The Installment Sale Strategy (Section 453): Become the Bank to Save Millions in Taxes
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Result: The Installment Sale generated an extra $1.1 Million in net wealth.
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The Installment Sale Strategy (Section 453): Become the Bank to Save Millions in Taxes
CORE INSIGHTS
- The Trap: Selling a business for a lump sum puts 100% of the gain in the top tax bracket in one year. You lose the earning power of the money sent to the IRS.
- The Strategy: “Seller Financing.” Instead of cash, you take payments over 5-10 years. This defers the tax bill and keeps you in lower brackets.
- The Bonus: You charge the buyer interest (e.g., 8%). This turns your exit into a high-yield, fixed-income investment secured by the asset you know best.
“Cash is King” is a lie when it comes to taxes. Cash is a liability. By using an Installment Sale, you tell the IRS: “I haven’t been paid yet.” This simple delay allows your pre-tax capital to compound for you.
The “Gross-Up” Arbitrage
Comparing a $5M Exit: Lump Sum vs. Installment.
- Lump Sum: $5M Sale – $1.5M Tax = $3.5M Invested.
- Installment: $5M Principal earning 8% Interest.
- The Spread: Earning interest on the $1.5M deferred tax. That extra ~$120k/yr is pure alpha.
What-If Scenario: $5M Business Exit
| Metric | Lump Sum Sale | Installment (7% Note) |
|---|---|---|
| Tax Paid (Year 1) | $1,500,000 | ~$150,000 (Pro-rated) |
| Wealth (Year 10) | ~$6.8 Million | ~$7.9 Million |
Visualizing the Deferral Advantage
*Figure 1: Wealth Accumulation. The Green line (Installment) compounds on a larger base principal.*
Strategic Action Steps
1
Secure the Note
Never accept an unsecured note. File a UCC-1 financing statement (lien on assets) or get a stock pledge. If they default, you take the business back.
Never accept an unsecured note. File a UCC-1 financing statement (lien on assets) or get a stock pledge. If they default, you take the business back.
2
Set Market Rate
Charge at least the AFR, but aim for Market Rate (Prime + 2%). Don’t give the buyer a cheap loan; you are taking risk.
Charge at least the AFR, but aim for Market Rate (Prime + 2%). Don’t give the buyer a cheap loan; you are taking risk.
3
Watch Recapture
Depreciation Recapture (Section 1245) is taxed in Year 1 regardless of payment. Plan cash flow to cover this immediate bill.
Depreciation Recapture (Section 1245) is taxed in Year 1 regardless of payment. Plan cash flow to cover this immediate bill.
The Bottom Line: Who Should Choose What?
- Do This: If you trust the buyer and want a steady 7-9% yield without management headaches.
- Avoid This: If the buyer is shaky or the industry is dying. If the business fails, your note is worthless.
Frequently Asked Questions
What is an Installment Sale (Section 453)?
A sale where you receive at least one payment after the tax year of the sale. You pay tax pro-rata as payments arrive, deferring the bulk of the liability.
Why is this better than a lump sum?
1) Tax Deferral (investment growth on tax money). 2) Interest Income (you charge the buyer 7-8% interest). It turns an exit into an annuity.
What is the risk?
Default Risk. If the buyer fails, you must foreclose. Always secure the note with a lien on business assets or stock pledge.
Disclaimer: Installment sales have complex rules regarding interest and recapture. Large notes (>$5M) may owe interest on deferred tax. Consult a tax attorney.
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