Selling a valuable asset, such as real estate or a business, in California can be a double-edged sword. On one hand, you anticipate a substantial profit; on the other, you're confronted with significant federal and state capital gains taxes that can substantially erode your earnings. Understanding and utilizing tax-deferral strategies is crucial to preserving your wealth. This comprehensive guide will delve into structured installment sales, compare them with 1031 exchanges and Deferred Sales Trusts (DSTs), and highlight why structured installment sales often emerge as the safer, more advantageous option.

Understanding Capital Gains Taxes in California

When you sell an appreciated asset, the profit—known as a capital gain—is subject to taxation. In California, this includes:

• Federal Long-Term Capital Gains Tax: Up to 20% for high-income earners.

 

• Net Investment Income Tax (NIIT): An additional 3.8% for individuals with significant investment income.

 

• California State Capital Gains Tax: Treated as ordinary income, with rates reaching up to 13.3%.

Total Potential Tax Liability: Up to 37.1% of your capital gain.

Example: Selling a property with a $1,000,000 gain could result in approximately $371,000 in taxes, leaving you with $629,000.

Structured Installment Sales: A Strategic Approach

A structured installment sale allows you to receive the proceeds from the sale over time, rather than in a lump sum, deferring tax liability and potentially reducing your immediate tax burden.

How It Works:

1. Installment Sale Agreement: You agree to sell your asset, receiving payments over a specified period.

 

2. Assignment to a Third Party: The buyer's obligation is assigned to a specialized company that manages structured sales.

 

3. Funding the Obligation: This company purchases an annuity from a reputable provider to ensure consistent payments.

 

4. Payment to Seller: You receive scheduled payments directly from the annuity provider.
5. Flexibility and Security: Customize your payment schedule (monthly, quarterly, annually) with the assurance of payment security backed by the annuity.

 

Key Benefits:

• Tax Deferral: Spread your tax liability over several years.
• Predictable Income: Establish a steady cash flow aligned with your financial goals.
• Reduced Immediate Tax Impact: Potentially lower your tax bracket by receiving smaller annual payments.
• Best Tax Deferral Strategies for Sellers: Ideal for those seeking wealth protection through estate planning for business owners and real estate investors.

 

Example: Selling a property with a $1,000,000 gain and receiving payments over 10 years could reduce your annual tax liability, keeping you in a lower tax bracket each year.

Comparing Tax-Deferral Strategies

1031 Exchange

A 1031 exchange allows you to defer capital gains taxes by reinvesting the proceeds from the sale of a property into a similar ("like-kind") property.

Pros:

• Full Tax Deferral: Taxes are deferred as long as the investment continues in like-kind properties.
• Wealth Accumulation: Allows for portfolio growth without immediate tax consequences.

Cons:

• Strict Timelines: Identification of a new property within 45 days and closing within 180 days.
• Like-Kind Requirement: Limited to real estate; the replacement property must be of similar nature.
• Continuous Management: Requires ongoing property management, which may not suit all investors.

Example: Selling a rental property and purchasing another within the specified timeframe defers the capital gains tax but keeps you tied to property management responsibilities.

Deferred Sales Trust (DST)

A DST involves selling your asset to a trust in exchange for a promissory note, allowing you to defer capital gains taxes.

Pros:

• Tax Deferral: Similar to other methods, taxes are deferred over time.
• Investment Flexibility: Proceeds can be reinvested in various assets, not limited to real estate.

Cons:

• Complexity and Costs: Setting up and managing a DST can be intricate and expensive, often resulting in lower net returns.
• IRS Scrutiny: The IRS has increased scrutiny of DSTs, considering certain transactions as potentially abusive tax shelters.
• Risk of Mismanagement: Relinquishing control to a third-party trustee can lead to potential mismanagement of assets.

Example: Utilizing a DST to defer taxes on the sale of a business could lead to unexpected tax liabilities if the IRS deems the trust's structure non-compliant.

Why Structured Installment Sales Are the Better Option

Pros:

• Regulatory Assurance: Explicitly recognized under IRS Section 453, providing clear legal standing.
• Lower Costs: Typically involves fewer setup and administrative expenses.
• Control and Security: Directly tied to an annuity from a reputable provider, offering greater security and predictability.

Cons:

• Credit Risk: Dependence on the buyer's ability to make installment payments, though this is mitigated by the annuity structure.

Real-World Examples

Example 1: Selling a Residential Property – Traditional vs. Structured Installment Sale

Scenario: John, a homeowner in California, is selling his rental property for $1,000,000. He originally purchased the home for $400,000. His total taxable gain is:

$1,000,000 - $400,000 = $600,000 (capital gain).

Traditional Sale:

John sells the property outright and receives the full $1,000,000 in one year.

• Total Tax Paid: $222,600
• Net Proceeds After Tax: $777,400

Structured Installment Sale:

Instead, John negotiates a structured installment plan to receive payments over 10 years, lowering his annual tax liability.

• Total Annual Tax Liability: $22,260

Example 2: Selling a Business – Traditional vs. Structured Installment Sale

Scenario: Jane, a business owner, is selling her company for $2,000,000. Her cost basis is $500,000, leaving her with a taxable gain of $1,500,000.

