installment reporting for income tax purposes · installment reporting for income tax purposes ......

Installment Reportingfor Income Tax Purposes

by Randall W. Roth andJohn T. Kearns

Randall W. Roth, Denver, is in the privatepractice of law as a shareholder-employee ofRandall W. Roth, P.C. He is also an AssistantProfessor of Accounting at Metropolitan StateCollege. John T. Kearns, Denver, is in the pri-vate practice of law as a shareholder-employee of John T. Kearns, P.C.

Section 453 of the Internal RevenueCode grants taxpayers the election to re-port the gain from the sale or other dis-position of certain property on the in-stallment method for income tax pur-poses regardless of their regular methodof accounting.I By making this election,a taxpayer can spread the amount of gainover the number of tax years in whichpayments are received, thereby defer-ring the payment of taxes and avoidingan unusually high marginal tax bracketfor the year of sale. Appreciation of thepotential advantage of this method ofreporting gain requires an understandingof the alternatives.

DEFERRED PAYMENT SALEUNDER TAXPAYER'S REGULAR

METHOD OF ACCOUNTING

If § 453 is not available or if it isavailable but is not elected, the gainfrom a sale or exchange of property willgenerally be recognized for tax purposesin the year of sale. 2 This results eventhough the seller may receive little or nocash in that year. The amount of the gainin the year of sale will depend upon thetaxpayer's regular method of account-ing.

Cash basis taxpayerUpon the sale or exchange of proper-

ty, a cash basis taxpayer must include inthe amount realized from the sale or ex-change the cash received as well as thefair market value (hereinafter referred toas "FMV") of any other property re-ceived. 3 The taxpayer's recognized gainfor the year of sale is the difference be-tween the amount realized and his basisin the property sold or exchanged.' Thecharacter of this gain (capital or ordi-nary) will depend upon the nature of theproperty sold or exchanged, as well asthe taxpayer's holding period for thatproperty. 5 If the payments to be re-ceived by the taxpayer have a face valuein excess of the FMV which was in-cluded in the amount realized, this ex-cess will be treated as ordinary incomeand a portion of such excess must bereported in each year in which a deferredpayment is received.

To illustrate the income tax results ofa deferred payment sale by a cash basistaxpayer, assume the following facts.

S sells a tract of land in 1976 to B fora total sales price of $100,000. B makesa $20,000 down payment and gives S an$80,000, 6 percent promissory note,payable $10,000 of principal per yearover the next 8 years. Because of thelow rate of interest and the term of the

THE COLORADO LAWYER

note, the note has a FMV of only$60,000. S had paid $10,000 for theland in 1970 and has held it strictly forinvestment purposes.

Being a cash basis taxpayer, S wouldinclude the amount of cash, $20,000,and the FMV of other property received,$60,000, in his amount realized; less his$10,000 basis, S will report a recog-nized gain of $70,000 in 1976. Since theproperty sold was a capital asset and Shad a holding period in excess of sixmonths, this $70,000 will be reported asa long-term capital gain. In 1977 when Sreceives his first $10,000 deferred pay-ment, he will have to report $2,500 asordinary income while the remaining$7,500 will constitute a return of capitaland be tax-free.

To understand why $2,500 of thispayment has to be reported and why it isreported as ordinary income, keep inmind that S expects to receive $80,000of principal payments from B over theeight-year period following the year ofsale. Irrespective of that fact, he wasrequired to include only $60,000, thenote's FMV, in his amount realized forpurposes of computing the gain on thesale. The excess of the note's face valueover its FMV, which was not includedin S's amount realized, will presumablybe received by S over the eight-yearperiod. Since gross income includes all"gains from dealings in property" this$20,000 must be taken into income by Sas it is received. 6 This income generallydoes not qualify for capital gains treat-ment as it results from collection of anote rather than a sale or exchange.7

Even though there are no assurances thatthe full face value of B's note will becollected, S cannot delay recognition ofthe ordinary income amounts until hehas realized a complete return of capital.Instead, only a percentage of each pay-ment can be considered as a return ofcapital.8 That percentage is determinedby dividing the face value of the note

into its FMV at the date of sale. In theabove example, $60,000/$80,000 or 3/4

of each payment represents a return ofcapital; the remaining / has to be re-ported as ordinary income. In addition,any interest received by S will be re-ported as ordinary income for the year ofreceipt.9

In the above example, it was assumedthat B's note had an ascertainable FMV.In rare situations, it may be impossibleto value B's obligation with any reason-able degree of certainty. This may beparticularly true if the amount of B's ob-ligation is based upon factors unknownat the time of sale, such as future profits.When such a situation exists, the selleris allowed to exclude the obligationsfrom his amount realized. The paymentsreceived by the seller are treated as areturn of capital up to the amount of hisbasis in the property sold. Once his basishas been completely recovered, all addi-tional payments are taxed when re-ceived.10 The character of this income isdetermined by the circumstances of theoriginal sale. In the above example, Swould, under this cost recovery ap-proach, spread his taxable gain over thenine-year period (the $10,000 basis hav-ing been recovered in the year of sale)and, except for interest, all incomewould be reported as long-term capitalgain.

Of course, the cost recovery methoddoes not apply to S in the above examplesince B's note was subject to valuation.Furthermore, it is only in rare and ex-traordinary cases that the buyer's obliga-tion will be considered to have noFMV. 1 The fact that the buyer's obliga-tion may have a FMV considerablybelow its face amount does not qualifythe seller to utilize the cost recovery ap-proach. 1 2 Non-negotiability of thebuyer's obligation may affect theamount of its FMV, but it generallydoes not permit the use of the cost re-covery method.'"

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INSTALLMENT REPORTING FOR INCOME TAX

Accrual basis taxpayerAn accrual basis taxpayer must in-

clude income when "all events have oc-curred to establish the right to the in-come and the amount thereof can be de-termined with reasonable accuracy."1Furthermore, there must be at least areasonable expectation that the amountwill eventually be received.' 5 Since it isthe right to receive, rather than actualreceipt, that determines inclusion intoincome, an accrual basis taxpayer musttake the entire selling price into theamount realized, even if the FMV of thebuyer's obligation is substantially belowits face value. To illustrate, in the aboveexample S would have an amountrealized of $100,000, cash received of$20,000 plus the $80,000 face value ofB's obligation; less his $10,000 basis,S's gain would be $90,000. It would allbe reported as long term capital gain in1976, the year of sale. Interest would bereported as ordinary income when it wasearned.

Although its applicability is uncer-tain, the regulations under § 453 seem togive an option to the accrual basis tax-payer who sells real property on a defer-red payment basis. 16 It purports to allowsuch a seller to include only the FMV ofthe buyer's obligation, rather than faceamount, in the amount realized from thesale. Basically, this enables the accrual

basis taxpayer in that narrow situation toreport his gain in the same way as itwould have to be reported by a cashbasis taxpayer.Problems without installment reporting

As discussed above, whether the sell-er is normally on the cash basis or theaccrual basis, a deferred payment salewill almost always create two substan-tial problems. Both problems stem fromthe fact that the greatest portion of thegain will have to be recognized in theyear of the sale. First, by lumping all ormost of the gain into one taxable year,the seller may find himself in an unusu-ally high marginal tax bracket. Second,the resulting tax on the recognized gainwill be due relatively soon after the ac-tual sale even though the down paymentreceived by the seller might be substan-tially less than the taxes which are due.

The seller may be able to negotiate orotherwise transfer the buyer's obligationin order to raise more cash. Even if theobligation is transferable, however, itmay not be desirable for the seller to dothis for any one of a number of reasons.For example, if the obligation is securedby the property itself, he may wish toretain the obligation to preserve his rightto regain the property in the event of asubsequent default. Also, the obligationmay be transferable only at a substantialdiscount even though the accrual basis

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taxpayer had to include its full facevalue in computing his gain on the sale.

APPLICATION OF SECTION 453

Assuming that § 453 is available to Sin the example above, a much differenttreatment results. S still has a realizedgain of $90,000 ($100,000 selling priceminus $10,000 basis), but his recog-nized gain in the year of sale and futureyears is limited to a percentage of thepayments received in each of thoseyears. The percentage is computed inthis example by dividing the $90,000gain by the $100,000 selling price.

Since $20,000 is received by S in1976, he will report a long-term capitalgain for that year of $18,000 ($20,000x 90 percent). In 1977, when S receivesthe first $10,000 payment, he will reporta long-term capital gain of $9,000($10,000 x 90%). Of course, any inter-est received from B will be reportedseparately, in accordance with S's regu-lar method of accounting, as ordinaryincome.

