Category: Sales & Exchanges Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com My concern with your client's revisions to the installment note is that the deferred gain inherent in the note has been triggered by the modifications. In general, under Sections 1001 and 453B, if a note modification materially changes the holder's rights and economic position, the old note is deemed to have been exchanged for a new note containing the modified terms. This exchange is a taxable disposition of the note triggering the deferred installment profit. The problem for us is there is no "bright-line" standard for determining how much of a modification is needed in order to trigger a deemed disposition of the note. The rules in this area are very hazy. Clearly, the father's economic risks have changed as a result of the extensions of the note. Presumably the son is not paying because the business is doing badly. The father's economic position is thus weakened by allowing further time for payment of the note during which the remaining value of the collateral continues to be exposed to and diminished by the forces that are causing non-payment now. In addition, the father's position is clearly changed by the rather wide swings in interest rates described. Under proposed regulations issued under Section 1001, I believe the changes in question would clearly be viewed as deemed dispositions of the note. These regulations are not yet effective, however. Also, according to the proposed regulations, it is not necessarily the case that a disposition under Section 1001 creates a disposition under Sections 453 and 453B which is necessary to trigger the installment gain. Personally, I fail to see how a Section 1001 disposition would not be a Section 453B disposition. In addition, I am concerned about the length of time during which the notes in question were not paid. Although your memo was not very specific on this point, clearly the notes have been significantly in arrears over some considerable time period. If the father has lost his legal ability to enforce his rights under the note by reason of expiration of the statute of limitations under state law, this is also deemed disposition of the installment note. If this has happened, there is black-letter law which requires us to recognize the deferred profit. See IRC Section 453B(f). I suggest taking up this issue with the attorney. I can say based on the work that I have done that I feel that your client definitely has some exposure. If we need to go further than that and actually quantify the exposure, that will take some time, perhaps 4-6 hours over and above the rather modest investment I have in the project already. Since the modifications in question are in the past, I wonder why we should do that. This is up to your client, of course, and I am glad to pursue whatever your client needs. As for the private annuity issue, I have not pursued it at all. I have a very strong feeling that it is not possible to exchange the installment note for a private annuity without triggering the deferred installment gain. I will look into this further if you wish. I simply have not been in the office to have the opportunity to look. Please advise. |
