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Structured Sales: FAQ
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What is a Structured Sale?
Why consider a Structured Sale?
How do I avoid my immediate capital gains liability in a sale by using a Structured Sale?
Is the concept of the Structured Sale approved by the IRS?
Why haven’t I heard of this concept before?
What type of transaction qualifies for a Structured Sale?
What is the minimum amount required to participate in a Structured Sale?
How is Structured Sale Income calculated and taxed?
What is a Structured Sale?
A Structured Sale is defined in Sec. 453 of the Internal Revenue Code of 1986 [PDF:64K] as a disposition of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs.
A structured sale is really no different than an Installment Sale, but for one important caveat. Rather than the Seller being dependent on the solvency and financial performance of the Buyer, as they are in a traditional Installment Sale, the Seller is now dependent on the solvency and financial performance of a highly rated life insurance company to make all future periodic payments as they are designed.
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Why consider a Structured Sale?
While there are many viable options available to individuals who are selling highly appreciated assests, such as homes, property or business, not any one product is the panacea to all situations. The Structured Sale provides a myriad of solutions to the capital gains issues one faces in the sale of their asset:
• The Seller defers the recognition of taxable income in the year of sale, on the portion they designate for structured sale treatment – much more desirable than paying a sometimes enormous tax liability upon closing.
• A Structured Sale offers unprecedented flexibility for the Seller to design payments that meet their unique life needs. Selling parties can defer their first payment up to 20 years! Moreover, a guarantee period up to 40 years can be incorporated into the payment design, with remaining payments made payable to the Estate of the Seller in the event they decease prematurely.
Monthly, quarterly, semi-annual or annual payments are all available, as are future lump sums in any combination. Your client has the choice of starting payments immediately (regardless of their age) or deferring payments for up to 20 years, maximizing the growth and creating a subsequently higher yield on the back end. This is a great tool to help supplement retirement, fund a college education for children or grandchildren or provide for future lump sums that can be used to take advantage of other investment opportunities or help pay large estate tax burdens.
• A Structured Sale offers a guaranteed yield and rate of return from a highly rated Life Insurance company – ideal for the Seller who does not want the stress associated with stock market performance.
• A Structured Sale is cost effective to implement and manage. Contract fees rarely exceed $500 as a one time expense, and there are no annual management fees charged by the life insurance company or Atlas Settlement Group.
• Efficient Closings – The Seller can afford to accept a smaller asking price knowing they can increase the net yield through the purchase of a guaranteed Structured Sale Annuity.
• Creates a diverse portfolio as a compliment to other investments.
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How do I avoid my immediate capital gains liability in a sale by using a Structured Sale?
In order for the benefits of a Structured Sale to be realized, the Seller must avoid constructive receipt of the funds. Thus, the Buyer, at the Seller’s request, will direct appropriate funds to be sent directly from the escrow account - to the assignment company owned by the life insurance company. The assignment company, in turn, purchases the identified annuity and promises to make all future periodic payments to the Seller. A simple one page sales agreement between the Buyer and Seller includes the necessary language allowing for the structure, with the terms of the agreement governing the payment schedule.
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Is the concept of the Structured Sale approved by the IRS?
Aside from being defined in Sec. 453 of the Internal Revenue Code of 1986 [PDF:64K], the Structured Sale is vested in two IRS Revenue Rulings (82-122 [PDF:104K] and 75-457 PDF:80K]) .
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Why haven’t I heard of this concept before?
The Structured Sale is fairly new to the market, first introduced in the fourth quarter of 2004 by Allstate Life Insurance Company. There are a finite number of approved brokers on a national level who are qualified and approved by the life insurance companies, to offer the product. Thus, initial marketing efforts have been slow to develop. With recent IRS rulings regarding Private Annuity Trusts, and the time constraints associated with 1031 Exchanges, the Structured Sale is quickly growing in popularity as a viable alternative for Sellers.
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What type of transaction qualifies for a Structured Sale?
