Installment sales: allocation of installment payments.

• Author: Klunk, Jon R.

In certain circumstances the installment sale method permits a sale of property without the seller being required to report the gain until the actual receipt of payment. The rules governing installment sales are well defined, and the gain deferral achieved through installment sale treatment enables the seller, in certain circumstances, to spread gain over the period of installment payments based on the proportion that the gross profit on the sale bears to the contract price. Agreements between buyer and seller to specifically allocate installment payments can maximize tax deferral.

To be eligible for installment sale treatment, at least one payment must be received after the close of the tax year in which the sale occurs (Sec. 453(b)(1)); however, not all transactions involving deferred payments qualify for installment sale treatment. There are a number of ineligible transactions, including transactions where:

* The overall sale creates a loss;

* Inventory is sold;

* The property sold is stock or securities traded on established securities markets; or

* Depreciable property is sold to a related party.

In addition, Sec. 453 does not permit deferral of depreciation recapture when Sec. 1245 recapture applies to assets sold on installment (Sec. 453(i)).

When a taxpayer sells or exchanges several items of property for an aggregate price that includes installment payments, an allocation of purchase price as well as a specific allocation of particular installment payments is often advantageous. When a taxpayer sells assets comprising a business at a gain and all payments are not received in the year of sale, unless the taxpayer elects otherwise, the gain is required to be reported based on the installment method of accounting. However, tax deferrals in situations in which a number of assets are sold for an aggregate price can be limited when the assets include a variety of tax characteristics--i.e., inventory, items sold at a loss, and other items ineligible for installment sale treatment. An agreement between the parties specifically allocating installment payments to particular assets can maximize tax deferral.

To maximize the installment sale tax deferral, buyer and seller should negotiate an agreement on the allocation of particular installment payments to particular assets. Rev. Rul. 68-13 states that

the sale of a business must be "comminuted into its fragments" where either the selling price or the down payment, or both of them, is...