Section 21 Section 453Installment Method

• Library: Bus Trans 2005

The installment method of gain recognition is defined in I.R.C. § 453(c) as a “method under which the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price.”

The installment method automatically applies to, and is available for, any disposition of property except:

• a disposition of personal property (other than property used or produced in the trade or business of farming) on the installment method by a dealer who regularly sells on the installment plan; and

• a disposition of inventory that is personal property

The installment method of I.R.C. § 453 requires that at least one payment be received after the close of the taxable year of disposition. Thus, a seller could use the installment method even if only one payment was received as long as the seller received that payment after the taxable year of disposition. Under those facts, the seller would recognize all of the gain in the year that the one payment is received.

If the installment method is applicable, it automatically applies unless the taxpayer affirmatively elects not to have it apply. A taxpayer who elects out of I.R.C. § 453 treatment must recognize gain on the sale in accordance with the taxpayer’s method of accounting. The receipt of the installment obligation would be deemed a receipt of property in an amount equal to its fair market value. See §10.11, supra.

I.R.C. § 453(f)(3) provides that a payment will not
include evidences of indebtedness of the person acquiring
the property—i.e., amounts received under the note are payments, but the receipt of the note is generally
not a payment. The temporary regulations provide
further clarification of what will constitute a “payment.” A
standby letter of credit, as defined in Temp. Treas. Reg. § 15a.453-1(b)(3)(iii), will be treated as a third-party guarantee rather than as a payment. Similarly, the granting of a security interest in other collateral such as real estate, accounts receivable, or equipment should not result in
a note being considered a payment. But the temporary treasury regulations state the IRS’s position that a note secured directly or indirectly by cash or a cash equivalent, such as a bank certificate of deposit or a treasury note, will be treated as the receipt of payment. Temp. Treas. Reg. § 15a.453-1(b)(3)(i).

In this regard, the practitioner...