NATIONWIDE - JULY 2025 - (USAnews.com) — When selling highly appreciated assets, investors and business owners are focused on maximizing after-tax returns, ensuring investment flexibility, and supporting long-term financial goals. Two strategies often discussed are the familiar 1031 exchange and the increasingly popular intermediated installment sale trust (also called a deferred sales trust). While both allow for tax deferral, the intermediated installment sale trust offers greater flexibility, a broader range of assets, and more investment opportunities.
The 1031 Exchange: A Familiar but Limited Strategy
The 1031 exchange has long been the go-to for investors, particularly in real estate. This strategy allows investors to defer capital gains taxes by exchanging one investment property for another of equal or greater value. However, the 1031 exchange has limitations:- It’s restricted to real estate transactions, excluding businesses, equipment, and collectibles.
- There are strict time limits: investors must identify a replacement property within 45 days and complete the transaction within 180 days.
The Intermediated Installment Sale Trust: Greater Flexibility
The intermediated installment sale trust, governed by IRS Code Section 453, provides a powerful alternative. It allows sellers to defer taxes when selling a variety of assets—such as real estate, businesses, equipment, or collectibles. Here’s how it works: the seller transfers their property to the trust, which then sells it to a buyer. Rather than receiving a lump sum, the seller is paid in installments. This incremental payment structure spreads out capital gains taxes, offering financial benefits.Key Advantages Over the 1031 Exchange
Investment Flexibility: Unlike the 1031 exchange, the trust isn’t limited to real estate. The proceeds can be reinvested in a diverse array of assets, such as stocks and bonds, allowing for a customized strategy based on individual goals. Wider Asset Eligibility: The trust applies to various types of assets—not just real estate. This makes it more versatile for business owners and individuals selling a range of items. No Deadlines: The 1031 exchange requires investors to meet tight deadlines for property identification and purchase. With the intermediated installment sale trust, there are no such deadlines, giving sellers more time to make thoughtful investment decisions. Tax Deferral and Savings: The trust structure allows capital gains taxes to be spread out over time, which can help maintain cash flow, keep the seller in a lower tax bracket, and enable better growth on the full proceeds. Asset Protection and Estate Planning: Assets in the trust are shielded from creditors and lawsuits. The trust can also be easily integrated into estate planning, reducing estate taxes and facilitating charitable donations.Jane's Story: How the Intermediated Installment Sale Trust Worked for Her
To understand how the trust works in practice, consider the case of Jane, a business owner in Maple Shade, NJ, looking to sell her $1,000,000 business. Jane wanted to minimize taxes and maximize her retirement savings. With a 20% long-term capital gains tax rate and a 30% federal income tax rate on ordinary income, she faced a substantial tax bill. Jane considered an outright sale but was concerned about the tax hit. Instead, she worked with Genesis Wealth Advisor Group to arrange the sale through an intermediated installment sale trust. Here’s how the two options compared:Option 1: Outright Sale
- 20% Immediate Capital Gains Tax: $200,000
- Net Proceeds to Invest: $800,000
- If Invested at 7% for 20 Years: Grows to $3,095,000
- Immediate Tax Paid: $200,000
Option 2: Intermediated Installment Sale Trust
In this option, the entire $1,000,000 went into the trust, and Jane was paid $50,000 per year over 20 years:- No Immediate Tax: The full $1,000,000 was invested.
- Annual Payment: $50,000/year for 20 years.
- Annual Capital Gains Tax: $10,000 (20% of $50,000), paid each year.
- After-Tax Annual Payment: $40,000, which Jane could reinvest or use.
- Asset Growth: The trust’s $1,000,000 grew at 7% annually, potentially reaching $3,870,000 after 20 years.
- Total Taxes Paid: $10,000/year for 20 years, totaling $200,000.
Key Benefits for Jane:
- Larger Investable Base: By deferring taxes, Jane could invest the full $1,000,000, rather than just the after-tax proceeds, allowing for better compounding growth.
- Improved Cash Flow: With taxes deferred, Jane had more favorable cash flow over the years.
- Greater Investment Flexibility: Jane could diversify her investments and adjust her portfolio as her needs evolved.
- Asset Protection: Her assets were protected from creditors and lawsuits.
- Estate Planning: The trust structure complemented Jane’s estate plan, offering long-term financial benefits.
Risks and Considerations
While the intermediated installment sale trust offers many advantages, it’s not without risks. A few key considerations:- Surrender of Control: The seller must give up control of the asset, with the trustee managing the asset and making installment payments. If the trust is mismanaged, the seller may face limited recourse.
- No Step-Up in Basis at Death: Unlike a 1031 exchange, the trust doesn’t offer a step-up in basis for heirs, which could lead to potential tax consequences for beneficiaries.
- Tax Reporting: The seller must file periodic tax reports on the installment payments.