PORTFOLIO

Installment Sales (Portfolio 565)

Tax Management Portfolio, Installment Sales, No. 565-3rd, explains the tax treatment of transactions completed under the installment method. An installment sale is a disposition of property in which one or more payments are received by the seller after the close of the taxable year in which the sale occurs. If a disposition qualifies as an installment sale, the installment method permits the seller to report the gain and pay the associated tax over the period during which the payments are received. The installment method of reporting mandatorily applies to all qualifying installment sales unless the seller makes a specific election not to use the installment method.

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DESCRIPTION

Tax Management Portfolio, Installment Sales, No. 565-3rd, explains the tax treatment of transactions completed under the installment method. An installment sale is a disposition of property in which one or more payments are received by the seller after the close of the taxable year in which the sale occurs. If a disposition qualifies as an installment sale, the installment method permits the seller to report the gain and pay the associated tax over the period during which the payments are received. The installment method of reporting mandatorily applies to all qualifying installment sales unless the seller makes a specific election not to use the installment method.

Installment sale treatment is generally available only with respect to dispositions by nondealers. Dealers in both personal and real property are generally barred from using the installment method to report sales gain. However, a limited exception from this disallowance permits installment sale treatment for sales by dealers of farm property, and dealer sales of time-shares and unimproved residential lots, provided the dealer elects to pay interest on the tax deferred from use of installment reporting.

This portfolio describes the history and application of prior law pertaining to installment sales, and analyzes and discusses: (1) the eligibility requirements and restrictions for use of the installment method; (2) the computation of gain on installment sales; (3) the determination of when payments are received or deemed received on installment obligations; (4) the tax consequences of the sale, exchange or other disposition of an installment obligation; and (5) other collateral matters relating to installment sales.

The benefits of the installment method of reporting gain on installment sales are limited by a number of statutory rules including the following: (1) recapture income arising from an installment sale must be recognized in the year of sale; (2) interest must be paid on the tax attributable to the deferred gain where installment obligations arising in a taxable year exceed a certain threshold amount; (3) the pledging of certain installment obligations is treated as a payment which results in the recognition of gain; and (4) a disposition of an installment obligation generally triggers the recognition of any deferred gain remaining on the sale.


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AUTHORS

LISA MARIE STARCZEWSKI
Lisa Marie Starczewski, J.D. (summa cum laude), Villanova University School of Law; B.A. (magna cum laude), Smith College. Starczewski served as Editor-in-Chief of the Villanova Law Review (1987–88) and has practiced law with Morgan, Lewis & Bockius and Schnader, Harrison, Segal & Lewis. She taught at Villanova University School of Law. Ms. Starczewski has authored and coauthored several Accounting Policy and Practice Portfolios, including 5101, Revenue Recognition: Fundamental Principles; and 5114, Accounting for Leases: Fundamental Principles. She has also authored numerous Tax Management Portfolios, including 714 T.M., Partnerships — Allocation of Liabilities; Basis Rules; 587 T.M., Noncorporate Alternative Minimum Tax, 752 T.M., Corporate Alternative Minimum Tax, 621 T.M., IRS National Office Procedures — Rulings, Closing Agreements, 550 T.M., At-Risk Rules, co-author, 517 T.M., Scholarships and Educational Expenses. She is also the author and co-author of numerous Tax Practice Series chapters. She has received the Tax Management Distinguished Author Award and is a member of the Tax Management U.S. Income Advisory Board.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction to Installment Method

