re-sales after installment sales. The section picks out one situation—a re-sale within two years by a related person to the installment seller—and denies installment reporting to the installment seller in that one instance. No exception was provided for any other re-sale situation. S.Crow Collateral Corp. is not related to anyone who sells to it.
Q. Does S.Crow Collateral Corp. guarantee that a collateralized installment sale will qualify for the installment method of reporting for me?
Dealburt: No, because it would be unhelpful to do so. A guarantee of a certain tax result is explicitly a ground for the IRS specially to examine the transaction. Anyway, whether the collateralized installment sale will qualify for installment reporting is for you and your legal and tax advisors to determine for yourselves. S.Crow Collateral Corp. is not a legal or tax advisor for you; S.Crow Collateral Corp., is the opposite party in a sale-and-purchase transaction with you. We can tell you what our view of the matter is, but your position is for you to determine with your legal and tax advisors.
Q. Instead of selling on an installment basis to obtain tax deferral, would I be better off to pay the tax now, in case the federal tax rate goes up later?
Dealburt: Although we cannot predict what will happen to tax rates—just as they have gone up twice and down twice in the past 25 years, they may go up, and then down, and then up again, and so on—for two reasons we believe tax deferral will more than make up for any increase in the capital gains tax rate: (1) The rate of return on the money that’s invested now instead of being paid now in taxes should, over time, out-run any increase in the tax rates; and (2) by postponing the payment of the tax, you will eventually pay it in dollars that will be worth much less then than they are now, if inflation continues. Postponing payment of the tax can be the equivalent of an 80% or 90% reduction in the tax rate, depending how long you put off paying the tax. To maximize your financial resources, in general it is best to receive income as soon as possible and to pay expenses (including taxes) as late as possible. Would you rather pay, say, $100,000 in tax in today’s dollars now, or maybe $40,000 or $50,000 in today’s dollars in the future? This isn’t rocket science.
Q. If I sell an asset now on a collateralized installment contract, will my estate or heirs enjoy a step-up in basis for the asset in the event of my death while the installment contract remains unpaid?
Dealburt: See Stepped-up Basis.
Q. Can the capital gain tax be deferred when debt is paid off upon sale, and debt exceeds basis?
Dealburt: Among the many things which the collateral fund makes possible is the refinancing of that debt, without the necessity of a lien on the asset you’re selling. The collateralized installment sale can make that possible for you, at a modest cost, so that the debt is not paid off at closing, and yet the ultimate buyer obtains free and clear title to the asset.
Collateral, Investment and Substitution:
Q. Would I retain a lien on the asset which I sell?
Dealburt: You may retain either title to the asset or a lien on the asset, until the re-sale of the asset by S.Crow Collateral Corp. but not after the closing of that re-sale.
Q. After the asset re-sells, what is the collateral?
Dealburt: After the asset re-sells, the cash proceeds of the re-sale by S.Crow Collateral Corp., less the agreed amount retained by S.Crow Collateral Corp., are transferred from the closing agent directly to the bank, financial services firm or other independent third party (“collateral holder”) you approve or select, to be held by the collateral holder in an investment account which is in the name of a “vault” limited liability company1 arranged by S.Crow Collateral Corp., but which is pledged as collateral for the installment obligation of S.Crow Collateral Corp. to you. That investment account, then, is the collateral. The re-sale cash proceeds which go into that investment account do not typically pass through the hands of S.Crow Collateral Corp. and are not available to it for its own use.
Q. What assets are contained in the collateral investment account?
Dealburt: After you select the collateral holder and an agreement is entered into for the collateral holder to recognize the pledge of the account for your security, the collateral holder uses the money to purchase or issue, in the name of the “vault” limited liability company2, such marketable securities, financial instruments or other assets in such categories or classes as you are willing to accept as collateral. When the money is expended and those assets are acquired or issued, they become the collateral for S.Crow Collateral Corp.’s installment obligation to you.
Q. Can other assets be substituted as collateral from time to time? May I change the collateral holder? May I use more than one collateral holder?
Dealburt: The composition of the collateral account may be changed if you so permit. The account may be moved to a different collateral holder, and there may be more than one collateral holder.
