The act's repeal of the use of the installment method for accrual-basis taxpayers as outlined by IRC Section 453 has sweeping implications for most taxpayers, including those in the real estate industry. Interest included in each payment would be reported separately by A as ordinary income. The remaining $50 of each payment is a nontaxable recovery of basis. Accordingly, the amount of each payment received by A that would have been reported as gain is $50 (50 percent multiplied by $100 payment). The gross profit percentage is 50 percent ($250 gross profit divided by $500 total contract price). A's gross profit on the sale is $250 ($500 sales price less $250 basis). Taxpayer A sells real estate with an adjusted tax basis of $250 to taxpayer B for $500, which is payable to A in five annual installments of $100 (plus annual market-rate interest). The following example illustrates the basic mechanics of an installment sale under IRC Section 453. This amount, which was reported as income, was calculated by multiplying the total amount of payments received during the year by the ratio of the gross profit to the total contract price - the gross profit percentage. Accordingly, the taxpayer was taxed only on the part of the payment that represented the gain on the sale. The first part was the nontaxable recovery amount of a portion of the seller's tax basis or net investment in the property, and the second part was the taxable realization of a portion of the seller's gain. Under IRC Section 453, the recognized reportable gain was calculated when each installment was received, and each payment represented two components. However, qualifying sales did not include sales of personal property held as inventory or most dispositions by “dealers.” Sales that qualified for installment-method treatment generally were property dispositions for which at least one payment was received after the close of the taxable year in which the sale occurred. The rules governing installment sales that developed since then were found in IRC Section 453.īefore the Ticket to Work Act was signed, IRC Section 453 provided that if a property disposition qualified as an installment sale, accrual-method taxpayers could defer recognition of a proportional amount of the profit on the sale until they actually received payments.Īccordingly, any installment-sale gain could be spread over the period during which the payments were received, rather than being taxed in the year of sale. It primarily was designed to provide deferral of income-tax liability on profits from a sale until the deferred payments for the property that was sold actually were received. The Revenue Act of 1926 first allowed installment-method reporting of gains on sales of property with deferred payments. Moreover, Congress added insult to injury by making the act applicable immediately, casting its net over all property sales after the date of its enactment, rather than allowing a grace period for taxpayers to adjust. 1180, the Ticket to Work Incentives Improvement Act, which officially renewed a number of expired business tax breaks and eliminated others - specifically the use of the installment method for most accrual-basis taxpayers. 17, 1999, President Clinton signed into law H.R. However, as Congress engages in its infamous “open a door and shut a window” approach to financing new tax cuts, the installment method of recognizing gain on the disposition of property for accrual-basis taxpayers has fallen victim to the political chopping block.
This genre of tax-deferred transaction historically has provided taxpayer-friendly mechanisms for taxpayers to manage their overall effective tax rate.
Internal Revenue Code Section 1031, which governs like-kind exchanges, is a familiar example of such a provision that allows taxpayers to defer the payment of income taxes on any gain realized from the exchange of a like-kind property until a future point in time when the taxpayer disposes of the exchanged property. Hoppe |Ĭongress periodically has provided taxpayers with relief from the burden of current income tax liabilities generated in qualified transactions. Tax issues Accrual-Basis Taxpayers Lose the Use of Installment-Sales Tax Breakīy Steven M.