Keeping in mind the general advan-tage of electing installment reporting,the remainder of this article reviews therequirements of § 453, who can elect itsprovisions, when the election must bemade, how the transaction must bestructured, how the statute operates, andthe tax results of a disposition of thebuyer's obligation.

PERSONS ELIGIBLE TOELECT INSTALLMENT REPORTING

Section 453 limits the availability ofinstallment reporting to (1) dealers inpersonal property, (2) persons who en-gage in casual sales of personal propertyfor a price exceeding $1,000, and (3)persons who sell real property.'" The lat-ter two groups must satisfy a further re-quirement that payments deemed re-ceived in the year of sale cannot exceed

30 percent of the sales price.1 8 Althoughthis article concentrates on the latter twogroups, a general outline concerningdealers in personal property follows.

Dealers in personal propertyA dealer is one who regularly sells or

otherwise disposes of personal propertywhich is regarded as his inventory. Hecan qualify for § 453 if he regularly sellson the installment plan or under a re-volving credit plan. Basically, theamount of gain which must be recog-nized in any year is that proportion ofthe payments received in that year whichthe total gain realized on qualified salesbears to the total contract price of suchsales. No requirement exists as to theamount of each sale or the amount of theinitial payments received. 19

Sales on an installment plan or a re-volving credit plan must contemplatepayment in at least two installments.Furthermore, sales on an installmentplan must actually result in at least twoseparate payments. When some sales aremade on an installment plan and otherson open account, an election can bemade as to the former but the latter willnot qualify for § 453 treatment. 20

The election can be made in the firstyear in which sales under an installmentplan or revolving credit plan are made,without obtaining the approval of theInternal Revenue Service (hereinafterreferred to as "IRS"). 2 ' The electionmust be made on a timely filed incometax return for the taxable year of theelection.2 2 Upon default by the pur-chaser, the dealer may deduct, as a baddebt, the adjusted basis of the unpaidobligations. However, if the property isrepossessed, a disposition of the obliga-tion is considered to have occurred andthe dealer will recognize gain or loss tothe extent of the difference between theFMV of the repossessed property andthe adjusted basis of the obligation. 2 3 Inthis situation, the FMV becomes the

762 June


dealer's new basis in the repossessedproperty. The dealer on the installmentbasis can discontinue the election at anytime without prior approval of theIRS .24

Sales of personal and real propertyThe casual sale of personal property

and dispositions of real property will bediscussed together since the rules relat-ing to these two categories are quitesimilar, except for the $1,000 minimumsales price for the casual sales of per-sonalty.

Section 453 is available to personsfalling into either of these categoriesonly so long as payments received in theyear of sale do not exceed 30 percent ofthe selling price. 2 5 Furthermore, al-though no payments are required to bereceived in the year of sale in order toqualify for installment reporting, theIRS has taken the position that at leasttwo separate payments, in at least twoseparate years, must be made in order toqualify. 2 6 Since the position of the IRShas been upheld,2 7 in structuring trans-actions intended to qualify for install-ment reporting it is imperative that therebe a down payment in the year of sale orpayment in some other year prior to a"balloon" payment in the final year.Whether a token down payment in aneariy year coupled with a balloon pay-ment in the final year will pass IRS

scrutiny remains an undecided question.However, this literal compliance withthe position of the IRS may prove to be asimple solution to this practical prob-lem.

PAYMENTS RECEIVED INTHE YEAR OF SALE

In structuring a transaction to qualifyfor installment reporting, normally themajor concern is that payments in theyear of sale do not exceed 30 percent ofthe selling price. If the payments exceedthe 30 percent figure by even one dollar,§ 453 does not apply.2 8 Undoubtedly,the possibility of this unhappy result ex-plains the conservative approach whichcalls for a 29 percent down payment,even though 30 percent is permitted.

Several easily overlooked factors cancause an unintentional failure to limitthe payments received in the year of saleto the 30 percent maximum. Amountspaid to the seller in years preceding theyear of sale, such as earnest money oroption payments, which are creditedagainst the purchase price in the year ofsale, are considered to be payments inthe year of sale.2 9 Furthermore, pay-ments received in the year of sale in-clude payments, other than the downpayment, which are made by the pur-chaser during the seller's taxable year inwhich the sale occurs.3 0 Consequently,

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a prepayment of an installment whichwas not due until the first day of theseller's taxable year following the yearof the sale would be added to the downpayment for purposes of applying the 30percent test.31

To avoid both of these problems, thecontract of sale should limit the downpayment to that amount which, whenadded to monies already received,equals no more than 30 percent of sell-ing price. Furthermore, prepayments inthe year of sale should be expressly pro-hibited to the extent they would causetotal payments already received beforeand during the year of sale to exceed the30 percent ceiling.

Assumption of mortgageA further problem can result when the

property to be sold is encumbered by amortgage or any other security interest.Generally, the buyer can assume thedebt or take the property subject to theoutstanding mortgage without theamount of the mortgage being added tothe payments deemed to have been re-ceived by the seller in the year of sale.3

1

However, an important exception to thisgeneral rule can result in the loss of in-stallment reporting to the unwary seller.If the amount of the mortgage indebted-ness exceeds the seller's adjusted basisin the property, the excess is treated as apayment in the year of sale. 3 3 Forexample, assume that property with anadjusted basis of $10,000 is sold for$100,000. The buyer assumes an exist-ing $11,000 mortgage and makes a$30,000 (30 percent of selling price)down payment. Section 453 will not beavailable because when the $1,000 ex-cess of the mortgage over basis is addedto the $10,000 down payment, a viola-tion of the 30 percent ceiling results.

Wrap-around mortgagesObviously, the problem in the above

example could have been circumvented

merely by reducing the down paymentby the $1,000 excess. But what if themortgage had been $50,000 instead of$11,000? Now the excess itself exceedsthe 30 percent ceiling. A viabletechnique for qualifying such a situationfor installment reporting requires thatthe property be sold for its unencum-bered value and that the seller remainliable and continue to make payments onthe mortgage. Even though the existingmortgage constitutes a superior lien onthe property, the Tax Court has reasonedthat the buyer neither assumed themortgage nor acquired the property sub-ject to it since the purchase price was notreduced by the amount of themortgage.34 Under the general rule, theobligation of the buyer to the seller isnot considered to be a payment in theyear of sale. 35 This obligation is gener-ally structured as a second mortgage onthe property and is often referred to as awrap-around mortgage.

In order to illustrate the advantageoususe of a wrap-around mortgage, con-sider the following situation:

S has a $50,000 basis in a piece of realproperty which is subject to a $150,000mortgage. He wishes to sell it to B for$300,000. S wants the transaction toqualify for installment reporting and hewants to receive some cash initially.

If B assumes the mortgage, the excessof the mortgage over S's basis will beconsidered to be a payment received byS in the year of sale. Since this amountalone ($150,000 - $50,000 =$100,000) exceeds the 30 percent limita-tion (30 percent of $300,000 =$90,000), installment reporting will notbe available. To remedy this, S couldtake back a $300,000 second mortgage(wrap-around mortgage) and agree topersonally remain liable for and dis-charge the existing mortgage. Use of thewrap-around mortgage also permits adown payment of up to $90,000 (30 per-cent of $300,000 = $90,000). If this

764 June


were desired, S could receive up to thatamount as a down payment and takeback B's obligation for the remainder ofthe sales price, $210,000.

Pre-sale mortgagesIn the opposite situation, that is, when

the seller has a high basis and little or nooutstanding mortgage indebtedness, itmay be possible to structure the sale soas to yield cash of more than 30 percentof the sales price to the seller in the yearof sale and still qualify for installmentreporting. This is accomplished by hav-ing the seller mortgage the property justprior to the sale. The proceeds of thisloan would not be included in the pay-ments in the year of sale for purposes ofthe 30 percent test provided the sellerhad a substantial business reason formortgaging the property. The definitionof what constitutes a substantial busi-ness reason is as difficult in this situa-tion as in any other area of the tax law.The IRS would, however, probablyclaim the lack of a business purpose ifthe only reason is to generate more cashin the year of sale than could otherwisebe received and still qualify under §453.36 In one case, the fact that thebuyers did not have sufficient resourcesto obtain mortgages on their own was

deemed reason enough for the seller tomortgage the property just prior tosale. 37 Arguably, the same result wouldfollow if the seller were able to obtain amore favorable interest rate for amortgage than the buyer.