In general, the sale of property, including primary and/or secondary residence, investment property and/or homes, raw land, businesses and certain types of asset collections, such as antique collections, sports memorabilia collections, art collections, etc. all qualify for Installment Sale or Structured Sale opportunities.
This question, however, is perhaps best answered by stating the type of transactions that DO NOT qualify for Installment Sale/Structured Sale treatment, which are as follows, per IRS publication 537 [PDF:408K]:
• Stock or securities. You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. You must report the entire gain on the sale in the year in which the trade date falls.
• Dealer sales. Sales of personal property by a person who regularly sells or otherwise disposes of the same type of property on the installment plan cannot be reported under the installment method. This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. However, the rule does not apply to an installment sale of property used or produced in farming. Special rule. Dealers of time-shares and residential lots can report certain sales on the installment method if they elect to pay a special interest charge. For more information, see section 453(l) of the Internal Revenue Code [PDF:64K].
• Sale at a loss. If your sale results in a loss, you cannot use the installment method. If the loss is on an installment sale of business assets, you can deduct it only in the tax year of sale. You cannot deduct a loss on the sale of property owned for personal use.
• Sales to related persons where the related person disposes of the property within 2 years as defined under I.R.C. 267(b).
• The sale of inventory does not qualify.
• Depreciation Recapture does not qualify. The portion of the sale that represents amounts previously deducted for depreciation are includible as ordinary income.
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What is the minimum amount required to participate in a Structured Sale?
$100,000 is the minimum required by the life insurance companies, to participate in a Structured Sale contract. Thus, in nearly every situation where there is at least a $100,000 capital gains problem it makes sense to contact Atlas Settlement Group to request illustrations to consider.
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How is Structured Sale Income calculated and taxed?
Each payment on an installment sale usually consists of the following three parts:
• Interest income.
• Return of your adjusted basis in the property.
• Gain on the sale.
In each year you receive a payment, you must include the interest part in income, as well as the part that is your gain on the sale. You do not include in income the part that is the return of your basis in the property. Basis is the amount of your investment in the property for tax purposes.
Interest income
You must report interest as ordinary income. Interest is generally not included in a down payment. However, you may have to treat part of each later payment as interest, even if it is not called interest in your agreement with the buyer. See Unstated Interest and Original Issue Discount, later.
Return of basis and gain on sale. The rest of each payment is treated as if it were made up of two parts. One part is a tax-free return of your adjusted basis in the property. The other part is your gain.
Figuring gain part of payment
To figure what part of any payment is gain, multiply the payment (less interest) by the gross profit percentage. Use the following worksheet to figure the gross profit percentage:
1) Selling price ____________
2) Installment sale basis:
Adjusted basis of property ____________
Selling expenses ____________
Depreciation recapture ____________
3) Gross profit (line 1 - line 2) ____________
4) Contract price ____________
5) Gross profit percentage (line 3 ÷ line 4) ____________
Selling price
The selling price is the total cost of the property to the buyer. It includes any money and the fair market value of any property you are to receive. Fair market value (FMV) is discussed later. It also includes any debt the buyer pays, assumes, or takes, to which the property is subject. The debt could be a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property. If the buyer pays any of your selling expenses, that amount is also included in the selling price. The selling price does not include interest, whether stated or unstated.
Installment sale basis
Three items comprise installment sale basis:
• Adjusted basis
• Selling expenses
• Depreciation recapture
Adjusted basis
Basis is the amount of your investment in the property for tax purposes. The way you figure basis depends on how you acquire the property. The basis of property you buy is generally its cost. The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently.
While you own personal-use property, various events may change your original basis. Some events, such as adding rooms or making permanent improvements, increase basis. Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. The result is adjusted basis.
For more information on how to figure basis and adjusted basis, see Publication 551.
Selling expenses
Selling expenses are any expenses that relate to the sale of the property. They include commissions, attorney fees, and any other expenses paid on the sale. Selling expenses are added to the basis of the sold property.
Depreciation recapture
If you took depreciation deductions on the asset, you may need to recapture part of the gain on the sale as ordinary income. See Depreciation Recapture Income, later.
