Using an Installment Sale With the Sale of a Farm or Ranch
An installment sale, also known as a contract for deed, is another option available to families selling their farm or ranch. An installment sale involves a sale of property where a landowner receives at least one payment after the tax-year of the sale.
Installment sales
An installment sale can be advantageous to a seller, because as the seller of the property, they can receive payments over a number of years.
Additionally, by having payments spread over a number of years, they may be able to receive some of the payments when they are in a lower tax bracket.
An installment sale is attractive to a buyer because it allows them to obtain financing and make payments over a period of time at possibly lower interest rates than they could get at a bank.
Each payment on an installment sale usually consists of three parts – interest income, return of the adjusted basis in the property and gain on the sale.
As the seller, they need to make sure they separate the principal from interest on each installment. The interest portion must be reported as ordinary income.
When a payment is received, the amount reported as gain is the same percentage of the net as the total gain is of the total sale price.
For example, if a ranch sold for $5 million and the cost basis at the time of sale was $1 million – in this example, it is assumed there aren’t any assets included in the sale that have been depreciated, because any gain due to depreciation has to be recaptured as ordinary income in the year of sale regardless of it being an installment sale – the gain would be $4 million or 80 percent of the sale price – $4 million divided by $5 million.
If the buyer and seller agree to an installment sale, the buyer would need to report 80 percent of each installment payment as gain.
If a landowner is considering an installment sale for their property, they need to ensure they receive a large down payment, so if the buyers default on their contract, one will not lose money if they have to take the property back and re-sell it.
It’s also important to earn a competitive interest rate on the contract compared to the rate of return they could receive if they invested the cash themselves or if they did a 1031 exchange into other income producing real estate investments.
Installment sales with
1031 exchange or CRT
It is possible to use a 1031 exchange or a charitable remainder trust (CRT) with an installment sale.
There are, however, added complexities to doing so. If one is interested in combining a 1031 or CRT with an installment sale, they need to consult with an experienced 1031 intermediary or planned giving specialist prior to the sale, as well as consulting with an attorney or CPA.
Chris Nolt is an independent registered investment advisor and the owner of Solid Rock Wealth Management, Inc. and Solid Rock Realty Advisors, LLC, sister companies dedicated to working with families around the country who are selling a farm or ranch and transitioning into retirement. To order a copy of Chris’s book “Financial Strategies for Selling a Farm or Ranch,” visit amazon.com or call Chris at 800-517-1031. For more information, visit solidrockproperty.com and solidrockwealth.com.
