A. Disposition of installment obligation—
1. The privilege of income deferral by installment reporting under I.R.C. § 453 is generally personal to the party electing the installment method and does not outlast the period during which the obligation is held.
2. Sale, gift or other disposition or satisfaction of an installment obligation results in recognized gain to the taxpayer. I.R.C. § 453B(a).
a. The amount of gain or loss is the difference between the basis of the installment obligation at the time of disposition and either the amount realized in a sale or the fair market value of the obligation at the time it is disposed of other than by sale. I.R.C. § 453B(a). The rules for determining taxable gain on disposition of an installment obligation are different depending upon how the disposition occurs.
(1) If the installment obligation is satisfied at other than face value or it is sold or exchanged, the amount to be included in income is the difference between the amount realized and the income tax basis of the obligation. I.R.C. § 453B(a)(1). With this type of disposition, consideration is received.
(2) If the disposition takes the form of a “distribution, transmission, or disposition otherwise than by sale or exchange,” the amount included in income is the difference between the fair market
value of the obligation and its income tax basis. I.R.C. § 453B(a)(2). Rev. Rul. 79-371, 1979-
2 C.B. 294.
b. For a discussion of the consequences of pledging an installment obligation, see Part Five.
c. Disposition of a contract to children in exchange for annuity payments constitutes a taxable disposition. Harold W. Smith, 56 T.C. 263 (1971).
d. In a disposition by gift, the donee’s income tax basis presumably would be the fair market value of the obligation inasmuch as the donor’s basis would be increased by virtue of the taxable disposition.
e. A tax-free exchange to a corporation or partnership does not trigger taxability of installment obligations transferred. See Treas. Reg. § 1.453-9(c)(2).
f. Assignment of a note by a nominee to a beneficial owner does not trigger recognition of gain.
Irving Snyder, 66 T.C. 785 (1976), acq., 1976-2 C.B. 3.
g. Death of the seller—
(1) In the event of death of the seller within the term of an installment sale transaction, income tax on the deferred gain is not immediately due, but the installment obligation as an asset of the estate does not receive a new or adjusted basis. I.R.C. §§ 691(a)(4), 453B(c). Payments received after death are treated as income in respect of decedent and the recipient, whether estate representative, legatee or other successor, reports the income in the same manner as the decedent would have done if living. Treas. Reg. § 1.691(a)-5. See Trust Co. of Georgia v.
Ross, 262 F. Supp. 900 (N.D. Ga. 1966), aff’d, 392 F.2d 694 (5th Cir. 1967), cert. denied, 393
U.S. 830 (1968) (sale of stock in escrow); Ray Bert Hedrick, 63 T.C. 395 (1974); Claiborne
v. United States, 648 F. 2d 448 (6th Cir. 1981) (closing of land transaction after owner’s
death); Ltr. Rul. 9023012, March 6, 1990 (land contract cancelable if mortgage commitment not obtained within 45 days and decedent died within 45-day period; mortgage commitment not obtained but parties proceeded to closing and gain was income in respect of decedent). See Ltr. Rul. 8302044, October 8, 1982 (any difference in face amount of obligation and valuation for federal estate tax purposes has no effect on amount included in recipient’s gross estate). Cf. Rev. Rul. 76-100, 1976-1 C.B. 123 (community property). See Sun First National
Bank of Orlando v. United States, 607 F.2d 1347 (Ct. Cl. 1979) (amounts received by
grantor trust).
(a) The fair market value of the obligation is includible in the decedent’s gross estate. However, a deduction is permitted each recipient of income in respect of decedent equal to the death taxes attributable to the value of the obligation. I.R.C. § 691(c). See Ltr.
Rul. 9007016, November 16, 1989 (no recognition of gain to estate where installment
obligation transferred outright to surviving spouse or in satisfaction of residuary bequests). The value of the installment obligation may not be reduced by the estimated amount of income tax payable on installments remaining to be paid. Estate of Robinson,
69 T.C. 222 (1977).
(b) Except for distributions to the obligor, a decedent’s estate is not charged with income inclusion as a result of distribution of the obligation to a beneficiary. I.R.C. § 453B(c). The basis in the hands of a beneficiary is the decedent’s basis, adjusted for installments received by the estate prior to distribution.
(c) However, disposition of installment obligations entered into by the estate constitutes a taxable disposition. See Rev. Rul. 55-159, 1955-1 C.B. 391. I.R.C. § 1040 operates to shield from recognition the gain on transfer of special use value land to a qualified heir.
gain on distribution of an installment obligation from the estate. This problem is especially severe for sale by an estate of land under a special use valuation election. The exception in I.R.C. § 453B(c) would appear not to apply to installment obligations entered into by the estate inasmuch as the distributions of installment obligations from estates would not involve “transmission of installment obligations at death”. I.R.C. § 453B(c). See Rev. Rul. 55-159, 1955-1 C.B. 391 (distribution of installment obligation from trust to beneficiary was taxable disposition). See also Ltr. Rul. 8317050, January 25, 1983 (same).
(d) Disposition of an installment obligation at death to the obligor is treated as a taxable disposition. I.R.C. § 691(a)(4),(5). See Rev. Rul. 86-72, 1986-1 C.B. 253 (gain recognized and includible in decedent seller’s estate where installment note automatically cancelled upon seller’s death). Any previously realized gain from an installment sale is recognized by a deceased seller’s estate if the obligation is transferred by bequest, devise or inheritance to the obligor or is cancelled by the executor or administrator of the estate. [1] The disposition is considered to occur at the earliest of the executor’s assent to
distribution of the installment obligation to the buyer, the cancellation of the obligation by the executor, the time the obligation becomes unenforceable or the termination of the administration of the estate for federal estate tax purposes. Ltr.