Q. May I take ownership of the collateral or sell or borrow against it?
Dealburt: Except in the instance of hardship, mentioned below, you may not take ownership of the collateral, borrow against it, pledge it or sell it until the due date of the final payment under the installment contract. Of course, you might well find a lender which would lend in reliance on your right to future payments on the installment contract, but you may not directly borrow against the collateral, because S.Crow Collateral Corp. owns the collateral. Your future income from the installment contract is an asset which you may declare to your lender in support of other borrowing you may wish to do, such as to acquire some other asset.
Q. What about hardship?
Dealburt: If you incur unforeseen financial hardship and so persuade the collateral holder, the collateral holder may pre-pay one or more sums to you from the collateral fund, sooner than would otherwise be the case under the schedule that is stated in the installment contract.
Q. What if I decide that I want the money earlier, or that I want to postpone it further?
Dealburt: In either event you may request that S.Crow Collateral Corp. agree to amend the installment contract to shorten or lengthen the time.
Q. Who pays income tax on the income the collateral produces?
Dealburt: The collateral holder reports to the IRS the payment or accrual to S.Crow Collateral Corp. of the taxable income and gains on the collateral, so S.Crow Collateral Corp. pays the tax on that income and gains (and reports any losses). In turn, though, S.Crow Collateral Corp. reports to the IRS the payment or accrual to you as seller of interest on the installment contract.
Q. What if the collateral and its earnings are insufficient to pay the full amount of any interim payments or the final payment on the installment contract?
Dealburt: Then you as seller receive only what is available from the collateral and its earnings.
Q. What if the collateral and its earnings are more than enough to pay the full amount of the final payment on the installment contract?
Dealburt: In that event the excess—that is, the amount that’s available in excess of the amount owed—is allocated between you and S.Crow Collateral Corp. in such percentages as we agreed upon in the installment contract.
Q. Who makes the payments on the installment contract?
Dealburt: The payments are made in the name of S.Crow Collateral Corp., but the collateral holder is the one who actually makes the payments to you. S.Crow Collateral Corp. does not handle the money or have free access to it at any time while any amount remains owing on the installment contract.
Q. Would I be protected in the event of the bankruptcy of S.Crow Collateral Corp.?
Dealburt: You would be protected in three ways: (1) You would have a first lien on the collateral account, which would give you first rights to the collateral account ahead of other creditors; (2) when the collateral account is set up, it is promptly transferred by S.Crow Collateral Corp. to a bankruptcy-remote entity to hold the account for your protection, away from the creditors of S.Crow Collateral Corp.3; and (3) our agreement with you gives you the right to exercise an irrevocable power of appointment to replace S.Crow Collateral Corp. with another unrelated party, in the event of a bankruptcy proceeding involving S.Crow Collateral Corp.
Q. Does S.Crow Collateral Corp. receive part of the income the collateral produces?
Dealburt: We are periodically allowed to withdraw from the collateral fund a modest sum to cover our on-going administrative costs with regard to the collateral fund.
1 See The S.Crow Family of Companies.
2 See The S.Crow Family of Companies.
3 See The S.Crow Family of Companies, about the “vault” limited liability companies.
The Installment Contract:
Q. If I have already signed an agreement to sell my appreciated asset to someone else, is it too late for me to sign a collateralized installment contract with S.Crow Collateral Corp.?
Dealburt: No, if the closing on your sale has not yet occurred.
Q. How long or short may the term of the installment contract be?
Dealburt: It can be for whatever term you choose, up to thirty years; it can be a short time or a long time, but your benefit from postponing the payment of taxes will tend to be greater, the longer the installment contract’s term is.
Q. Will there be interim installment payments?
Dealburt: Generally the installment contract will provide for interim payments of interest but not principal, until the end of the contract term. You may, of course, receive a downpayment at the outset if you so desire, and balloon payments are permissible (but then are taxed).
Q. If I decide later that I wish to extend the term of the installment contract, may I do so?
Dealburt: You may request that S.Crow Collateral Corp. agree to such an extension.
Q. What would happen if S.Crow Collateral Corp. were to default under the installment contract?
Dealburt: You are protected from substantial risk of default, because the collateral holder will make our payments to you on our behalf. If we were to fail to perform some other duty, such as the annual reporting to the IRS, that failure would allow you to exercise an irrevocable power of appointment to replace S.Crow Collateral Corp. with some other party that is unrelated to you.
