Unlocking Tax Savings on Land sales using Structured Installment Sales
When landowners decide to sell, the prospect of a hefty tax bill can quickly dampen the appeal of the transaction—capital gains taxes on appreciated property can erode a sizable chunk of the proceeds, leaving less for retirement or reinvestment. Structured installment sales offer a compelling opportunity to ease this burden, allowing sellers to spread payments over time and reduce their tax liability by deferring capital gains into future years. The purpose of this article is to explore how this strategy works, why it’s particularly valuable for landowners like farmers, and how it can transform a daunting sale into a manageable, financially savvy decision.
Installment sale VS Structured Installment Sale
Normal Installment Sale: The buyer makes payments directly to the seller over time. The seller bears the risk of the buyer defaulting, and there’s no guarantee of payment beyond the buyer’s ability to pay.
Structured Installment Sale: The buyer pays the all or part of the purchase price upfront to a third-party assignment company. This company uses the lump sum to purchase an annuity, typically backed by highly rated financial instruments like U.S. Treasuries. The seller then receives guaranteed periodic payments from the annuity, which include both principal and interest, ensuring a reliable income stream while eliminating the risk of buyer default.
In short a SIS allows a seller to turn a lump sum into a customized installment sale.
Key advantage: Lower taxes
A primary advantage of a Structured Installment Sale is its ability to lower taxes by deferring capital gains recognition, offering significant relief across federal capital gains brackets, Net Investment Income Tax (NIIT), and state taxes, all while providing the seller with an internal rate of return (IRR) on funds that would otherwise be lost to taxes.
Capital gains tax rates are progressive, meaning the more income you earn in a given year, the higher the rate applied to your gains. A lump-sum farmland sale could push the seller into the highest federal capital gains bracket of 20%. Additionally, state taxes can add another layer of expense, with rates varying widely depending on the seller’s location. By using a SIS, sellers can spread their capital gains across multiple years, reducing their taxable income annually and potentially staying within lower brackets like 0% or 15%, resulting in significant savings.
The Net Investment Income Tax (NIIT) is an additional 3.8% tax applied to certain investment income for individuals with adjusted gross income (AGI) above $200,000 (single filers) or $250,000 (married couples filing jointly). Farmland sales often trigger this tax due to the large one-time capital gain. However, by deferring income through structured installments, sellers can keep their AGI below these thresholds each year, avoiding or significantly reducing their exposure to NIIT.
In addition to federal capital gains taxes, farmland sellers face varying state-level taxes that can significantly impact their bottom line. While some states, such as Texas and Nevada, impose no additional capital gains tax, others like California have rates exceeding 13%, making it one of the most expensive states for property sales. These taxes are compounded with federal obligations, leaving sellers with a smaller portion of their proceeds.
Financial Flexibility
One of the standout features of a Structured Installment Sale is its high level of customization, allowing sellers to tailor the payment plan to fit their unique financial needs and goals. Sellers can decide on the amount of upfront cash they want to receive, the duration of the payment period, and the frequency of payments—whether monthly, quarterly, annually, or even bi-weekly.
Sellers don't typically structure the whole sale. For example, in a $1 million farmland sale, a seller might opt for $500,000 as an immediate lump sum to cover short-term expenses or investments while structuring the remaining $500,000 into periodic payments over 5 years.
How does a Structured Installment Sale transaction work?
Confirm Eligibility
The first step is to confirm that the property or asset qualifies for installment sale tax treatment under IRS Section 453. Eligible properties include appreciated real estate, farmland, or business assets. Sellers should consult with tax and legal advisors to ensure the transaction meets IRS requirements
Formalize purchase and sale agreement
The seller and buyer negotiate the terms of the sale, including the purchase price and payment schedule. These terms are formalized in a Purchase & Sale Agreement, which serves as the foundation for structuring the installment payments. An addendum is added to outline the installment schedule, specifying payment amounts, frequency, and duration. A structured settlement consultant will ensure proper execution of required documents.
Buyer Pays Upfront and Assigns Installment Obligations
Once the sale terms are finalized, the buyer pays a lump sum upfront to a third-party assignment company. This entity assumes responsibility for making periodic payments to the seller. The assignment company uses the buyer’s funds to purchase an annuity or other secure financial instruments from an A-rated insurance company, ensuring reliable future payments.
The SIS is finalized during escrow
At this stage the buyer transfers funds to the assignment company, the assignment company purchases an annuity, the seller begins receiving periodic payments according to the agreed schedule.
Structured installment sale VS other tax deferral strategies
1031 Exchange (Like-Kind Exchange)
A 1031 exchange, is a tax deferral strategy that allows an investor to sell an investment property and reinvest the proceeds into another "like-kind" property without immediately paying capital gains tax on the sale. The process requires strict adherence to IRS rules, including using a qualified intermediary to handle the funds and completing the exchange within specific timelines (45 days to identify a replacement property and 180 days to close). The key benefit is that the entire gain is deferred indefinitely, as long as the new property is held and potentially exchanged again, making it an attractive option for those looking to stay invested in real estate while postponing tax liability. It’s limited to real property held for investment or business use, and the seller doesn’t receive cash directly—instead, the value rolls into the new asset.
In contrast, a structured installment sale, governed by IRC Section 453, involves selling an asset (not limited to real estate) and receiving payments from the buyer over time, with capital gains tax recognized only as each payment is received. Unlike a 1031, which requires reinvestment and keeps your wealth tied up in property, a structured sale provides liquidity through a stream of cash payments. This makes it a more attractive option for individuals looking to completely exit.
Deferred Sales Trust (DST)
A Deferred Sales Trust (DST) defers capital gains tax by transferring your asset to a trust, which sells it to a buyer and pays you over time, taxing gains only as payments are received. A seller sees a stark cost contrast with a DST: setup expenses in the thousands, plus annual trustee, management, and investment fees—fixed or as a percentage—that can eat away at savings. An SIS, however, involves just a modest one-time assignment fee, a fraction of a DST’s setup, and whatever the seller’s tax pro might bill.
So whether you're looking for a tax smart way to retire or to simply save on tax, a structured installment sale may be the right option. By spreading payments over time, sellers can reduce their taxable income annually, avoid higher tax brackets, and potentially eliminate exposure to additional taxes like the Net Investment Income Tax. Ultimately, structured installment sales can transform a potentially overwhelming transaction into a simple and financially smart decision, paving the way for retirement planning or reinvestment opportunities.