Traditional Sale:

• Total Tax Paid: $556,500
• Net Proceeds After Tax: $1,443,500

Structured Installment Sale:

Jane structures her payments over 15 years, deferring taxes and optimizing cash flow.

• Total Annual Tax Liability: $37,100

Conclusion: Optimize Your Sale with Informed Choices

Navigating the sale of a significant asset requires careful planning to maximize returns and minimize tax liabilities. Structured installment sales offer a balanced approach, combining tax deferral, simplicity, and security. While 1031 exchanges and DSTs provide alternatives, they come with complexities and potential risks that may not align with every investor's goals.

Before proceeding with any tax-deferral strategy, consult with experienced professionals who can tailor solutions to your unique circumstances.

Frequently Asked Questions (FAQs) About Structured Installment Sales & Tax Deferral Strategies

1. What is a Structured Installment Sale?

A structured installment sale allows a property or business owner to receive sale proceeds over time instead of a lump sum. This strategy helps defer capital gains taxes, providing long-term tax efficiency and financial security.

2. How does a Structured Installment Sale help reduce capital gains taxes?

Under IRS Section 453, structured installment sales allow the seller to only pay capital gains taxes on the amount received each year rather than on the entire sale price in the year of sale. This can keep sellers in a lower tax bracket and reduce the overall tax burden.

3. How does a Structured Installment Sale compare to a 1031 Exchange?

Feature	Structured Installment Sale	1031 Exchange
Tax Deferral	Yes, over multiple years	Yes, indefinitely if reinvested
Property Reinvestment Required?	No	Yes, into a like-kind property
Flexibility	High – cash payments received over time	Low – must reinvest in real estate
IRS Approval	Recognized under IRS Section 453	Recognized under IRS Section 1031
Best For	Sellers wanting tax deferral and liquidity	Investors wanting to stay in real estate

A structured sale is ideal for sellers who want tax deferral without buying another property, whereas a 1031 exchange requires reinvestment into another real estate asset.

4. What is a Deferred Sales Trust (DST), and why is it controversial?

A Deferred Sales Trust (DST) is another tax deferral method where the seller transfers their asset to a trust in exchange for an installment note. However, DSTs face increased IRS scrutiny, and there are concerns about high setup costs, legal complexity, and potential mismanagement by trustees.

Many tax professionals recommend structured installment sales as a safer, IRS-approved alternative to DSTs.

5. Who is eligible for a Structured Installment Sale?

Structured installment sales are available to business owners, real estate investors, and individuals selling high-value assets who want to defer taxes. They work well for:
✔ Business Owners selling a company
✔ Real Estate Investors selling properties
✔ High-Net-Worth Individuals seeking tax-efficient liquidation

6. Can a Structured Installment Sale be used for selling a primary residence?

If you sell your primary residence, you may already qualify for the $250,000 (single) or $500,000 (married) capital gains exclusion under IRS rules. However, if the sale exceeds this threshold, a structured sale can be used on the taxable portion to further defer taxes.

7. What are the risks of a Structured Installment Sale?

✅ Key benefits: IRS-recognized, flexible payment options, tax-efficient
⚠ Potential risks: Payments depend on the annuity provider's ability to pay, and early withdrawal may have penalties

To minimize risks, sellers should work with trusted financial institutions and legal professionals.

8. How do I set up a Structured Installment Sale?

ü  Consult a tax attorney to confirm eligibility

ü  Negotiate an installment sale agreement with the buyer

ü  Assign payments to a structured settlement company

ü  The annuity provider funds and guarantees payments

ü  Receive payments while deferring capital gains taxes

9. How does a Structured Installment Sale affect estate planning?

A structured sale can be integrated into an estate plan, allowing heirs to inherit income streams rather than a lump sum. This can help reduce estate tax exposure and provide financial stability for beneficiaries.

10. How can I get expert advice on Structured Installment Sales?

With over 25 years of experience, 6,000+ clients served, and 200+ five-star Google reviews, James Burns Law is the trusted expert in estate planning, tax deferral, and wealth preservation.

📞 Call (949) 305-8642 or visit www.jamesburnslaw.com to schedule your consultation.

Take Action Now – Consult with the Law Office of James Burns

With over 25 years of experience, more than 6,000 clients served, and over 200 five-star Google reviews, James Burns is a trusted expert in helping clients navigate complex tax strategies to preserve and grow their wealth.

Call now at (949) 305-8642 or visit www.jamesburnslaw.com to schedule your consultation today.

Legal & Tax Disclaimer

The information provided in this blog is for general informational and educational purposes only and should not be construed as legal, tax, or financial advice. Laws and regulations regarding structured installment sales, tax deferral strategies, and estate planning may vary based on individual circumstances and jurisdiction. Readers should consult with a qualified tax attorney, CPA, or financial advisor to determine the best strategy for their specific situation.

While structured installment sales, 1031 exchanges, and Deferred Sales Trusts (DSTs) are recognized tax deferral strategies, their implementation and effectiveness depend on compliance with IRS regulations and state laws. The Law Office of James Burns does not provide investment or annuity services and does not guarantee specific financial outcomes.

Engaging with our firm does not create an attorney-client relationship unless a formal agreement is signed. For personalized advice, please contact the Law Office of James Burns at (949) 305-8642 or visit www.jamesburnslaw.com to schedule a consultation.