453 Installment Sale
What is an Installment Sale?
An installment sale under Section 453 involves a disposition of property where at least one payment is received by the seller after the tax year in which the disposition occurs. The installment method of reporting is mandatory in the case of an installment sale. However, a taxpayer may elect out of the installment method. Taxpayers contemplating a sale of property at a gain should consider the installment method of reporting because it typically provides favorable tax treatment in that tax is paid as payments are received rather than entirely in the year of disposition.
Prior to the passage of the current tax code, one used to be able to sell collectibles and other highly appreciated assets such as works of art under Section 1031.
All such appreciated assets, save for real estate investments, are no longer covered under Section 1031.
For the sale of such assets, and also for the sale of businesses where goodwill and other intangibles and where any real estate is either not a part of the sale or is de minimis in comparison to the scope of the sale, we can structure transactions pursuant to Section 453, the installment sale provision, that can defer and delay the payment of capital gains taxes, putting the portion of the sale price that would otherwise have gone to the federal and state government to work for the taxpayer in a wide array of income producing investments.
In detail
General principles
- The installment method is used for reporting gains (but not losses) from an installment sale, which is a sale involving a disposition of property where at least one payment is received by the seller after the tax year in which the disposition occurs. The installment method applies even if only one payment is to be received, as long as that payment is received in a tax year following the year of sale. It also applies without regard to the timing of the transfer of title (e.g., even if the transfer of title will not occur until all of the agreed-upon selling price has been paid).
- The installment method may apply to the sale of a single asset, the sale of several assets in a single transaction, or the sale of a business. However, use of the installment method is prohibited with respect to the following transactions and types of gain (among others):
- Sales made by a dealer (Section 453(b)(2)(A))Sales of inventory related to personal property (Section 453(b)(2)(B))
- Sales of depreciable property to a related person (Section 453(g))
- Sales of personal property under a revolving credit plan (Section 453(k)(1))
- Sales of publicly-traded property (Section 453(k)(2))
- Gain attributable to depreciation recapture (Section 453(i))
- Observation: While the installment method of reporting affects the year in which gain is recognized, it does not affect the character of the gain.
- Finally, the benefits of the installment method may be limited by Section 453A, which generally imposes an interest charge on the deferred tax liability attributable to installment obligations arising from certain non-dealer installment sales.
The takeaway
Taxpayers must consider the requirement to use the installment method where at least one payment is received by the seller after the tax year in which a disposition occurs. However, taxpayers may elect out of the installment method, allowing for certain planning opportunities. By using the installment method, taxpayers are able to pay tax on their gains as payments are received.
