Monetized Installment Sales

The IRS includes Monetized Installment Sales as part of their Dirty Dozen. However, this does not apply to the sale of any farm asset.

The IRS typically updates their list of issues that they believe are not proper. This is commonly referred to as the Dirty Dozen list. The latest Dirty Dozen list starts with Employee Retention Credit and then goes over other items of concern to the IRS. We have discussed the ERC issue in previous posts.

However, one of the issues in the list is Monetized Installment Sales. Promotors will argue that you can sell your property for an installment sale; enter into an escrow agreement; borrow money against their note; and then defer the gain for perhaps 30 years or more.

However, tax laws prevent these types of arrangements since any pledge of an installment note creates a taxable event.

However, the good news for farmers is that any sale of farm property (grain, land, buildings, etc.) can be sold on an installment sale and only report the income as cash is received even if the farmer borrows against the note. This rule is specifically in the tax code. This rule applies to even the sale of farm equipment, however, Section 1245 recapture typically trumps the installment sale rules and makes the gain fully taxable in the year of sale.

How does this sale work:

• Farmer sells land on an installment basis over 25 years. The note calls for 4% interest and will be amortized over the 25-year period.

• A bank will provide a loan to the farmer equal to about 95% of the face value of the note with an interest rate that may be the same or higher.

• An escrow company handles the collection of the proceeds from the sale and the offsetting loan payment to the bank.

• The farmer received 95% of their cash up front, but pays capital gains taxes over 25 years.

What are the drawbacks:

• If the farmer spends the cash and has a large balloon payment, then there may not be enough funds to cover the taxes owed.

• Since this is an installment note, heirs will owe taxes on any inherited note, but they may not have the cash available to pay the tax since cash is required to pay the bank.

Only the sale of farm property can use a monetized installment obligation and, in many cases, the economics work, but you do need to review this with your tax advisor before you ever enter into this type of arrangement.