Assumption of unsecured liabilitiesAs previously discussed, the buyer's

assumption of a mortgage on the realproperty sold is not considered as apayment received in the year of sale,provided that the debt does not exceedthe seller's basis. Case law has extendedthis approach to include the assumptionof unsecured liabilities having nospecific relationship to the assets pur-chased which were paid by the buyer inthe year of sale." The IRS has acceptedthis treatment in the case of a casual saleof personal property. It specifically li-mited its approval, however, to the situ-ation where these liabilities were incur-red in the ordinary course of businessand not for the purpose of avoiding the30 percent test.3 9 Furthermore, the IRShas indicated that it will continue to treatliabilities which are directed to be paidout of the original purchase price aspayment in the year of sale.40 Becauseof these added uncertainties, in the situa-tion where these liabilities are relatively

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THE COLORADO LAWYER

small, consideration should be given tohaving the seller pay them.

Imputed interestThe applicability of § 483 can also

result in the disqualification of an in-stallment sale for failure to meet the 30percent test. Section 483 may apply toall payments made after 1963 on thesale or exchange of property. 4' Thissection contains a number of specificrules and exceptions, but basically itstates that interest of 7 percent will beimputed to any obligation that does notitself provide for interest of at least 6percent. 4 2 Section 483 was primarilyenacted in retaliation to the situationwhere a seller would convert ordinaryincome into capital gains by simply in-creasing the selling price by the sameamount that was lost by not chargingany interest. If the seller was in a highertax bracket than the buyer, overall taxsavings were realized even though thebuyer lost the interest deduction.

Unfortunately, the enactment of thisstatute also created a major problem forthe unwary seller who assumes that thecontracted selling price equates to theselling price for purposes of the 30 per-cent test for installment sales purposes.For example, with a selling price of$100,000 and a down payment of$29,000, the seller would normally feelsecure that he has qualified for install-ment reporting. However, if the buyer'sobligation in this case was noninterestbearing, then § 483 requires that interestbe imputed. If the remaining $71,000was due just over one year from the dateof the sale, interest of $4,721 would beimputed.4 3 The selling price wouldtherefore be reduced by that amount to$95,279, and since 30 percent of thisrecomputed selling price is approxi-mately $42 shy of the down payment,the 30 percent test is not met and the saledoes not qualify under § 453.44

In the planning stage, this problem

can be surmounted in either of twoways. The down payment can be re-duced so as to be less than 30 percent ofthe "adjusted selling price," that is, sel-ling price less imputed interest. In thealternative, interest of at least 6 percentcan be provided in order to make § 483inapplicable. What about the taxpayer,however, who learns about § 483 afterhis sale transaction has been closed? Isthere any action which can be taken?Although only unproven courses of ac-tion may be available, there is probablynothing to lose in attempting to utilizethem.

The seller should consider either a re-cision of the entire deal or a modifica-tion of its terms. If the seller is in a hightax bracket, he may prefer no sale to asale that results in recognition of his en-tire gain in the year of sale. There issome indirect authority for the proposi-tion that a sale can be rescinded and theparties returned to their original posi-tion. 4 5 However, the IRS could be ex-pected to interpret the recision as eithera repurchase or a repossession by theseller. (The results of these characteriza-tions are discussed below under "Dis-positions.") The correct interpretationwould seem to depend upon the intent ofthe parties in unwinding the transaction.If the transaction was based upon a mis-take of fact or law as of the day of sale,rather than a later change of mind, avalid argument could be made for reci-sion. On the other hand, this argumentwould be weaker as the time span be-tween the sale and the recision in-creases.

Unfortunately, a recision requires theagreement of both parties, which makesit an impractical alternative in most situ-ations. A second approach would be tohave the seller return the money re-ceived in the year of sale which ex-ceeded 30 percent of the adjusted salesprice. This money can then be repaid tothe seller at the beginning of his next

766 June


taxable year.4 6 Actually, this procedure,because it is based more in equity thanlaw, has only limited justification andshould be used as a last resort. Its valueis further strained as a result of a recentfinding by the Tax Court that a retroac-tive amendment to the sales contract inorder to reduce the selling price and addinterest did not suffice in an attempt toavoid the application of § 483.47

Constructive receiptSuppose a buyer offers to pay cash for

the property. If the seller rejects thisoffer and then negotiates a sale basedupon a payment schedule which willqualify the sale for installment report-ing, § 453 is applicable. 48 If the sellerwere to accept the original offer, how-ever, and then later determine that hedid not want to receive more than 30percent of the selling price in the year ofsale, the IRS might possibly argue thatthe seller could have received more than30 percent in the year of sale and that hetherefore was in constructive receipt ofan amount which disqualified him forinstallment reporting. This is generallytrue even if the seller demanded that thebuyer establish an escrow for the re-maining 70 percent so that the fundswould be beyond the seller's reach dur-ing the year of sale.4 9

If, on the other hand, the buyer hadrequested that such an escrow be utilizedas a substitution of security, then the ar-rangement should qualify for § 453treatment. 50 More than a mere requestfrom the buyer will be required; thestructure of the escrow arrangement isvital. If the arrangement actually resem-bles a vehicle providing security for theeventual payment of the buyer's obliga-tion, rather than an actual payment, theseller should qualify for installment re-porting. One important consideration inaccomplishing the desired result is to en-title the buyer, rather than the seller, tothe interest earned on the escrowed

amount. 5 Another consideration dic-tates that the buyer remain liable on hisobligation so that the seller looks to theescrow as security rather than payment.Unfortunately, the IRS has ruled thatsuch an escrow arrangement preventsinstallment reporting where the sellerwas not in fact relying on the installmentobligation of the buyer, but upon the es-crow. 52 Although the reasoning of theIRS in this matter is questionable, mosttaxpayers will want to avoid the potentialproblem. Therefore, additional steps willgenerally be necessary to emphasize thefunction of the escrow arrangement assecurity rather than as payment. Severalpossibilities exist.

First, the agreement could possibly bestructured so that the escrow could, atany time, be replaced by equallyadequate security or the furnishing of abond. Second, payments from the es-crow could be made subject to continu-ing fulfillment of the seller's covenantnot to compete, or some similar condi-tion, if applicable. Caution must beexercised in this latter approach, how-ever, as amounts due from a buyerwhich are allocable to the seller's co-venant not to compete are not consid-ered part of the selling price of the busi-ness, and therefore may reduce theamount of payments that can be receivedin the year of sale.5 3

The buyer's obligationIn applying the 30 percent test, pay-

ments in the year of sale generally donot include evidences of indebtedness ofthe buyer. 54 This is true even if thebuyer's obligation is negotiable. At onetime, § 453 did not distinguish betweenthe various types of evidences of indebt-edness of the purchaser which could beutilized in installment sale transactions.Now, however, the buyer's debt instru-ment cannot be a bond or other evidenceof indebtedness which is payable on de-mand or which is readily tradable on an

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THE COLORADO LAWYER

established securities market. Such aninstrument also cannot be with couponsattached or in registered form. Theselimitations create no problems in the typ-ical situation.

Obligations of a third partyThe buyer's obligation should not

constitute a payment to the seller, evenwhen it is guaranteed by a third party,and possibly even when it is secured bya pledge of property by the third party. 5

However, if the seller is given a note orother evidence of indebtedness of a thirdparty as part payment under the sale, theFMV of this item will be included in thepayments in the year of sale for purposesof the 30 percent test. This is the casewhether or not the buyer is liable as anendorser or guarantor of the note. 56

If the buyer's transfer of the thirdparty note to the seller would cause afailure to meet the 30 percent test, theseller should request that the buyer issuehis own note instead. If practicality dic-tates, the buyer can arrange to have thenote endorsed by the third party and/orsecured by the third party's note whichthe buyer now holds.

Liability of seller to buyerA further complication arises in the

situation where the seller is indebted tothe buyer at the time of the sale. Clearly,if the buyer, in part payment of the sel-ling price, cancels all or part of the sel-ler's debt to the buyer, the amount socancelled will be considered a paymentreceived by the seller in the year ofsale."7 Even if no portion of the seller'sdebt is cancelled, a potential problemstill exists. If each party's obligation tomake payment is conditioned upon thereceipt of payment from the other, it ispossible that the IRS will offset theliabilities and treat the double cancella-tion as mutual payments.5 8

This cancellation would not be war-ranted if the debts were separately en-

forceable or if the debt of either partycould be accelerated independently ofthe other. The buyer's obligation, how-ever, cannot be subject to accelerationbefore the year after the year of sale or itwill be included as a payment receivedin the year of sale. Perhaps the answerwhich would work in most cases is tohave the seller pay off his debt to thebuyer prior to the sale, even if thisnecessitates borrowing against the prop-erty which is about to be sold (see dis-cussion above on pre-sale mortgages).Where feasible, a simpler solutionwould be to either request that the buyerassign the seller's debt to a related party,or to sell the property in question to asubsidiary or other related party of thebuyer.