Section 1031 Exchanges:
Q. I intend to do a 1031 exchange involving my business or investment property, but I want a collateralized installment sale as a tax-deferral back-up, in case I’m unable to identify or acquire suitable replacement property within the 45 days and 180 days allowed by Section 1031. When do I need to sign an installment contract with S.Crow Collateral Corp. to have that back-up?
Dealburt: You may do so at any time before you sign the exchange agreement with the 1031 company, or you may arrange with the 1031 company—preferably before you sign an agreement with them—for them to sell the property to S.Crow Collateral Corp. on an installment basis, before the property is conveyed further to anyone else. That way, if the 1031 exchange is unsuccessful, what the 1031 company will have to give to you will be the installment contract with tax deferral, instead of immediately taxable cash sale proceeds.
Q. After my 1031 company has conveyed my relinquished property to someone else, is it too late for me to have an installment sale in lieu of a 1031 exchange, when it appears that I won’t be able to identify suitable like-kind replacement property within 45 days or acquire it within 180 days?
Dealburt: With the 1031 company’s cooperation, S.Crow Collateral Corp. can assume the 1031 company’s contract with you and then re-structure the deal to provide for installment payments to you rather than a lump-sum payment. As a further benefit, our installment obligation to you will be collateralized by the cash the 1031 company has been holding, and that makes you a secured creditor with ready collateral rather than merely a general, unsecured creditor of the 1031 company.
Q. Why must the collateralized installment sale contract be entered into before I have the right to the cash the 1031 company is holding?
Dealburt: Once you have the right to that cash, whether or not you actually receive it, you will be deemed for tax purposes to have “constructive receipt” of the cash, and you will be at risk of being taxed on the entire taxable gain on the disposition of the relinquished property.
Q. I have heard that some 1031 companies have gone into bankruptcy, and people have lost a great deal of money that the 1031 companies had received from the sale of relinquished properties. With that in mind, if the 1031 company enters into an exchange agreement with me, then sells my property to S.Crow Collateral Corp. on an installment contract, and then goes bankrupt, what will happen to the proceeds of the sale of my property?
Dealburt: When S.Crow Collateral Corp. buys your property from the 1031 company and re-sells the property for cash, we have every right to insist, as a condition of our allowing the 1031 company to hold the money while you look for replacement property, that the 1031 company place the money into a pledged and collateralized account in the hands of a third party for safe-keeping, much as we would do for all of our sellers in collateralized installment sale transactions. The 1031 company should do no less.
Independent Third Party (“Collateral Holder”):
Q. May I use my local bank or a local firm to hold, invest and manage the collateral?
Dealburt: The collateral holder may be any unrelated party which is acceptable to you and to S.Crow Collateral Corp.
Q. May I from time to time replace the independent third party with another?
Dealburt: The collateral account may indeed be moved to a different collateral holder, with your and our okay.
S.Crow Collateral Corp.:
Q. What does S.Crow Collateral Corp., do?
Dealburt: S. Crow Collateral Corp. is a dealer which buys and re-sells appreciated assets of all kinds, including business entities of all kinds, real estate of all kinds, art collections, collector automobiles, yachts, airplanes, whatever, through collateralized installment sale transactions.
Q. What would happen to my transaction if S.Crow Collateral Corp. were to cease to exist?
Dealburt: Pursuant to an irrevocable power of appointment, you would have the right to replace S.Crow Collateral Corp. with another unrelated party, in the event of a bankruptcy involving S.Crow Collateral Corp., or in the event of its dissolution, or its breach of the installment contract, or a failure by S.Crow Collateral Corp. to respond to notice.
Q. How long has S.Crow Collateral Corp. been in business?
Dealburt: Since 1982.
Q. Are there others who do what you do?
Dealburt: S.Crow Collateral Corp. is believed to be the first company (and so far the only one) in the nation to buy and sell appreciated assets, as a dealer, using collateralized installment sale transactions to do so. If you have wondered why, by reading this far you may have come to understand that what we do—while it makes your part quite easy and straightforward—does not attract those who want to collect a fee from you and never see you again. We enter into a long-term contractual relationship with you, and that sets us apart from most others.