During the past few years there have been a growing number of advocates who have been touting new forms of installment sales including Deferred Sales Trusts and Monetized Installment Sales as alternatives to 1031 Exchanges and Delaware Statutory Trusts to defer taxes on the sale of real estate properties including rentals and even personal residences.
In September 2019 the California Franchise Tax Board (FTB) issued a notice to 1031 Exchange Qualified Intermediates (QIs) that the state will begin imposing penalties against QIs who actively assist clients with deferring taxes through Deferred Sales Trusts or Monetized Installment Sales. Some QIs promote the use of Deferred Sales Trusts or Monetized Investment Sales as back-up strategies in cases where a seller is unable to complete a 1031 Exchange.
An installment sale is a type of sale where a buyer takes possession of the property and agrees to pay the seller over time, often making interest only payments for some period followed by a balloon payment to the seller which includes any remaining owed principal. IRS tax code M453 states that no capital gains taxes are owed by the seller in an installment sale until such time that they begin collecting principal funds from their sold property. While sellers would be obligated to pay income tax on any interest income that they receive in an installment sale, they could defer the payment of capital gains taxes into the future until they receive the principal funds from their sale.
In a Deferred Sales Trust or Monetized Installment Sale, an intermediary is involved who accepts purchase proceeds from a buyer and then provides funds to seller in either the form of loan or through a stream of payments from investments that are made by the intermediary. These quasi-installment sales are structured to yield a more immediate use of sale proceeds to the seller than what the FTB believes is intended by tax laws.
One of the nation’s largest Qualified Intermediary firms, IPX1031 quoted FTB officials as stating that “they view these transactions as “clearly improper” and “blatantly unsupported by the law.”
The Delaware Statutory Trust and Internal Revenue Code 1031 remain fully approved by both state and federal tax regulators as a means of deferring taxes on the sale income and business properties. To read the notice, go here.
Several questions have been raised over this notice and we expect more information to become available which we will share in future blog posts.
For more information on Delaware Statutory Trust options and approved 1031 Exchange tax deferral strategies, please contact First Guardian Group at 866-398-1031 or info@FirstGuardianGroup.com.