Like-kind exchangesThe installment method can be used

for reporting taxable gain on exchangesof like-kind property with "boot" in-volved. 9 However, this combinationwill, in most cases, prove to be imprac-tical since all of the cash and propertyreceived, including the like-kind prop-erty, must be included in the paymentsreceived in the year of sale. Any downpayment plus the value of the propertyreceived will almost always exceed the30 percent limitation.6 0

Sale and redemption of stockOccasionally, a shareholder in a

closely held corporation may want tosell his stock to someone who eitherwants stock in a corporation with fewerassets or lacks the resources to purchaseall of the stock. In such a situation, theshareholder may consider a "bootstrap"arrangement whereby he simultaneouslysells part of this stock to the purchasingparty and has the remainder of his stockredeemed by the corporation. Ideally,the redemption will qualify as a com-plete termination of his stock interest,and thereby result in capital gains treat-

768 June


ment.6 1 Such a transaction can qualifyfor installment reporting only if theamounts received in the year of salefrom both the sale and the redemptiondo not exceed 30 percent of the com-bined sales price and redemptionprice. 6 2

Multiple asset dispositionsWhen a taxpayer sells a going busi-

ness, the transaction is regarded as adisposition of the various assets con-stituting the business." The sametreatment results from the sale of othertypes of multiple assets under a singlesales contract." If sold under an in-stallment arrangement which meets therequirements of § 453, installment re-porting would be available regarding allof the assets sold, with the exception ofinventory and property sold at a loss forwhich § 453 cannot be utilized. Sincethe IRS has ruled that the initial pay-ments under a multiple asset sale will bepresumed to have been received for eachasset on a pro rata basis in proportion toits relative FMV, a down payment inexcess of 30 percent of the total sellingprice would cause a violation of the 30percent requirement for each and everyasset, thereby causing § 453 to be com-pletely unavailable. 6 5

This presumption, however, does notapply if the parties, at the time of thesale, agree to the contrary. The partiescan agree to a special allocation of thedown payment and/or the selling priceand thereby qualify the sale of all or partof the qualifying property for install-ment reporting. 6 6 For example, a 40percent down payment could be allo-cated to inventory and property sold at aloss; the buyer's obligation, which rep-resents the remaining 60 percent of totalselling price, could then be allocated tothe purchase of qualifying property.This special allocation is not foolproofand cannot be made after the fact, socareful tax planning is necessary to in-

sure that the seller and buyer agree uponsuch an allocation at the time of thesale. 67

A recent case stressed the need to es-tablish a reason other than the desire toutilize installment reporting for the allo-cation.68

While the fragmenting of a sale of agroup of assets in order to permit in-stallment reporting on some of them hasproven effective in several cases, com-bining sales of several assets into asingle sale in order to qualify for in-stallment reporting on an overall basis isnot so easy. In one case, the taxpayerbelatedly attempted to treat sales of apartnership and stock in a corporation asone single business unit in order to meetthe 30 percent test. The partnership andthe stock were sold at the same time, butseparate sales agreements were pro-vided. The court found that the taxpayershad conducted the businesses separatelyand viewed their sale as separate transac-tions. Consequently, these assets couldnot be brought together merely to servethe seller's tax objectives. 6 9

Fragmenting the sale of a single assetSometimes a taxpayer will want to

qualify a sale for § 453 treatment, butfor some reason needs more than 30 per-cent of the selling price as a down pay-ment. It is conceivable that the sale canbe structured in such a way as to make §453 at least partially applicable. In onecase, the taxpayer sold a tract of land for$262,800, of which $118,020 was paidimmediately in cash, the balance beingrepresented by the buyer's notes whichwere secured by a purchase moneymortgage on a portion of the land. Tak-ing into consideration testimony thatsuggested a logical division of the landinto two parcels, the Tax Court treatedthis as a sale of one tract for $98,350cash and a sale of the other tract (theland subject to the mortgage) for only$19,670 cash and notes of $114,780 (the

1976 769

THE COLORADO LAWYER

total face value of the buyer's notes)."oThus, in situations where the asset

sold has multiple purposes or lends itselfto being viewed as the aggregation ofseparate parts, this planning techniquemay enable a sizable down paymentwithout the total unavailability of § 453.The taxpayer should be cautioned as tothe uncertainty of this approach as it isbased upon a case with rather unusualfacts. Proper adherence to form, how-ever, may make this a viable approachin a situation which would otherwiseoffer no hope for installment reporting.

SALES BETWEENRELATED TAXPAYERS

Sometimes the taxpayer desires thebenefits of § 453 but does not reallywish to part with the property in ques-tion, or perhaps he wants the immediateavailability of more cash than would beallowed under the 30 percent limitationof § 453. To accomplish the first objec-tive, he may want to "sell" the propertyto his spouse or children on an install-ment basis. He receives the tax benefitsof § 453 but has kept the property withinthe family. If the need for cash out-weighs the desire to keep the propertywithin the family, the transferee familymember can "resell" the property to anoutsider and require much more than a30 percent down payment. It makes nodifference whether this second sale qual-ifies for § 453 as it will result in little orno gain since the second seller will havea cost basis equal to the selling price ofthe first sale." This arrangement is soattractive that it comes as no surprisethat the IRS has ruled that an installmentsale to a spouse, child or controlled cor-poration, coupled with a prearrangedsale to an outsider in the same year, willnot qualify for § 453. The rationale forone of the rulings in this area was thatthe "installment sale" lacked reality

and served no purpose other than to re-duce income taxes.7 2 The other rulingviewed the transferee spouse as merelyacting as the original owner spouse'sagent in effecting the sale of the prop-erty to the outsider.73

It should be noted, however, that theapplicability of these rulings dependsupon a finding of a prearranged plan toresell the property. In a recent case,7 4 aninstallment sale was made betweenspouses. The buying spouse, the hus-band, resold the property within thesame year. The husband used the pro-ceeds to satisfy a personal obligation.The IRS did not contend that a prear-ranged plan existed and the court foundnothing wrong with the transactions.Hence the original owner, the wife, con-tinued to report her gain on the install-ment basis even though her husband hadresold the property for cash. Since theyfiled a joint return for the year of thetransactions, both spouses benefitedfrom the availability of installment re-porting of the gain from the sale of theproperty from the wife to her husband.For planning purposes, four factors inthis case deserve emphasis. The secondsale was not prearranged, the spouseswere separate, healthy economic en-tities, the proceeds of the second sale bythe husband did not directly benefit hiswife, and the installment sale was madeat FMV.

What is or is not prearranged gets oneinto the metaphysical, nevertheless, forpractical purposes it probably dictates aCourt Holding/Cumberland approach. 75

That is, care should be taken thatnegotiations with the outside buyer arenot conducted by the original ownerspouse and should not begin prior to theinstallment sale between spouses. As forthe financially independent element,care should be taken to ensure thatneither spouse can be viewed as beingsubordinate to the other in their financialaffairs. In some situations, this may be

770 June


accomplished only through the use of atrust arrangement.

By having the taxpayer deal with atrustee, especially an independent trus-tee, the appearance of arm's-length deal-ing is preserved. In fact, utilization of atrust also served in one case to success-fully combat the application of the"prearrangement" theory detailed in therevenue rulings discussed earlier.7 6

In that case, the taxpayer sold stock ina closely held corporation to an irrevoc-able trust on the installment basis afterthe corporation had adopted a § 337one-year plan of liquidation. Althoughthis prearranged liquidation was the taxequivalent of a prearranged resale, thecourt allowed the taxpayer to utilize §453 because the sellers had parted withall control over the proceeds from thesecond sale (the liquidation) and derivedno economic benefit from the liquida-tion.

MECHANICS OFINSTALLMENT REPORTING

Section 453 allows the taxpayer tospread the gain realized from the in-stallment sale over the taxable years inwhich payments are received. In orderto compute the taxable gain in any par-ticular year, a formula must be deter-mined at the time of the sale. This for-mula only makes sense after a completeunderstanding of the terminology is ac-quired.

Selling priceThe selling price is the total amount

involved in the sale. It includes cash, theFMV of any other property received bythe seller, and the face amount of anynotes or other evidences of indebtednessof the buyer. If there is an existingmortgage on the property, it is also in-cluded as a portion of the selling price,as long as it is either assumed by thebuyer or the property is sold subject to

the mortgage. Since § 453 is availableonly if the payments received by the sel-ler in the year of sale do not exceed 30percent of selling price, knowledge ofthe exact amount of the selling price isessential. As discussed earlier in this ar-ticle, the amount of the selling price isnot always obvious.