A. In General

1. Basic Rules

2. Restrictions on Use of Installment Method

B. Historical Background

1. In General

2. Statutory Structure

II. Eligibility for Use of Installment Method

A. In General

B. Dispositions by Accrual Method Taxpayers

C. Dispositions of Inventory

D. Dispositions by Dealers of Real or Personal Property

1. In General

2. Definition of Dealer Disposition

a. Personal Property Dealers

b. Real Property Dealers

3. Exceptions for Farm Property, Timeshares and Residential Lots

a. Farm Property

b. Timeshares and Residential Lots

(1) In General

(2) Interest Charges on Sales of Timeshares and Residential Lots

(3) Carrying Charges

E. Sales of Publicly Traded Property

1. In General

2. Authority to Prevent Avoidance

F. Sales of Depreciable Property to Related Persons

1. Related Persons Defined

a. In General

b. Controlled Group

c. Constructive Ownership of Stock

2. Exception for Non-Tax-Avoidance

G. Revolving Credit Plans

H. Dispositions of Interests Representing Income from Services Rendered

III. Computation of Gain on Installment Sales

A. In General

B. Determining Gain

1. Selling Price

2. Adjusted Basis

3. Selling Expenses

4. Gross Profit

5. Contract Price

6. Gross Profit Percentage

7. Sample Computations

C. Recapture Income

D. Contingent Payment Sales

1. In General

2. Sales with Stated Maximum Selling Price

3. Sales with Fixed Payment Period

4. Sales with No Maximum Selling Price or Fixed Payment Period

5. Alternative Methods of Basis Recovery

a. Income Forecast Method

b. Rule to Prevent Substantial Distortion

(1) Basis Recovery Inappropriately Deferred

(2) Basis Recovery Inappropriately Accelerated

E. Self-Canceling Installment Notes (SCINs)

IV. Payments Received or Deemed Received on Installment Obligations

A. In General

B. Evidences of Indebtedness

1. Indebtedness of Person Other Than Purchaser

2. Cancellation of Indebtedness

3. Demand Notes and Readily Tradable Obligations

a. Obligations Payable on Demand

b. Readily Tradable Obligations

(1) Registered Form

(2) Designed to Be Readily Tradable

(3) Convertible Obligations

c. Amount Treated As Payment

4. Mortgages and Other Liabilities of Seller Assumed or Paid by Buyer

a. Qualifying Debt

(1) Mortgages Assumed by Buyer

(2) Wraparound Mortgage

b. Nonqualifying Debt

5. Security Arrangements

a. Third Party Guarantees and Standby Letters of Credit

b. Third-Party Debt

c. Escrow Accounts

6. Proportionate Disallowance Rule (Prior Law)

C. Payments Before Year of Sale

V. Installment Sales by Nondealers - The Interest and Pledge Rules

Introductory Material

A. Installment Obligations Subject to Interest and Pledge Rules

B. Installment Obligations to Which Interest Charge Applies

1. $5 Million Threshold Requirement

2. Computation of Interest

C. The Pledge Rule

1. Loan Proceeds from Pledged Obligation Treated as Payment

2. Reporting of Payments

3. Repledges

VI. Resales of Property by Related Persons

A. In General

B. Definition of Related Person

C. Limitation on Amount Treated as Received

D. Interaction Between Related-Party Resale Rules and Sales of Depreciable Property

E. Exceptions to Related Party Resale Rules

F. Extension of Statute of Limitations

VII. Nontaxable Exchanges

A. Like-Kind Exchanges Involving Installment Obligations

B. Like-Kind Exchanges Involving Installment Obligations and Other Boot

C. Regulations Related to Like-Kind Delayed Exchanges Involving Installment Obligations

D. Other Tax-Free Exchanges

1. Section 356 Exchanges

2. Section 351 Exchanges

VIII. Dispositions of Installment Obligations

A. In General

B. Transactions Generally Resulting in Taxable Dispositions

1. Sale, Exchange or Gift

2. Substantial Changes or Modifications

3. Cancellation of Installment Obligation

4. Corporate Distributions

a. In General

b. Twelve-Month Liquidations and Shareholder-Level Gain

(1) Qualification Rules

(2) Computational Rules

5. Conversion of Convertible Installment Obligation

6. Transfer to a Trust

7. Transfer to Life Insurance Company

C. Transactions Generally Not Resulting in Taxable Dispositions

1. Renegotiation of Sales Price

2. Substitution of Obligor

3. Nonrecognition Transfers to Controlled Corporation and Nonrecognition Corporate Reorganizations

4. Complete Liquidation of Subsidiary

5. Partnership Transactions

a. Contributions to Capital

b. Partnership Distributions

c. Contribution/Distribution of § 704(c) Property

6. Transfers of Installment Obligations at Death

7. Transfer Between Spouses or Incident to Divorce

8. Liquidating Distribution by S Corporation

IX. Electing Out of Installment Method

A. In General

B. Revocation of Election

C. Election Out by Partnerships and S Corporations

D. Treatment of Installment Sale When Election Made

X. Tax Treatment of Deferred Payment Sales Not Reported Under the Installment Method

A. In General

B. Section 1001 Rules

1. In General

2. Treatment of “Debt Instruments” Issued for Property

3. Contingent Payment Debt Instruments

C. Section 453 Temporary Regulations

1. In General

2. Fixed Amount Obligations

3. Contingent Payment Sales

XI. Other Collateral Matters

A. Alternative Minimum Tax

B. State Tax Matters

C. Imputed Interest

1. In General

2. Application of Imputed Interest Rules

D. Default and Repossession of Real Property

1. In General

2. Computation of Gain

E. Passive Loss Rules


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Excerpts from S. Rep. No. 1000 on the Installment Sales Revision Act of 1980

Worksheet 2 Excerpts from S. Rep. No. 313 on the Tax Reform Act of 1986

Worksheet 3 Excerpts from H.R. Rep. No. 841 (Conf.) on the Tax Reform Act of 1986

Worksheet 4 Excerpts from H.R. Rep. No. 495 (Conf.) on the Omnibus Budget Reconciliation Act of 1987

Worksheet 5 Excerpts from H.R. Rep. No. 795 on the Technical and Miscellaneous Revenue Act of 1988

Worksheet 6 Excerpts from H.R. Rep. No. 247 on the Omnibus Budget Reconciliation Act of 1989

Worksheet 7 Ticket to Work Incentive Improvement Act of 1999, P.L. 106–170, 114 Stat. 3061, § 536

Worksheet 8 Installment Tax Correction Act of 2000, P.L. 106-573, § 2

Worksheet 9 Client Letter: Electing Out of Installment Method

Worksheet 10 Nondealers' Use of Installment Method - Computation of Interest Charge and Effects of Pledge Rule

Worksheet 11 Dealers' Use of Installment Method - Computation of Interest Charge

Bibliography

OFFICIAL

Internal Revenue Code:

Public Laws:

Legislative History:

Revenue Rulings and Procedures:

Cases:

UNOFFICIAL

Tax Management Portfolios:

Articles:

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