When a seller is paid over several years, she may be eligible to report some of the gain pro rata with each installment, rather than all at once. See IRC §453(c) (installment method defined). However, the installment method is not always available.
In some cases, installment treatment is denied because of some feature of the property sold. Where the property sold is a partnership interest, the question is whether to apply the test to the partnership interest itself, or alternatively, whether to “look through” the partnership and test its assets. Each exception, and its treatment where the property sold is a partnership interest, is discussed below. In several cases, the law is still unclear.
- Inventory (IRC §453(b)(2)(B)). When the asset sold is an interest in a partnership which owns inventory, look-through treatment (and denial of installment treatment) is probably appropriate. See Rev. Rul. 89-108, which denied installment treatment to “substantially appreciated” inventory in IRC 751(a). This ruling was issued before IRC 751(a) was amended to include all inventory. After that amendment, the ruling’s reasoning probably applies to all inventory.
- Depreciable property, to the extent of any depreciation recapture (IRC §453(i)). This is generally limited to personal property under IRC §1245. Compare IRC §751(c)(2) (listing other forms of recapture); IRC §1(h)(6) (tax treatment of “unrecaptured section 1250 gain” for real property).
- When the asset sold is an interest in a partnership which owns this type of property, look-through treatment is expressly provided by IRC §453(i)).
- Depreciable property, where buyer and seller are related (IRC §453(g)). For an example where the IRS declined to apply look-through treatment, see Priv. Ltr. Rul. 8052086.
- Debt-encumbered property, to the extent the resulting relief of debt exceeds the basis of the property (Treas Reg §15a.453-1(b)(3)(i)). Debt relief is not affected by holding the debt through a partnership. Thus, when a partnership interest is sold, look-through treatment is appropriate.
- Other installment obligations (IRC §453B; Rev Rul 60–352). When a partnership interest is sold, look-through treatment seems appropriate. See Mingo v Commissioner, 773 F.3d 629 (5th Cir. 2014), aff’g T.C. Memo 2013-149 (applying look-through to the partnership’s interest in unrealized receivables).
- Personal property under a revolving credit plan (IRC §453(k)(1)). In many cases, look-through treatment seems appropriate, in light of the discussion for inventory and installment obligations above.
- Publicly traded stock (IRC §453(k)(2)). There is no direct authority in the partnership context. For an argument that, by specifically providing for look-through in certain cases, Congress implied that there should be no look-through for the other cases, see Wilson, 718-3rd T.M., Partnerships—Disposition of Partnership Interests or Partnership Business; Partnership Termination, at II.A.2.8.
In addition, installment treatment can be denied for reasons less closely connected with the asset sold. These include:
- Sales by dealers (IRC §§453(b)(2)(A); 453(l));
- Sales where the installment obligation is secured by cash or cash equivalents (Treas Reg §15a.453-1(b)(3)(i)). See Bittker & Lokken, Federal Taxation of Income, Estates and Gifts ¶ 108.3 (“cash equivalent” likely does not include widely traded stocks; however, “prudence counsels against securing an installment obligation with a pledge of any debt instrument for which a market exists”);
- Sales in a particular year, if the seller holds installment obligations arising during that year of more than $5 million (in which case, installment treatment is not denied, but the taxpayer owes interest on the excess over $5 million) (IRC §453A(c));
- Sales to a related party, if the related party later resells the asset without having borne the risk of loss in value for at least two years (IRC §453(e)); and
- Sales in which the taxpayer affirmatively elects out of the installment method (IRC §453(d)).
Under IRC 453A(e), Congress has instructed Treasury to prescribe regulations providing that, in the context of installment sales, “the sale of an interest in a partnership or other pass-thru entity will be treated as a sale of the proportionate share of the assets of the partnership or other entity.” Treasury has not yet issued these regulations, and it is unclear what force the statute has in their absence. See Phillip Gall, Phantom Tax Regulations: The Curse of Spurned Delegations (analyzing when delegations to create regulations have independent legal force); Field Service Advice, 1995 FSA Lexis 124 (Sept. 11, 1995) (citing §453A(e)(2) and Rev. Rul. 89-108 as authority to treat sale of partnership interest as sale of proportionate shares of partnership assets).