1031 Exchange Alternative (M453) Monetized Installment Sales – Cashing Out While Deferring Capital Gains Tax
Newly revised Internal Revenue Code 453 now allows you to defer your capital gains taxes for 30 years. An owner of highly appreciated assets can sell them and defer 100% of the capital gains tax for up to 30 years while receiving up to 93.3% of the value in cash.
These appreciated assets can included real estate, mineral rights, water rights, privately held stock, partnership interests, etc.
The transaction allows a seller to:
- - Sell the asset
- - Walk away from escrow with no immediate capital gains taxes due
- - Defer the taxes for 30 years
- - Receive tax free 93.3% of the sale proceeds in cas in the form of a loan
The dealer offers to purchase the appreciated assets in exchange for an installment note. In addition, the owner is offered, but is not required to accept a limited recourse "monetization loan" from a third-party lender introduced by the dealer.
The dealer will immediately re-sell the asset to the ultimate buyer, who otherwise could have purchased the asset directly from the owner who sells to the dealer. The closing on the Monetized Installment sale transaction and the closing on the resale will occur simultaneously, typically where the closing would have occurred if there had been no monetized installment sale transaction.
If the seller enters into the monetization loan, it will be funded "up front", i.e. the seller receives the loan proceeds promptly after the closing on the sale of the asset. The entire transaction occurs within a third-party escrow.
- 1. An installment sale of the asset, with the capital-gains tax deferred for as long as 30 years, with no net tax cost to the seller during that time;
- 2. Near immediate availability ( i.e. within days) of a non-taxable monetization loan for the seller, with the entire repayment of the monetization loan funded by the dealers payments to the seller, at no net cost to the seller for interest or principal payments;
- 3. Ability for the seller to invest the loan proceeds at the seller's full discretion;
- 4. No risk that the seller will have to use any funds to repay the loan other than the money which the dealer pays to the seller pursuant to the monetized installment sale contract;
- 5. Administrative ease on the installments of the M453 sale and payments on the loan managed automatically by an escrow company and reported annually to the parties and the internal Revenue Service;
- 6. Minimized credit risk, default risk and performance risk.
- How it works
- Seller sells an appreciated asset at fair market value to a dealer for an interest only, non-amortizing long-term installment note ( which is tax deferred under IRc 453 ).
- The dealer sells the asset to the end buyer at fair market value.
The seller obtains a loan from a third-party lender equal to 95% of the sales price.
The seller and the dealer continue to make loan payments on their respective notes. The dealer's installment payments fund seller's payments on the limited recourse loan.
While the seller defers the tax on the sale, inflation during the contract term acts in seller's favor allowing them to pay the future tax bill tax in depreciated dollars.
In the meantime, the seller uses the proceeds to invest or consume as he would on any general-purpose loan
A successful business was being prepared for sale for approximately $84 million dollars, with a $64 million-dollar gain. The gain was expected to generate $19 million in IRS taxes due!
The Plan We implemented a strategic tax sale opportunity, that allows the client to defer paying the taxes on the business sale for 30 years. In the meantime, the client has full access to invest the proceeds in full for the 30 years.
The Results Rather than paying $19 million in tax today, investing that amount at just a 5% rate for 30 years, turns the balance to an incredible $82 million dollars. At the end of the 30 years the $19 million of tax would be paid, leaving a $63 million dollar increase in the client’s net worth, just by using this tax deferral method!
Other Companies That Have Done This
Several public companies have engage in this type of transaction, in amounts that have ranged from $22 million to over $4.5 billion. These companies and their transactions have included:
1. $617 million Monetized Installment Sale by Kimberly Clark
2. $4.8 Billion Monetized Installment Sale by International Paper.
3. $1.47 Billion Monetized Installment Sale by OfficeMax
4. $774 Million Monetized Installment Sale by Meadwestvaco.
5. $283 Million Monetized Installment Sale by the St. Joe Company
Because You Asked
Investing in Opportunity Zone Funds
What is an Opportunity Zone Fund?