Generally, the total selling price mustbe ascertainable at the time of sale inorder for the seller to qualify for install-ment reporting. 7 However, the IRS re-cently ruled that a nonascertainable salesprice in a casual sale of personal prop-erty did not prevent use of installmentreporting by the seller as long as thesales price became ascertainable beforethe end of the seller's taxable year.78The same rule would logically extend tothe sale of real property.

Gain realizedThe gain realized is calculated by sub-

tracting the selling expenses and the sel-ler's adjusted basis in the property soldfrom the selling price. Gross profit is aterm often used in lieu of gain realized.

Contract priceThe contract price is the total amount

to be received by the seller from thebuyer. In a sense, it is the seller's equityin the property at the time of sale. Forexample, if S sells to B property whichis subject to a $50,000 mortgage for aselling price of $200,000, in exchangefor a $20,000 down payment and B'sobligation with a face value of$130,000, the contract price is$150,000. (This assumes that S's basisin the property exceeded the mortgage.)

An exception to the general rule oc-curs when the amount of the mortgageon the property exceeds S's basis, inwhich case that excess is treated as partof the contract price. If S's basis in theabove example was only $40,000, thecontract price would be increased by the$10,000 excess of mortgage over basis,

1976 771

THE COLORADO LAWYER

resulting in a contract price of $160,000.The contract price is also increased by

the amount of certain liabilities of theseller which are paid by the buyer. If theliabilities arose directly out of the saleitself (i.e., brokerage fees, legal and ac-counting costs), as opposed to liabilitieswhich had been incurred by the seller inthe ordinary course of business, theamount assumed or paid by the buyer willincrease both the payments received inthe year of sale and the contract price."

Payments received in the year of saleKnowledge of the exact amount of the

payments received in the year of sale bythe seller is essential in order to ensurecompliance with the 30 percent test. Asdiscussed earlier in this article, pay-ments in the year of sale include morethan just the down payment; such pay-ments can also include earnest and op-tion money received in years before theyear of sale, any payments actually orconstructively received during the yearof sale, and certain evidences of indebt-edness of the buyer (e.g., marketablebonds, demand notes).

Gross profit percentageThe gain which is recognized and

therefore taxable in any year is deter-mined by multiplying the amount ofpayments received in that year by thegross profit percentage. This percentageresults from the division of the contractprice into the gross profit.

For example, S sells property, with abasis of $100,000 and subject to a$50,000 mortgage, to B for a sellingprice of $200,000. B makes a downpayment of $60,000 and gives hisinterest-bearing note, payable $10,000per year for nine years beginning in theyear after the year of sale. If S elects tohave his gain taxed under § 453, hisgross profit would be $100,000($200,000 selling price - $100,000basis). The contract price is $150,000

($200,000 selling price - $50,000mortgage). The gross profit percentagewould then be 66% percent ($100,000gross profit + $150,000 contract price).Since a $60,000 payment (other thanB's note) is received by S in the year ofsale, 66% percent of this amount, or$40,000, will be reportable for thatyear. In the second year when $10,000plus interest is received, 66% percent of$10,000, or $6,667, will be reportablefor that year. If the property was a capi-tal asset in S's hands and if his holdingperiod at the time of the sale exceededsix months, all of this gain would bereported as a long-term capital gain, ex-cept to the extent of depreciation whichwould be subject to recapture.8 0 If thesale resulted in the recapture of depre-ciation, the income portion of each in-stallment payment is deemed to consistof recaptured depreciation until all suchordinary gain has been reported.8 1 Inter-est collected on the notes would be taxedaccording to S's regular method of ac-counting and would be treated as ordi-nary income.

Selling expensesAs explained above, the excess of the

amount of the existing mortgage overthe seller's basis in the property is con-sidered a payment in the year of sale forpurposes of the 30 percent test. How sel-ling expenses fit into this situation hasbeen and continues to be an uncertainarea.

The Ninth Circuit Court of Appealshas held that the seller's expenses of saleare an addition to his basis in determin-ing the excess mortgage amount. 8 2 Un-fortunately, the IRS has stated that itwill not follow that decision.8 3 Instead,it contends that basis is unaffected byselling expenses. The importance of thisissue is illustrated by the following fig-ures:

Selling priceBasis of property

$500,000100,000

772 June


Selling expenses 25,000Existing mortgage

on property 175,000Down payment 80,000If case law is followed, the excess of

mortgage over basis, $75,000, is re-duced by the selling expenses of$25,000. Consequently, for purposes ofthe 30 percent test, the seller is consid-ered to have received $130,000; that is,cash of $80,000 and the "excessmortgage" of $50,000. This amounts to26 percent of selling price and hencequalifies the sale for § 453 treatment.However, if the IRS position were fol-lowed, the excess mortgage would be$75,000 (unreduced by selling ex-penses) and, together with the $80,000cash received, would amount to$155,000, or 31 percent of the sellingprice. Section 453 would then be in-applicable. Since this is an all or nothingtype of situation, a prudent taxpayershould steer clear of the argument.

TO ELECT THEINSTALLMENT METHOD

Since § 453 is optional, the taxpayermust make an election to obtain its bene-fits. Generally, the election must bemade in the year of sale and must bemade for each qualifying sale for whichinstallment reporting is desired. An elec-tion to report under § 453 in one year forone or more sales has absolutely no ef-fect on the taxpayer's ability or require-ment to elect § 453 in other years or forother sales.

The election is made by the taxpayer"who sells or otherwise disposes of'the property.8 4 Consequently, the elec-tion is made by the trustee of nongrantortrust.85 Furthermore, a partnership, notthe partners, makes the election.8 6

Unfortunately, neither the statute northe regulations thereunder address thequestion of when the nondealer seller isrequired to make the election. Con-

sequently, this void has been filled bynumerous court decisions and an exten-sive, but somewhat inconclusive, re-venue ruling.87

Basically, it appears that a retroactiveelection is sometimes allowed if made in"good faith" and prior to the running ofthe statute of limitations for the filing ofthe return for the year of sale." Theruling also requires that no election in-consistent with the installment electionhad been made with respect to the sale.This clouds the issue since it is not clearas to what constitutes an "inconsistentelection." The cases have not directlyaddressed this particular issue, but sev-eral of them have implied that an invalidelection is to be considered as no elec-tion.89

This is important because the desirefor a retroactive election usually arisesin the situation where the seller hadclaimed that the buyer's obligation hadno ascertainable FMV and, therefore,reported the gain from the sale under thecost recovery method (see discussion ofcost recovery above, under "Cash BasisTaxpayer").co Upon being audited, helearned that almost everything is subjectto an ascertainable FMV, even thoughsometimes at a substantial discount, andthus the seller desires to reduce his taxesdue to the sale by making a retroactiveelection to report on the installmentbasis. If his original election to utilizethe cost recovery method is found to beinvalid, the seller can argue that henever made an "inconsistent election"and, therefore, should be entitled tomake a good faith retroactive election ofinstallment reporting.

Proper planning can provide a muchstronger argument for a retroactive elec-tion. If a sale qualifies under § 453, butthe cost recovery method is preferable,the taxpayer can provide for the possibil-ity that the cost recovery method will befound inappropriate (a very real possibil-ity) by making an alternative election to

7731976

THE COLORADO LAWYER

report under § 453. The taxpayer didthis in one instance and the IRS con-ceded that the election, as an alternativemethod of reporting, was proper. 9

1

There is some question as to why thisparticular concession was made andsome commentators feel that the IRSwill continue to object to almost everyretroactive election, even if it is listed asan alternative election in the year ofsale. 92 From a planning point of view,this uncertainty makes no difference asthe taxpayer in the proper situation hasmuch to gain and little to lose in makingthe alternative election.

Revocation of the electionOnce an election under § 453 has

been made, it may not be revoked,whether by amending the return for theyear of sale or otherwise.9 3 Section 453would not be desirable if losses fromother sales exist which would offset theentire gain from the sale which is eligiblefor installment reporting. In such a situa-tion, by electing § 453 in error, the taxbenefits of the losses may be lost forever.

