On August 3, 2023, Treasury and the IRS issued proposed regulations and a press release identifying monetized installment sale transactions and substantially similar transactions as Listed Transactions. A Listed Transaction is a type of transaction that requires participants (and material advisers) to report their involvement in the transaction to the IRS on a special disclosure form that is attached to their tax return and sent to the IRS’s Office of Tax Shelter Analysis. Penalties can apply for failure to make the required disclosure.
Monetized installment sales were always considered to be on the aggressive end of the tax spectrum, and the issuance of the proposed regulations indicates that the IRS is redoubling its efforts to identify taxpayers that engaged in them so it can ramp up its enforcement efforts. It has previously included monetized installment sales on its annual Dirty Dozen list of common tax scams and schemes.
A monetized installment sale transaction is one where a taxpayer identifies a buyer for its appreciated property and then structures the sale in a series of steps where the property and purchase price flow indirectly to the seller through one or more intermediaries. Here’s how it works in its simplest form: the seller sells the property to an intermediary for an installment note (this is how the seller obtains its tax deferral). The intermediary instantaneously sells the property to the buyer for cash. The seller then receives the amount of the sales proceeds (less fees to various parties) indirectly through a loan from a third-party lender (the loan proceeds are not subject to tax). The terms of the loan are such that the seller’s interest payments on the loan hew to the seller’s receipt of interest on the installment note. The lender, in turn, received from the intermediary the funds it loaned to the seller, thereby closing the loop on the flow of funds. The cash travels from the buyer to the intermediary to the lender to the seller.
The IRS is expected to attack these transactions using many arguments, including that the intermediary is not a bona fide purchaser of the property, the seller is treated as having received the sale proceeds at the time of sale, and the transaction should be disregarded or recast under the economic substance doctrine, the step transaction doctrine, and agency or conduit principles. It is also expected to assert accuracy-related penalties ranging from 20% to 40% of the underpayment of tax, or a civil fraud penalty of 75% of the underpayment of tax, depending on the facts.
The IRS is aware that promoters are marketing these transactions to taxpayers and are receiving significant fees for arranging the transactions, which is why it issued the proposed regulations. The proposed regulations would not take effect until the date they are finalized.
What Should a Seller Do if It Engaged in One of These Transactions?
Wait and see is probably not the best approach here. Participants should seek competent tax advice immediately, and probably not from the advisor that recommended or advised on the deal. Corrective action may include undoing the transaction or filing amended tax returns, or both.
Withum has experience with monetized installment sale transactions and can assist taxpayers in considering their options.
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For more information on this topic, please contact a member of Withum’s Business Tax Services Team.
