Category: Sales & Exchanges; Real Estate; Accounting Periods & Methods
Subject: Installment Sales
Title: Installment Sales--Purchase Price Adjustments
IRC Sections: 453B(a), 1231
Filename: 1246.html
Date Produced: 07/95

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Background
In 1988 the taxpayer sold property for $235,000 on the installment basis. He collected $188,00 right away and took a note for $47,000. Subsequently, he collected only $37,000 of the note. The seller settled with the buyer (i.e., adjusted the selling price) such that no further payments are due under the note.

The taxpayer's basis in the property was $211,000. The original gross profit and gross profit percentage are $24,000 and 10.21%, respectively. A total of $225,00 has been collected and roundly $23,000 of gain recognized.

Based on the reduced selling price, the total gain that should have been recognized is only $14,000 ($225,000 less $211,000). Accordingly, $9,000 too much has been recognized as gain.

Issue
How is the above transaction reported?

Answer
The $9,000 excess gain is treated as a loss in the year of the settlement. The character of the loss is the same as the gain reported on the original sale.

Discussion
Ordinarily, a reduction in the selling price of an item sold on the installment basis is handled by simply reducing the gross profit percentage prospectively. That is the method prescribed by Rev. Rul. 72-570, 1972-2 CB 241, and Jerpe v Commr, 45 BTA 199 (1941).

In this case, that methodology does not work because the gain already recognized exceeds the recomputed gain based on the reduced selling price.

IRC Section 453B(a) provides in pertinent part as follows.

If an installment obligation is satisfied at other than its face value or is distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and the amount realized. Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received. Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received.

Accordingly, the $9,000 of excess gain is reported in the year of the settlement as a loss of the same character as the disposition of the original asset sold. I suggest placing a supporting schedule in the return explaining the facts and citing Section 453B(a).

I suggest the following as a model.

On xx/xx/88 the taxpayer sold property on the installment method. In prior years, gain in the amount of $23,000 has been recognized. On xx/xx/xx, the taxpayer and the buyer entered into an agreement whereby the original selling price of $235,000 would be reduced to $225,000. Based on the recomputed selling price, total gain of $14,000 should have been reported. Accordingly, $9,000 of excess gain has been reported.

IRC Section 453B(a) provides in pertinent part as follows.

If an installment obligation is satisfied at other than its face value or is distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and the amount realized. Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received. Any gain or loss so resulting shall be considered as resulting from the sale or exchange of the property in respect of which the installment obligation was received.

Accordingly, a loss of $9,000 is reported in this return. Since the gain originally reported is Section 1231 gain (or whatever it really was), the loss reported now must under Section 453B(a) be Section 1231 loss and is therefore reported on Form 4797 (or such other appropriate form).