Monetized installment sale transactions (“MISTs”) have been on the IRS’s radar for some time.  On May 7, 2021, IRS Chief Counsel issued an advice memorandum, contending such transactions were “problematic” and “flawed”.[1]  And shortly thereafter, on July 1, 2021, MISTs found themselves on the annual IRS “Dirty Dozen” list, or the publication the IRS uses to alert the public of abusive transactions.[2]  The IRS’s “Dirty Dozen” list for 2022 and 2023 also includes MISTs.[3]

The goal of a MIST centers on a taxpayer’s attempt to defer gain (often capital gain) associated with the transfer of a substantially appreciated asset. In a standard MIST, the taxpayer enters into the following transactions, often the aid and assistance of a material advisor or promoter:

  • First, the taxpayer-seller transfers title of the appreciated property to an intermediary (who may, or may not be, the promoter).  In exchange, the intermediary issues an installment note to the seller (the “Intermediary Note”).  Generally, the Intermediary Note requires the intermediary to pay only annual interest payments with a large balloon payment at the end of the loan term. 
  • Second, the intermediary transfers title of the property to the buyer in exchange for the full purchase price.  The intermediary, and not the taxpayer-seller, receives the purchase proceeds. 
  • Third, the intermediary lends funds to the taxpayer-seller, which represents the funds from the sale, minus the intermediary’s fees.  In exchange, the taxpayer-seller agrees to enter into another note with the intermediary (“Seller Note”).  Generally, the Seller Note has the same loan terms as the Intermediary Note. 

In effect, the taxpayer-seller has received the proceeds from the sale of the appreciated property. However, the promoter advises the taxpayer-seller that no gain must be recognized from the sale in the year of the property transfer under section 453 of the Code, which deals with the postponement of gain for installment sales. Under the promoter’s view, the gain must be recognized only in the tax year in which the balloon payment associated with the Intermediary Note is made.

To better identify taxpayers and material advisors to MISTs, the IRS issued proposed regulations on August 4, 2023 (the “Proposed Regulations”).  The Proposed Regulations, if finalized, would require taxpayers and material advisors who participated in MISTs to disclose their participation to the IRS.  Generally, taxpayers who entered into MISTs would be required to file Form 8886, Reportable Transaction Disclosure Statement.  Material advisors, on the other hand, would be required to disclose their participation in MISTs through filing Form 8918, Material Advisor Disclosure Statement

A taxpayer’s failure to timely and properly file a Form 8886, where required, may be costly and expensive. Under section 6707A, the IRS may impose a 75% penalty on the decrease in tax associated with a listed transaction; under section 6662A, the IRS may impose a 30% accuracy-related penalty on any understatement of tax associated with a listed transaction. Moreover, the statute of limitations for the IRS to assess additional tax remains open indefinitely under section 6501(c)(1), until the taxpayer files a Form 8886.

Material advisors are not immune to the panoply of listed transaction penalties. Under section 6707, their failure to timely and properly file Form 8918 may result in a civil penalty equal to the greater of $200,000 or 50% of the gross income derived from each MIST. In addition, material advisors are required to maintain a list of all of their clientele and to provide a complete client list to the IRS upon request. Their failure to provide a client list may result in additional civil penalties.

Although the Proposed Regulations remain unfinalized, the IRS’s message is clear:  the IRS will seek to identify taxpayers and material advisors who have entered into MISTs and, to the extent these persons are identified, will challenge any contention that the gain from a MIST should be deferred until a later tax year.  Accordingly, taxpayers who have entered into MISTs should consult with their tax professionals to determine what options they may have available to them prior to the likely finalization of the Proposed Regulations.  

[1] CCA 202118016.

[2] IR-2021-144.

[3] IR-2022-113; IR-2023-71.