Making a List and Checking it Twice: IRS Identifies Monetized Installment Sales as Listed Transactions
By Anthony P. Daddino on August 3, 2023
-
Anthony P. Daddino
View Bio
In proposed regulations released today, the IRS has identified monetized installment sales as listed transactions. You probably have questions – herein you will find some answers.
What is a monetized installment sale?
According to the proposed regulations (linked HERE), the Treasury Department and IRS have become aware of so-called promoters that purport to convert a cash sale of appreciated property to an installment sale. This is done through the introduction of an intermediary or “middle man.” The taxpayer sells the appreciated property to the intermediary in exchange for a purported installment note. The intermediary in turn sells the property to a buyer previously identified by the taxpayer in exchange for cash. The intermediary then transfers the proceeds to a third party, who holds the proceeds as collateral for a non-recourse loan that the third party makes to the taxpayer. When the dusts settles, the selling taxpayer has loan proceeds that the IRS contends are in substance the cash proceeds from the buyer without the triggering of gain. The gain is deferred until the maturity of the installment note.
Why is the IRS upset?
While only a tax deferral play, the IRS is upset because in practice, the installment notes are for an extended term and bear an extremely large balloon payment. From the IRS’ perspective, taxpayers are cashing in today and paying tax on the vast majority of their gain at the end of 20, 30, or in some purported transactions, 40 years. These proposed regulations dovetail with the IRS’ previous inclusion of monetized installment sales as part of its 2023 “Dirty Dozen” list (linked HERE).
Why does IRS listing of the transaction matter?
By virtue of listing the transaction, the IRS invokes a disclosure obligation that has real bite. If the taxpayer fails to file either an initial disclosure with the Office of Tax Shelter Analysis or annual disclosures with the IRS, they face disclosure penalties of up to $100,000 for individuals and $200,000 for businesses, an unlimited statute of limitations for the IRS to audit the transactions and seek additional taxes, and an increased accuracy-related penalty from 20% to 30%. There is also the potential for a 40% penalty in the event the IRS concludes that the transaction lacked economic substance. As explained below, the IRS has already stated that it plans to attack the monetized installment sales on economic substance grounds.
How does the IRS plan to attack it?
In the proposed regulations, the IRS previewed the legal arguments it plans to lodge in attack of these transactions. First, the IRS states it will challenge the intermediary as a mere accommodation party and not a bona fide purchaser of the assets. Additionally, the IRS states that it will challenge the third-party loan as not a bona fide loan, as well as argue that use of the intermediary sale proceeds as collateral is an event under IRC Sec. 453 that triggers taxation to the taxpayer seller. Lastly, the IRS plans to attack the transactions in their entirety based on a lack of economic substance.
What do we do now?
The IRS must solicit comments before it can finalize the proposed regulations. So the disclosure obligation is not yet effective. During this window of time, taxpayers and their advisors would be wise to assess prior transactions in an effort to reduce IRS risks, take action to head off potential IRS misunderstandings and in some cases, identify and evaluate potential remediation options.
If you have any questions about this blog post or any other tax-related topic, please do not hesitate to contact me at adaddino@meadowscollier.com or (214) 749-2464.
What is a monetized installment sale?
According to the proposed regulations (linked HERE), the Treasury Department and IRS have become aware of so-called promoters that purport to convert a cash sale of appreciated property to an installment sale. This is done through the introduction of an intermediary or “middle man.” The taxpayer sells the appreciated property to the intermediary in exchange for a purported installment note. The intermediary in turn sells the property to a buyer previously identified by the taxpayer in exchange for cash. The intermediary then transfers the proceeds to a third party, who holds the proceeds as collateral for a non-recourse loan that the third party makes to the taxpayer. When the dusts settles, the selling taxpayer has loan proceeds that the IRS contends are in substance the cash proceeds from the buyer without the triggering of gain. The gain is deferred until the maturity of the installment note.
Why is the IRS upset?
While only a tax deferral play, the IRS is upset because in practice, the installment notes are for an extended term and bear an extremely large balloon payment. From the IRS’ perspective, taxpayers are cashing in today and paying tax on the vast majority of their gain at the end of 20, 30, or in some purported transactions, 40 years. These proposed regulations dovetail with the IRS’ previous inclusion of monetized installment sales as part of its 2023 “Dirty Dozen” list (linked HERE).
Why does IRS listing of the transaction matter?
By virtue of listing the transaction, the IRS invokes a disclosure obligation that has real bite. If the taxpayer fails to file either an initial disclosure with the Office of Tax Shelter Analysis or annual disclosures with the IRS, they face disclosure penalties of up to $100,000 for individuals and $200,000 for businesses, an unlimited statute of limitations for the IRS to audit the transactions and seek additional taxes, and an increased accuracy-related penalty from 20% to 30%. There is also the potential for a 40% penalty in the event the IRS concludes that the transaction lacked economic substance. As explained below, the IRS has already stated that it plans to attack the monetized installment sales on economic substance grounds.
How does the IRS plan to attack it?
In the proposed regulations, the IRS previewed the legal arguments it plans to lodge in attack of these transactions. First, the IRS states it will challenge the intermediary as a mere accommodation party and not a bona fide purchaser of the assets. Additionally, the IRS states that it will challenge the third-party loan as not a bona fide loan, as well as argue that use of the intermediary sale proceeds as collateral is an event under IRC Sec. 453 that triggers taxation to the taxpayer seller. Lastly, the IRS plans to attack the transactions in their entirety based on a lack of economic substance.
What do we do now?
The IRS must solicit comments before it can finalize the proposed regulations. So the disclosure obligation is not yet effective. During this window of time, taxpayers and their advisors would be wise to assess prior transactions in an effort to reduce IRS risks, take action to head off potential IRS misunderstandings and in some cases, identify and evaluate potential remediation options.
If you have any questions about this blog post or any other tax-related topic, please do not hesitate to contact me at adaddino@meadowscollier.com or (214) 749-2464.