DISPOSITION OFINSTALLMENT OBLIGATIONS

If the installment obligation is satis-fied at other than face value or sold orexchanged, gain or loss is recognized ofthe difference between the amountrealized on the satisfaction, sale orexchange and the basis of the obliga-tion.94 The basis is the unrecovered costelement in the obligation; that is, the ex-cess of the face value of the obligationover the amount of income which wouldbe returnable if the obligation were fullysatisfied. 9 5

For example, if the buyer's $10,000note is sold for $9,000, the recognizedgain or loss would be the difference be-tween the amount realized, $9,000, andthe basis of the obligation. If the grossprofit percentage was 80 percent, gain

of 80 percent of $10,000, or $8,000, hasyet to be taken income; the basis wouldbe $2,000, the note's face value less theamount yet to be reported as income.Therefore, in this case, the seller wouldhave a $7,000 gain ($9,000 amountrealized - $2,000 basis) on the sale ofthe obligation. The character of this gainis determined by the nature of the gainon the sale of the underlying property. 9 6

Pledge vs. saleThe question often arises whether the

buyer's obligation was pledged for aloan or sold with a guarantee. Theformer is not a disposition, and thereforenot a taxable event, whereas the latterdoes constitute a taxable disposition.9 7

The problem normally occurs becausethe installment seller, for some reason,needs or wants to raise additional funds.To do so, he generally enters into anagreement whereby he is advanced cashagainst the buyer's obligation, but hehas to guarantee its payment. Theeconomic effect is the same whether thetransaction is called a sale with recourseor a secured loan. The courts have laiddown a number of factors which cansway their determination. For example,the name given to the arrangement canmake a difference. 98 More important isthe structure of the arrangement. The in-stallment seller should retain the obliga-tion and continue to collect it for thebenefit of the lender. 99 Where practical,some security, in addition to the obliga-tion itself, should be given. 00 For-malities normally followed in a loansituation should be adhered to as muchas possible. Finally, if possible, pay-ments on the loan should not exactlycoincide with the collection of the obli-gation.101

Substitution of obligor or securityIn Burrell Groves, Inc., the taxpayer

sold property, received back the buyer'sobligation ahd elected to report on the

774 June


installment basis.10 2 The buyer latersold the property to a third party. Thetaxpayer surrendered the original obliga-tion of the first buyer and received, inexchange, the obligation of the newbuyer, bearing a different interest rateand different maturity dates. The courtfound this to be a taxable dispositionunder § 453.

Since that time, however, IRS rulingsand court cases have permitted sep-arately what the court in Burrell Groves,Inc. disallowed in the aggregate. 0 3 Re-venue Rulings 55-5 and 74-157 permit-ted the substitution of security, RevenueRuling 68-419 permitted the modifica-tion of the buyer's obligation, and theTax Court permitted the substitution ofobligors. If none of these changes byitself results in a taxable disposition, it isreasonable to conclude that the threechanges together should not result insuch a disposition. For planning pur-poses, however, prudence dictates thatat least one of these aspects of the obli-gation be left unchanged. Furthermore,supporting documentation should beprepared to emphasize the intent to sub-stitute security or modify the obligation,rather than to exchange one obligationfor another. Although it is a fine line, itis one which may very well make thedifference.

RepossessionThe repossession of property sold by

the seller following default by the buyeris a taxable disposition.' The rules fordetermining the resulting gain or lossdepend upon whether the property re-possessed is personalty or realty.

The gain or loss on the repossessionof personal property is the difference be-tween the FMV of the property whenrepossessed and the seller's basis in theinstallment obligation adjusted for costsincurred in the repossession.' 0 ' Whethertitle was retained by the seller or trans-ferred to the buyer makes no differ-

ence.1 0 6 For example, seller sells apainting to B for $100,000; B gives sel-ler $30,000 and his 6 percent note in theamount of $70,000, payable $10,000per year over the next seven years. As-suming a basis in the painting of$50,000, S has a realized gain of$50,000 ($100,000 selling price -$50,000 basis). B defaults in year two,before making any payments on hisnote, so S repossesses the painting. Atthe time of repossession an objectivethird party appraises the painting as hav-ing a FMV of only $60,000.

Because of the repossession, S willhave a recognized gain of $25,000($60,000 FMV - $35,000 basis in B'snote). S's basis in B's note is computedby multiplying the outstanding balance,$70,000, by the gross profit percentage,50 percent.

If the painting was valued at $30,000as of the date of repossession, S wouldhave a $5,000 recognized loss ($30,000FMV - $35,000 basis in B's note).

The repossession of real property issubject to a different rule. Generally, arepossession of real property results ingain only to the extent that money andother property received by the seller ex-ceeds the amount of the gain alreadyrecognized by him. The amount of thegain that is taxable, however, is limitedto the gain on the original sale less re-possession costs and gain previously re-ported as income. 0 7

To illustrate this procedure, assumethe facts in the example above, exceptthat land, rather than a painting, is thesubject of the sale and repossession. Inthis situation, S will have a recognizedgain of $15,000 ($30,000 cash received- $15,000 gain already recognized).This is the result regardless of the thenFMV of the real property.

Disposition of buyer's obligation otherthan by sale or exchange

If the buyer's obligation is disposed

1976 775

THE COLORADO LAWYER

of in any manner other than by satisfac-tion at other than its face value, or bysale or exchange, the gain or loss recog-nized will be the difference between theFMV of the obligation at the time of thedisposition and the basis of the obliga-tion. 08 For example, the transfer of in-stallment obligations pursuant to a di-vorce decree is a taxable disposition.'o"However, an installment obligationtransmitted by the death of the holder isnot a tax disposition. 0 In this situation,the installment obligation is treated asincome in respect of decedent and taxedto the estate or beneficiary in the samemanner as the decedent would have beentaxed had he lived to receive the pay-ments.'I'

Gratuitous transfer of an installmentobligation

A gift of an installment obligationconstitutes a taxable disposition. 1 12 TheIRS has ruled that the same result isreached where the donee of the gift isthe debtor." 3

Nevertheless, the holder of an in-stallment obligation may benefit bymaking a gift of that obligation. If thegift is to a charitable organization, thedonor gets a charitable deduction basedon the FMV of the obligation." 4

Also, an installment sale may proveto be the perfect vehicle for making an-nual gifts which qualify for the $3,000gift tax exclusion."i 5 By systematicallycancelling the buyer's obligation tomake principal and interest payments,the seller may avail himself of the an-nual gift tax exclusion. Moreover, someauthority exists for the argument that a"cancellation" of the obligation, ratherthan delivery of the uncancelled obliga-tion to the buyer, constitutes a "satisfac-tion at less than face value," thus, notbeing considered a taxable disposition tothe seller." 6

Transfer of an installment obligation toor from a trust

A gratuitous transfer of an installmentobligation to a trust generally results in ataxable disposition." 7 Exceptions occurwhen the trust is a grantor trust or whenonly the right to collect the interest,rather than principal, is transferred to ashort-term trust." 8 A distribution of in-stallment obligations by a trust to its ben-eficiaries, whether during the term ofthe trust or at the termination of thetrust, is a taxable disposition." 9 Pre-sumably, the same rule would be appli-cable to a distribution of such obligationsfrom an estate to its beneficiaries, pro-vided that the obligations arose from thesale of property by the estate. Undersuch circumstances, it would be prefer-able to have the property distributed tothe beneficiaries prior to the sale so thatthey may elect the installment method,if they so qualify.

Transfers not regarded as dispositionsIn addition to installment obligations

transmitted at death, several other trans-fers escape being taxed as dispositions.

A renegotiation of the sales price doesnot constitute a taxable disposition.' 2 0

As the result of a renegotiation, therealized gain on the sale must be recom-puted. The difference between the re-computed gain and the gain already re-ported in prior years must be reportedratably upon receipt of the remaining re-computed installments.' 2 '

The transfer of an installment obliga-tion to a corporation will not constitute ataxable disposition so long as the trans-fer qualifies for nonrecognition under §351 (relating to transfers to a controlledcorporation) or § 361 (relating to certainreorganizations).1 2 2 An exception oc-curs, however, when the transferee cor-poration is the obligor under the install-ment obligation.1 2 3 Certain corporateliquidations can result in the transfer ofan installsmnent obligation not being

776 June


treated as a disposition.1 2 4 However, ina § 337 one-year plan of liquidation theFMV of the buyer's obligation must betaken into account by the shareholders incomputing their gain or loss on theliquidation distribution. Thus, it is im-portant to remember that when a corpo-ration is arranging for a sale of its assetsafter adopting a one-year plan of liquida-tion, its stockholders can derive no tax-deferral benefits from a sale on the in-stallment basis, even though there maybe business reasons for spreading thepayments over a period of time.1 5

The transfer of an installment obliga-tion to or from a partnership will gener-ally not constitute a taxable disposi-tion. 126

If the installment obligations aretransferred in a transaction which doesnot result in a gain or loss, the transfereeassumes the transferor's basis in the ob-ligations. 127

NOTES

1. Unless otherwise indicated, all sec-tion references are to the Internal RevenueCode of 1954, as amended, and the regula-tions promulgated thereunder; Section 453can not be utilized to report losses, Rev. Rul.70-430, 1970-2 C.B. 51; Martin v. Comm'r,61 F.2d 942 (2nd Cir. 1932).

