IRS identifies flaws in monetized installment sales

Plain-English summary

Chief Counsel advised that the common promoter theory behind monetized installment sale transactions was flawed, while noting that structures can vary. A purported unsecured, nonrecourse loan may not be genuine debt, causing its proceeds to be income. If cash escrow secures the loan, the seller may receive economic benefit and therefore payment under Section 453, while a loan secured by the dealer note may trigger the Section 453A(d) pledging rule. An intermediary that is not the true buyer cannot issue an excluded acquirer debt instrument under Section 453(f), and an installment note secured by cash or a cash equivalent is itself treated as payment. The advice also distinguishes a prior memorandum because that matter lacked an intermediary and involved farm property exempt from the pledging rule.

Ruling snapshot

• Question: Do common monetized installment sale structures defer gain as promoters claim?
• Outcome: Advice given: the common theory is flawed and several features can cause current payment or income.
• Key authorities: IRC §§ 453 and 453A(d); Treas. Reg. § 15a.453-1(b)(3)

Full text (IRS public release)

ID: CCA_2019103109421213
UILC: 453A.04-03

Number: 202118016
Release Date: 5/7/2021
From: ----------------
Sent: Thursday, October 31, 2019 9:42:12 AM
To: ---------------------
Cc: ------------------------------------------------
Bcc:
Subject: Installment Sale Analysis

This is in response to your request for our analysis regarding “Monetized Installment
Sale” transactions. Note that because there are multiple promoters/sub-promoters,
there could be variations in the way transactions are structured. Some of the points
below might not apply to every transaction. However, there do seem to be common
features that make the transactions problematic. And we generally agree that the
theory on which promoters base the arrangements is flawed. The general structure
raises a number of issues including, but not limited to, the following:

1. No genuine indebtedness. At least one promoter contends that the seller
   receives the proceeds of an unsecured nonrecourse loan from a lender, but a
   genuine nonrecourse loan must be secured by collateral. A “borrower” who is
   not personally liable and has not pledged collateral would have no reason to
   repay a purported “loan.” See Estate of Franklin v. CIR, 544 F.2d 1045 (9th Cir.
   1976). Therefore, the loan proceeds would be income.

2. Debt secured by escrow. In one arrangement, the promoter states that the
   lender can look only to the cash escrow for payment. It appears that, in effect,
   the cash escrow is security for the loan to taxpayer. If so, taxpayer economically
   benefits from the cash escrow and should be treated as receiving payment under
   the “economic benefit” doctrine for purposes of section 453. Compare Reed v.
   CIR, 723 F.2d 138 (1st Cir. 1983).

3. Debt secured by dealer note. Alternatively, the Monetization Loan to taxpayer is
   secured by the right to payment from the escrow under the installment note from
   the dealer. This would result in deemed payment under the pledging rule, under
   which loan proceeds are treated as payment of the dealer note. Section
   453A(d).

4. Section 453(f). The intermediary does not appear to be the true buyer of the
   asset sold by taxpayer. Under section 453(f), only debt instruments from an
   “acquirer” can be excluded from the definition of payment and thus not constitute
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     payment for purposes of section 453. Debt instruments issued by a party that is
     not the “acquirer” would be considered payment, requiring recognition of gain.
     See Rev. Rul. 77-414, 1977-2 C.B. 299; Rev. Rul. 73-157, 1973-1 C.B. 213; and
     Wrenn v. CIR, 67 T.C. 576 (1976) (intermediaries ignored in a back-to-back sale
     situation).

5. Cash Security. To the extent the installment note from the intermediary to the
   seller is secured by a cash escrow, taxpayer is treated as receiving payment
   irrespective of the pledging rule. Treas. Reg. section 15a.453-1(b)(3)(“Receipt of
   an evidence of indebtedness which is secured directly or indirectly by cash or a
   cash equivalent . . . will be treated as the receipt of payment.”)

6. NSAR 20123401F is distinguishable. The case addressed in the memorandum
   did not involve an intermediary. Further, loans to a disregarded entity wholly
   owned by seller were secured by the buyer’s installment notes, but the pledging
   rule of section 453A(d) was not applicable. There is an exception to the pledging
   rule for sales of farm property, which applied in the case.

Thank you, and please let us know if you have any questions.

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