Get Updates
July 14, 2022 •HoganTaylor
Individuals who plan to transfer real estate, a family business or other assets which are expected to appreciate dramatically in the future might consider an installment sale or a gift to a family member. These options may provide benefits, including the ability to freeze asset values for estate tax purposes and remove future appreciation from the owner’s taxable estate.
You’ve spent years building your company; you’re ready to move onto a new business, retirement, or goal. Whatever your plans, you want the best return from your business.
One option to maximize your cash proceeds is an installment sale, which allows you to defer and possibly reduce taxes.
Giving property away vs. selling it
If you have a taxable estate, it may be more advantageous to give property to your children than to sell it to them. By gifting the asset, you’ll deplete your estate and reduce your potential estate tax liability. In a sale, the proceeds generally will be included in your taxable estate.
But an installment sale may be desirable if you’ve already exhausted your $12.06 million (for 2022) lifetime gift tax exemption or if your cash flow needs preclude you from simply gifting the assets. Selling property at fair market value to your children or other loved ones rather than gifting it lets you avoid gift taxes on the transfer and freeze the property’s value for estate tax purposes as of the sale date. Future appreciation benefits the buyer and won’t be included in your taxable estate.
Of course, if the transaction is structured as a sale rather than a gift, your buyer must have the financial resources to buy the property. Using an installment note allows the buyer instead to make the payments over time. Ideally, the purchased property will generate enough income to fund these payments.
Pros vs. cons
One advantage of an installment sale is the flexibility you have to design a payment schedule that corresponds with the property’s cash flow, your financial needs and those of your buyer. You can arrange for the payments to increase or decrease over time or start with interest-only payments and an end-of-term balloon payment of the principal.
One disadvantage of an installment sale — as opposed to gifting property — is the tax on the gains recognized from the sale. If this is a sale of assets, a portion of the gain could be ordinary; inventory and depreciation recapture must be reported in the year of sale. For the capital gains, the gain and tax will be reported in the future when you receive the cash. As of this writing, the long-term capital gains rates are 0%, 15% or 20%, depending on the amount of your net long-term capital gains plus your ordinary income.
Also, interest rate on the note must comply with the IRS minimum interest rate guidelines in place at the time of the sale. Interest is subject to ordinary income tax
In addition to removing appreciating assets from your estate, it will also be reduced by any capital gains and ordinary income tax you pay.
A worthwhile approach
An installment sale is an approach worth exploring for anyone with high-value assets. It can play a key role in your estate plan, and assist in retaining a family-owned business in the family.
To determine whether an installment sale is the best path for you and your business — and to discuss other tax-smart options — please contact us.
If you have any questions about the content of this publication, or if you would like more information about HoganTaylor's Tax services, please contact Tony Otto, Lead Tax Partner. You may also contact Denise Felber, Tax Partner.
INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.