2. Section 1002.3. Section 1001(b).4. Section 1001(a).5. Sections 1221 and 1222.6. Section 61(a)(3).7. E. D. Rivers, Jr., 49 T.C. 663

(1968), Acq., 1968-2 C.B. 2; capital gaincould result under § 1232 if B was a corpora-tion and collection of the note qualified as abond retirement.

8. Id.9. Section 61.

10. Burnet v. Logan, 283 U.S. 404(1931); § 453 is unavailable when the con-tract provides for an open-ended sellingprice. Gralapp v. U.S., 458 F.2d 1158 (10thCir. 1972), affg 319 F. Supp. 265 (Kan.

1970); Steen v. U. S., 508 F.2d 268 (5th Cir.1975), aff g 61 T.C. 298 (1973).

11. Regs. § 1.1001-l(a); see also Regs.§ 1.453-6(a)(2); Rev. Rul. 58-402, 1958-2C.B. 15.

12. Warren Jones Co., 36 AFTR2d 75-5954 (9th Cir. 1975), rev'g 60 T.C. 663(1973).

13. Warren Jones Co., 36 AFTR2d 75-5954 (9th Cir. 1975), rev'g 60 T.C. 663(1973). But see Estate of Clarence W. Ennis,23 T.C. 799 (1955), Nonacq., 1956-2 C.B.10; Estate of Coid Hurlburt, 25 T.C. 1286(1956), Nonacq., 1956-2 C.B. 10; Rev. Rul.68-606, 1968-2 C.B. 42.

14. Regs. § 1.451-1(a).15. H. Liebes & Co. v. Comr., 90 F.2d

932 (9th Cir. 1937).16. Regs. § 1.453-6(a)(1); but see Rev.

Rul. 68-606, 1968-2 C.B. 42.17. Under § 7701(a)(1), the term "per-

son" includes an individual, a trust, estate,partnership, association, company or corpo-ration.

18. Section 453(b).19. Regs. § 1.453-1(b).20. Regs. § 1.453-1(a).21. Regs. § 1.453-7(a).22. Regs. § 1.453-8(a)(1).23. Regs. § 1.453-1(d).24. Section 453(c)(4).25. Section 453(b)(2)(A)(ii).26. Rev. Rul. 69-462, 1969-2 C.B. 107.27. 10-42 Corporation, 55 T.C. 593

(1971) Nonacq., 1972-2 C.B. 4; BaltimoreBaseball Club, Inc. v. U.S., 481 F.2d 1283(Ct. Cls. 1973).

28. Section 453(b)(2)(A)(ii); Daniel Ro-senthal, 32 T.C. 225 (1959).

29. Rev. Rul. 73-369, 1973-2 C.B. 155.30. Regs. § 1.453-5(a).31. Spielberger v. U.S., 58-1 USTC

9431, 1 AFTR2d 1435 (S.D. Calif. 1958).32. Regs. § 1.453-4(c); Burnet v. S & L

Building Corporation, 288 U.S. 406 (1933).33. Regs. § 1.453-4(c); Burnet v. S & L

Building Corporation, 288 U.S. 406 (1933);Waldrep v. Comm'r, 428 F.2d 1216 (5thCir. 1970), affg 52 T.C. 640 (1969);Richards, T.C. Memo 1972-126; Ledford v.U.S., 492 F.2d 1186 (9th Cir. 1974), aff gD.C. Calif., 5/18/72.

34. The Stonecrest Corp., 24 T.C. 659

1976 777

THE COLORADO LAWYER

(1955), Nonacq. 1956-1 C.B. 6; Estate of E.P. Lamberth, 31 T.C. 302 (1958), Nonacq.1959-1 C.B. 6; United Pacific InsuranceCorp., 39 T.C. 721 (1963); but see Waldrepv. Comm'r, 428 F.2d 1216 (5th Cir. 1970).

35. But see § 453(b)(3) for a descriptionof some buyer obligations which will be con-sidered as payment in the year of sale.

36. Rev. Rul. 73-555, 1973-2 C.B. 159;U.S. v. Marshall, 357 F.2d 294 (1966);Comm'r v. Irwin, 390 F.2d 91 (5th Cir.,1968).

37. Denco Lumber Co., 39 T.C. 8(1962), acq. in result only, 1963-2 C.B. 4;also see Albert W. Turner, 33 TCM 1167(1974).

38. U.S. v. Marshall, 357 F.2d 294(1966); Comm'r v. Irwin, 390 F.2d 91 (5thCir. 1968); Clodfelter v. Comm'r, 426 F.2d1391 (9th Cir. 1970), affg 48 T.C. 694(1967); Rev. Rul. 76-109, C.R.B. 1976-13,p. 10.

39. Rev. Rul. 73-555, 1973-2 C.B. 159.40. Rev. Rul. 73-555, 1973-2 C.B. 159;

Wagegro Corporation, 38 BTA 1225 (1933),Acq., 1939-1, Part 1, C.B. 36.

41. Section 483, Shanahan v. U.S., 447F.2d 1082 (10th Cir., 1971).

42. Regs. Section 1.483-l(c)(2)(B); forpayments on account of a sale or exchange ofproperty entered into before July 24, 1975,as well as a sale or exchange of propertypursuant to a binding written contract enteredinto before such date, the interest ratesutilized in § 483 are 4 percent / 5 percentinstead of the current 6 percent / 7 percentrates.

43. Regs. § 1.483-1, Table VI.44. Estate of Betty Berry, 43 T.C. 723

(1965), aff d 372 F.2d 476 (6th Cir. 1967);Robinson, 434 F.2d 767 (8th Cir. 1971),aff g 54 T.C. 772 (1970).

45. Spencer v. Granger, 102 F. Supp.205 (W. D. Pa. 1952).

46. Lewis M. Ludlow, 36 T.C. 102(1961), Acq. 1961-2 C.B. 5.

47. Dean W. Cox, 62 T.C. 247 (1974).48. Rev. Rul. 73-396, 1973-2 C.B. 161.49. Hendrix v. U.S., 73-2 USTC 9723,

32 AFTR2d 73-6089 (D.C. Ore., 1973);Everett Pozzi, 49 T.C. 119 (1967); Rev.Rul. 73-451, 1973-2 C.B. 158; Rev. Rul.71-352, 1971-2 C.B. 221.

50. Rev. Rul. 68-246, 1968-1 C.B. 198;Gibbs & Hudson, Inc., 35 B.T.A. 205(1936).

51. J. Earl Oden, 56 T.C. 569 (1971).52. Rev. Rul. 73-451, 1973-2 C.B. 158.53. Bolthrope v. Comm'r, 356 F.2d 28

(5th Cir. 1966).54. Section 453(b)(3); Regs. § 1.453-3.55. R. L. Brown Coal & Coke Co., 14

B.T.A. 609 (1928), Acq. IX-1 C.B. 8; butsee "Caveat" 48 4th T.M. p. A-26.

56. Carl F. Holmes, 55 T.C. 53 (1970).57. W. H. Batcheller, 19 B.T.A. 1050

(1939); Riss v. Comm'r, 368 F.2d 965(105th Cir., 1966); U.S. v. Ingalls, 399 F.2d143 (5th Cir. 1968); John H. Rickey, 54T.C. 680 (1970), affd 502 F.2d 748 (9thCir. 1974); Big "D" Development Corp. v.Comm'r, T.C. Memo. 1921-148, aff d 453F.2d 1365 (5th Cir. 1972).

58. Riss v. Comm'n, 368 F.2d 965(10th Cir. 1966); U.S. v. Ingalls, 399 F.2d143 (5th Cir. 1968); John H. Rickey, 54T.C. 680 (1970), affd 502 F.2d 748 (9thCir. 1974).

59. Rev. Rul. 65-155, 1965-1 C.B. 356.60. Clinton H. Mitchell, 42 T.C. 953

(1964). But see Charles W. Yaeger, 18T.C.M. 192 (1959); Richard H. Prichett, 63T.C. 149 (1974), Acq. I.R.B. 1975-21, p. 5.

61. Section 302(b)(3); Zenz v. Quinli-van, 213 F.2d 914 (6th Cir. 1954).

62. Farha v. Comm'r, 483 F.2d 18 (10thCir. 1973), affg 58 T.C. 526 (1972).

63. Williams v. McGowan, 152 F.2d570 (2d Cir. 1945).

64. Rev. Rul. 76-110, I.R.B. 1976-13,p. 11.

65. Rev. Rul. 55-79, 1955-1 C.B. 370.66. Rev. Rul. 68-13, 1968-1 C.B. 195;

Rev. Rul. 75-323, I.R.B. 1975-31, p. 19;Monaghan, 40 T.C. 680 (1963); Lubken, 8AFTR2d 5073 (D.C. Calif. 1961).

