Category: Sales & Exchanges
Subject: Installment Obligations
Title: Effect of Modifications to Installment Note
IRC Sections: 1001, 453, 453B
Date Produced: 9/96
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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
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.