Wednesday, July 15, 2009

installment sale financing

A popular method of deferring the taxes due on the sale of commercial property is the installment sale financing. Under this method, the seller allows the to pay the purchase price over a number of years. in effect, the seller collects a down payment and then loans the buyer the remainder of the purchase price. Subsequent to the sale, the buyer makes periodic payments to the seller (lender) that consist of both interest and principal amortization. Because the seller receives the sale proceeds (i.e.,the principal on the installment loan)over a number of years, the internal revenue service(IRS)allows the seller to recognize the taxable gain from sale as the sale proceeds are collected from the buyer.Spreading the recognition of the taxable gain over several years reduces the present value of the tax payments.
there is a potential cost, however,associated with this strategy:the seller does not immediately receive the full amount of the sale proceeds from the buyer. if the interest rate the seller charges the buyer is less than the seller's risk-adjusted opportunity cost, the seller's wealth is decreased by the installment sale loan.this loss would need to be balanced against the benefits of tax deferral. Nevertheless, the availability of installment sale tax treatment allows investors to pursue market timing and poryfolio reallocation strategies without triggering large capital gains.
Because the installment sale may provide the seller with significant tax benefits, the seller may be willing to offer the buyer-investor a below-market rate of interest. Installment sales are also popular with buyers because the seller often uses underwriting standard that are less strict than those used by traditional third party lenders(e.g., banks,insurance companies). this underwriting flexibility may allow the investor to increase the ratio of total debt to total property value, thereby minimizing the investor's required down payment.

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