Rul. 8552007, September 18, 1985.
[2] If the cancellation occurs at the death of the holder of the obligation, the cancellation is treated as a transfer by the estate of the decedent. However, if the obligation were held by a person other than the decedent such as a trust, the cancellation is treated as a transfer by that person immediately after the decedent’s death. I.R.C. §
691(a)(5)(A).
[3] If the decedent and the obligor are related persons, the fair market value of the obligation for disposition purposes is not less than the face amount. I.R.C. §
691(a)(5)(B).
(2) The feature of installment obligation taxation that converts gain in such obligations into income in respect of decedent constitutes an income tax disadvantage (for property that has appreciated substantially in value) compared with retention of the property until death and concomitant eligibility for a new basis. I.R.C. § 1014(a).
h. Cancellation of an installment obligation is treated as a disposition of the obligation by the holder.
I.R.C. § 453B(f).
(1) Thus, if the seller forgives or cancels the obligation to pay amounts due, the result is the same as a disposition of the obligation. If the obligor is a related party, the amount taken into account as a disposition triggering recognition of unreported gain attributable to the obligation is not less than the face amount of the installment obligation. I.R.C. § 453B(f)(2). (2) IRS has ruled that cancellation of principal in a debt restructuring involving an installment
sales contract does not result in income tax consequences to the seller. Ltr. Rul. 8739045,
June 30, 1987 (no recognition of the enactment of I.R.C. § 453B(f)).
i. All depreciation recapture on installment sales of real or personal property is taxed to the seller in the year of sale. This is the outcome even if no principal payments are received. This is a change applicable to installment sales entered into after June 6, 1984, except for contracts binding on March 22, 1984.
(1) For other installment sales, the income (other than interest) on each payment is first deemed to be recapture income under I.R.C. § 1245 or I.R.C. § 1250. Treas. Reg. § 1.1245-6(d)(1); Treas.
Reg. § 1.1250-1(c)(6). Dunn Construction Co. v. United States, 323 F. Supp. 440 (N.D. Ala. (1971); Antone E. Plese, T.C. Memo. 1978-326. If the statute of limitations has run on the
recapture year, the recapture amount cannot be assessed in a later, open, year. Ltr. Rul.
8326002, February 28, 1983.
(2) For expense method depreciation assets disposed of by installment sale, all payments received under the obligation are considered to have been received in the year of sale to the extent of expense method depreciation claimed on the property. I.R.C. § 453(i).
j. Exchange of the property securing the installment obligation for another property without otherwise changing the terms of the obligation is not a disposition. Ltr. Rul. 8848054, September
7, 1988 (substitution of new property as security for installment obligation secured by property
sold under threat of condemnation not disposition of installment obligation). B. Modification of contract terms
1. A modification resulting in a deferral of the principal due and an increase in the interest rate does not result in a taxable disposition. Rev. Rul. 68-419, 1968-2 C.B. 196. See Ltr. Rul. 8119030, February 11,
1981; Ltr. Rul. 8437091, June 14, 1984; Ltr. Rul. 9505011, November 4, 1994 (postponement of
maturity dates of note and deferral of principal payments for valid business reasons not disposition or satisfaction). See also Ltr. Rul. 8545010, August 12, 1985 (not a disposition where substitution in property securing debt, flat interest rate substituted for variable rate and term of obligation shortened from 16 to 10 years); Ltr. Rul. 9819043, February 11, 1998 (modifications of terms of notes not significant; rights of obligees not materially altered).
a. Similarly, an agreement reducing payments, allocating all payments to interest and deferring principal payments (and some interest) for two years is not a disposition. Ltr. Rul. 8606052,
November 15, 1985 (warning about using test rate of interest when payments resume). See Rhombar Co., 47 T.C. 75 (1966), acq., 1967-1 C.B. 2 (no constructive receipt on deferral of
scheduled payments); Ltr. Rul. 9506018, November 7, 1994 (postponing principal payments was not disposition of note).
b. The substitution of a mortgage contract, in an amount equal to the unpaid balance of the purchase price, payable on the same terms and conditions of payment as the balance under the installment obligation, results only in a change in the type of security and does not constitute a satisfaction or disposition of the installment obligation. Rev. Rul. 55-5, 1955-1 C.B. 331. See Rev. Rul. 82-122,
1982-1 C.B. 80 (substit ution of new obligor and change in rate of interest not considered
disposition); Rev. Rul. 75-457, 1975-2 C.B. 196 (substitution of obligors, deeds of trust and promissory notes not disposition where no change in terms or conditions of original deeds and notes); Rev. Rul. 74-157, 1974-1 C.B. 115 (substitution of two promissory notes and two deeds of trust for existing promissory note and deed of trust was not disposition). See also Ltr. Rul.
9238005, June 8, 1982 (mere change in collateral securing sale did not affect installment
reporting).
2. If the buyer sells the property and the seller agrees to a “novation” there apparently is no disposition. See John I. Cunningham, 44 T.C. 103 (1965).
3. No disposition occurs on release of a blanket mortgage to fa cilitate sale of individual land parcels. Ltr.
Rul. 7852124, October 2, 1978.
4. If there is a substantial change in the terms of the obligation, the current rules on minimum interest rates apply. See Treas. Reg. § 1.483-1(c)(4).