A qualified Opportunity Fund is any investment vehicle organized as a corporation or partnership with the specific purpose of investing in Opportunity Zone assets. The fund must hold at least 90% of its assets in qualifying Opportunity Zones property.
What are Opportunity Zones?
Opportunity Zones are economically-distressed communities, designated by states and territories and certified by the U.S. Treasury Department, in which certain types of investments may be eligible for preferential tax treatment. The tax incentive is designed to spur economic development and job creation in distressed communities by providing these tax benefits to investors. Opportunity Zone designations certified by Treasury will remain in effect until December 31, 2028
What can Opportunity Funds invest in?
Opportunity Funds can invest in any Qualified Opportunity Zone property, including stocks, partnership interest or business property ( so long as property use commences with the fund, or if the fund makes significant improvements to the qualifying property).
There are primarily three benefits available to investors who invest previously realized capital gains into an Opportunity Fund, with increasing benefits the longer the investment is held in the fund:
Deferral of capital gains taxes. An investor that re-invests capital gains (within six months of realizing the gains) into an Opportunity Fund can defer paying federal taxes on those realized gains until as late as December 31, 2026.
Reduction of capital gains taxes. Investors that hold the investment in the Opportunity Fund for at least five years can reduce their tax bill on the deferred capital gains by 10%. This reduction increases to 15% for investors that hold the investments in the Opportunity Fund for at least seven years.
Elimination of taxes on future gains. Investors that hold the investment in the Opportunity Fund for at least ten years will not be required to pay federal capital gains taxes on any gains realized from the investment in the Opportunity Fund.
TAX BENEFITS OF OIL AND GAS INVESTMENTS
OIL AND GAS INVESTMENTS PROVIDE A VARIETY OF TAX BENEFITS. A WORKING INTEREST PROVIDES THE ABILITY TO DEDUCT 80% OF AN ORIGINAL INVESTMENT IN YEAR ONE MAKING OIL AND GAS INVESTMENTS UNIQUELY SUITED TO TAX MOTIVATED INVESTORS. Download Guide To Income Taxes
OIL AND GAS INVESTMENT STRATEGIES
•Oil and gas working interest investments are considered qualified replacement properties in 1031 exchange transactions.
• First year tax deductions of working interests are well suited for investors considering Roth IRA conversions or other taxable transactions.
• Unlike most investments¨ working interest investments are not considered passive investments; initial losses on working interest investments can be used by high income taxpayers to offset W-2 and other ordinary income.
INTANGIBLE DRILLING COSTS TAX DEDUCTION The intangible expenditures of drilling (labor, chemicals, mud, etc) are usually about 65-80% of the cost of a well. These expenditures are considered intangible drilling costs (IDC), which are 100% deductible during the first year. For example, a $100,000 investment would yield up to $75,000 in tax deductions during the first of the venture. These deductions are available in the year the money is invested, even if the well does not start drilling until March 31 of the year following the contribution of capital.
TANGIBLE DRILLING COSTS TAX DEDUCTION Tangible drilling costs refers to money spent on equipment or other items that you can resell (wellheads, tanks, leaseholds, etc.). Tangible drilling costs (TDC) make up about 20% of the drilling costs and are 100% tax deductible. In the example above, the remaining tangible costs ( $25,000) may be deducted as depreciation over a seven-year period. ( see section 263 of the tax code )
DEPLETION ALLOWANCE The IRS also gives a 15% depletion allowance against production revenue to allow for the drop in oil and gas reserves in a well. The 1990 Tax Act allows certain entities to exempt 15% of their gross income from federal taxes to help support smaller oil companies and direct investors.
GENERAL VS. LIMITED PARTNER If you invest as a general partner, you can deduct your investments from active income. If you invest as a limited partner, you deduct your investment from passive income.
*information provided by Brian Hill, CPA Barnett & Company, Inc