67. Bar-Deb Corporation v. U.S., 75-1USTC 9453 (Ct. Cls. 1975); Richard H.Pritchett, 63 T.C. 149 (1974), Acq. I.R.B.1975-21, p. 5; James A. Johnson, 49 T.C.324 (1968).

68. Bar-Deb Corporation v. U.S., 75-1USTC 9453 (Ct. Cls. 1975).

69. Farha v. Comm'r, 483 F.2d 18 (10thCir. 1973), affg 58 T.C. 526 (1972).

778 June


70. Charles A. Collins, 48 T.C. 45(1967), Acq., 1967-2 C.B. 2.

71. Section 1012.72. Rev. Rul. 73-157, 1973-1 C.B. 213.73. Rev. Rul. 73-536, 1973-2 C.B. 158.74. Nye v. U.S., 36 AFTR2d 75-5150

(D.C.N.C., 1975).75. Comm'r v. Court HoldingCo.,324

U.S. 331 (1945); U.S. v. Cumberland PublicService Co., 338 U.S. 451 (1950); thesefamous cases dealt with the problem of de-termining which entity "arranged" the saleof a corporation's assets, the corporation it-self or the shareholders who, upon receipt ofthe assets through a liquidating distributionof the corporation, immediately closed thesale.

76. Rushing v. Comm'r, 441 F.2d 593(5th Cir. 1971), aff g 52 T.C. 888.

77. Gralapp v. U.S., 458 F.2d 1158(10th Cir. 1972); Steen v. N.S., 508 F.2d 268(5th Cir. 1975), aff'g 61 T.C. 298 (1973).

78. Rev. Rul. 76-109, I.R.B. 1976-13,p. 10.

79. Rev. Rul. 76-109, I.R.B. 1976-13,p. 10.

80. Sections 1245 and 1250.81. Regs. § 1.1245-6(d); Dunn Con-

struction Co., Inc. v. U.S., 323 F. Supp.440 (N.D. Ala. 1971); Regs. § 1.1250-1(c)(6).

82. Kirschenmann v. Comm'r, 488 F.2d270 (9th Cir. 1973).

83. Rev. Rul. 74-384, 1974-2 C.B. 152.84. Regs. § 1.453-8(b).85. Marcello v. Comm'r, 414 F.2d 268

(5th Cir. 1969).86. Section 703(b); Scherf, 20 T.C. 346

(1953).87. Rev. Rul. 65-297, 1965-2 C.B. 152.88. Mamula v. Comm'r, 346 F.2d 1016

(9th Cir. 1965); Estate of Broadhead,T.C.M. 1972-195; Rev. Rul. 74-421,1974-2 C.B. 151; for nonallowance due tobad faith, see John Harper, 54 T.C. 1121(1970) Acq., 1971-2 C.B. 2; Yellow Caband Car Rental Co., T.C.M. 1974-79.

89. Mamula v. Comm'r, 346 F.2d 1016(9th Cir. 1965); Estate of Broadhead,T.C.M. 1972-195.

90. Burnet v. Logan, 283 U.S. 404(1931).

91. Warren Jones Company, 36

AFTR2d 75-5954 (9th Cir. 1975), rev'g 60T.C. 663 (1973).

92. BNA, TMM 75-25, p. 7.93. Pacific National Co. v. Welch, 304

U.S. 191 (1938); Ivan D. Pomeroy, 54 T.C.1716 (1970); Youngblood v. U.S., 507 F.2d1263 (5th Cir. 1975).

94. Section 453(d)(1)(A); Rev. Rul.73-423, 1973-2 C.B. 161.

95. Section 453(d)(2); Regs. § 1.453-9.96. Section 453(d)(1); Regs. § 1.453-9.97. Pledge of the obligation as security

for a loan is not taxable disposition. EastCoast Equipment Co. v. Comm'r, 222 F.2d676 (3rd Cir. 1955); United Surgical SteelCo., Inc., 54 T.C. 1215 (1970) Acq.,1971-2 C.B. 3; Town and County FoodCo., Inc., 51 T.C. 1049 (1969); Acq. 1969-2C.B. XXV; Yancy Bros. Co. v. U.S., 319F. Supp. 441 (N.D. Ga. 1970). But see De-ssauer Comm'r, 449 F.2d 562 (8th Cir.1971), rev'g and rem'g 54 T.C. 327 (1970).Sale of the obligation with a guaranty is ataxable disposition. Estate of Broadhead,T.C. Memo 1972-195; John B. Mathers, 57T.C. 666 (1972) Acq., 1973-1 C.B. 2.

98. Town and County Food Co., 51T.C. 1049 (1969) Acq., 1969-2 C.B. XXV;United Surgical Steel Co., 54 T.C. 1215(1970).

99. Town and County Food Co., 51T.C. 1049 (1969) Acq. 1969-2 C.B. XXV;Rev. Rul. 65-185, 1965-2 C.B. 153; Joe D.Branham, 51 T.C. 175 (1968); PackardCleveland Motor Co., 14 B.T.A. 118(1928).

100. Town and County Food Co., 51T.C. 1049 (1969) Acq. 1969-2 C.B. XXV.

101. United Surgical Steel Co., 54 T.C.1215 (1970); Yancy Bros. Co. v. U.S., 70-2USTC 9619 (N.D. Ga. 1970).

102. Burrell Groves Inc., 223 F.2d 526(5th Cir. 1955), aff'g. 22 T.C. 1134 (1954).

103. Rev. Rul. 55-5, 1955-1 C.B. 331;Rev. Rul. 68-419, 1968-2 C.B. 196; Rev.Rul. 68-246, 1968-1 C.B. 198; Rev. Rul.74-157, 1974-1 C.B. 115; Rev. Rul. 61-215,1961-2 C.B. 110; John I. Cunningham, 44T.C. 103 (1965) Acq., 1966-2 C.B. 4; SamF. Soter, 27 T.C.M. 194 (1968); Wynne, 47B.T.A. 731 (1942), Rev. Rul. 75-457,I.R.B. 1975-43, p. 8.

104. Baca Raton Co. v. Comm'r, 86 F.2d

1976 779

THE COLORADO LAWYER

9 (3rd Cir. 1936); Walker v. Thomas, 119F.2d 58 (5th Cir. 1941); Morrison, 12 T.C.1178 (1949); Spencer v. Granger, 102 F.Supp. 205 (W.D. Ga. 1952).

105. Regs. § 1.453-1(d).106. Regs. § 1.453-1(d).107. Section 1038.108. Section 453(d)(1)(B).109. Redmon v. U.S., 471 F.2d 687 (6th

Cir. 1973), affg D.C. Ky., 3-15-72; HarryL. Swain, 417 F.2d 353 (6th Cir. 1959).

110. Section 453(d)(3).111. Section 691(a)(4).112. Marshall v. U.S., 26 F. Supp. 580

(S.D. Cal. 1939).113. Rev. Rul. 55-157, 1955-1 C.B. 293.114. Rev. Rul. 55-157, 1955-1 C.B. 293.115. Section 2503(b).116. Miller v. Usry, 160 F. Supp. 368

(W.D. La. 1958).117. Marshall v. U.S., 26 F. Supp. 580

(S.D. Cal. 1939); A. W. Legg, affg 496

F.2d 1179 (9th Cir. 1974); 57 T.C. 164(1971); Rev. Rul. 67-167, 1967-1 C.B. 107;Springer v. U.S. (D.C. Ala. 7/7/69).

118. Rev. Rul. 67-70, 1967-1 C.B. 106;Rev. Rul. 74-613, 1974-2 C.B. 153, super-ceding Rev. Rul. 73-584, 1972-2 C.B. 16.

119. Rev. Rul. 55-159, 1955-1 C.B. 391.120. Rev. Rut. 55-429, 1955-2 C.B. 252;

Sam F. Soter, 27 T.C.M. 194 (1968); Rev.Rul. 68-419, 1968-2 C.B. 196.

121. L. P. Jerpe, 45 B.T.A. 199 (1941)Acq. 1942-1 C.B. 9; Rev. Rul. 72-570,1972-2 C.B. 241.

122. Regs. § 1.453-9(c)(2); § 351, and §361.

123. Rev. Rul. 73-423, 1973-2 C.B. 161.124. Section 453(d)(4)(A) and (B).125. See Kearns, "Tax Tips," 4 The

Colorado Lawyer 2290 (November 1975).126. Regs. § 1.453-9(c)(2); Regs. §

1.721-1(a) and § 731.127. Regs. § 1.453-9(c)(3).

780 June

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