Gross profit
Gross profit is the total gain you report on the installment method.
To figure your gross profit, subtract your installment sale basis from the selling price. If the property you sold was your home, subtract from the gross profit any gain you can exclude. See Sale of your home, later, under Reporting Installment Income.
Contract price
The contract price is the total of all principal payments you are to receive on the installment sale. It also includes payments you are considered to receive. See Payments Received, later.
If part of the selling price is paid in cash and you hold a mortgage payable from the buyer to you for the remainder, then the contract price includes both.
Gross profit percentage
A certain percentage of each payment (after subtracting interest) is reported as gain from the sale. It is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price.
The gross profit percentage generally remains the same for each payment you receive. However, see the example under Selling price reduced, later, for a situation where the gross profit percentage changes.
Example
You sell property at a contract price of $2,000 and your gross profit is $500. Your gross profit percentage is 25% ($500 ÷ $2,000). After subtracting interest, you report 25% of each payment, including the down payment, as gain from the sale for the tax year you receive the payment.
Amount to include in income
Each year as you receive payments on the installment sale, multiply the payments (less interest) by the gross profit percentage to determine the amount you must include in income for the tax year. In certain circumstances, you may be considered to have received a payment, even though you received nothing directly. A receipt of property or the assumption of a mortgage on the property sold may be considered a payment. For a detailed discussion, see Payments Received, later.
Selling price reduced
If the selling price is reduced at a later date, the gross profit on the sale will also change. You must then refigure the gross profit percentage for the remaining payments. Refigure your gross profit using the reduced sale price and then subtract the gain already reported. Spread the remaining gain over the future installments.
Example
In 2000, you sold land with a basis of $40,000 for $100,000. Your gross profit was $60,000. You received a $20,000 down payment and the buyer's note for $80,000. The note provides for four annual payments of $20,000 each, plus 12% interest, beginning in 2001. Your gross profit percentage is 60%. You reported a gain of $12,000 on each payment received in 2000 and 2001.
In 2002, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2002, 2003, and 2004 are reduced to $15,000 for each year.
The new gross profit percentage, 46.67%, is figured as follows:
1) Reduced selling price $85,000
2) Minus: Basis 40,000
3) Adjusted gross profit $45,000
4) Minus: Gain reported in 2000 & 2001 24,000
5) Gain to be reported $21,000
6) Selling price to be received:
Reduced selling price $85,000
Minus: Payments received in 2000 and 2001 40,000 $45,000
7) New gross profit percentage (line 5 ÷ line 6) 46.67%
You will report a gain of $7,000 (46.67% of $15,000) on each of the $15,000 installments due in 2002, 2003, and 2004.
Reporting Installment Income
Form 6252 [PDF:102K] . Use Form 6252 to report an installment sale in the year it takes place and to report payments received in later years. Attach it to your tax return for each year.
Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and how much of each payment to include in income.
Form 6252 is divided into the following parts:
1. Part I, Gross Profit and Contract Price, is completed for the year of sale only.
2. Part II, Installment Sale Income, is completed for the year of sale and for any year you receive a payment or are considered to have received a payment.
3. Part III, Related Party Installment Sale Income, is completed if you sold the property to a related person, as discussed later under Sale to a Related Person.
Year of sale
Answer the questions at the beginning of the form and complete Part I and Part II. Line 3 asks whether you sold the property to a related party. If you answer Yes, answer the question on line 4 and complete Part III.
Later years
Answer the questions at the beginning of the form and complete Part II for each year in which you receive a payment on the sale. If you sold the property to a related person, you may have to complete Part III also.
Schedule D (Form 1040)
Enter the gain figured on Form 6252 (line 26) for personal-use property (capital assets) on Schedule D (Form 1040), Capital Gains and Losses. If your gain from the installment sale qualifies for long-term capital gain treatment in the year of sale, it will continue to qualify in later tax years. Your gain is long-term if you owned the property for more than one year when you sold it.
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"A structured sale annuity offers an exciting new wealth management tool."
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