Category: Sales & Exchanges; Accounting Periods
Subject: Sale of Property to Related Party
Title: Effects on Installment Reporting Provisions
IRC Sections: 453, 1060, 197
Date Produced: 12/95
Copyright 1998, The Tax Resource Group. All rights reserved. Telephone
800-578-3498. Internet: www.taxresourcegroup.com
Your letter of November 24, 1995 is incorporated by reference into this
Discussion: Related Party Rules
You have expressed concern about the taxpayer's inability to use the installment
reporting provisions because the sale is between the taxpayer and his son.
There are two sets of related party restrictions within the installment
sale provisions. One rule, Section 453(e), addresses the situation in which
a taxpayer sells property to a related party, and the related party disposes
of the property before the original seller recognizes all the gain from
the original sale. The other rule, Section 453(g), prohibits installment
reporting with respect to sale of depreciable property as between
certain related parties.
I assume that the first rule of Section 453(e) is not a problem in this
case. In other words the taxpayer does not expect his son to sell the business
within two years of the original sale as between the father and the son.
Section 453(e) would clearly apply to this situation in the event of a second
disposition, because as you point out, the father and son are clearly within
the group of related parties set forth in Section 453(f)(1). However, since
no second disposition is anticipated within the two-year time period, this
point is moot.
It seems to me that restriction on sale of depreciable property between
related parties, Section 453(g), is inapplicable to this situation because
father and son are not "related parties" as that phrase is defined
solely for purposes of Section 453(g). The definition of the phrase "related
party" which you cited as taking into account relationships as defined
under Sections 318(a) and 267(b) is found at Section 453(f)(1). This definition
of "related party" clearly would apply to a father-son sale. However,
looking closely at the scope of Section 453(f)(1), we can see that it clearly
does not apply to Section 453(g) transactions.
Observe the specific language of Section 453(f)(1).
For purposes of this section--
453(f)(1) RELATED PERSON.--Except for purposes of subsections (g) and
(h), the term "related person" means--
453(f)(1)(A) a person whose stock would be attributed under section 318(a)
(other than paragraph (4) thereof) to the person first disposing of the
453(f)(1)(B) a person who bears a relationship described in section 267(b)
to the person first disposing of the property. [Emphasis added.]
Notice that the definition of "related party" which includes
Section 318(a) and Section 267(b) relationships is made specifically inapplicable
to Section 453(g) which is the subsection with which we are concerned at
The reason the definition of "related party" under Section
453(f)(1) is inapplicable to Section 453(g) is very simple: Section 453(g)
has its own, narrower definition of "related party". Observe the
language of Section 453(g)(3).
453(g)(3) RELATED PERSONS.--For purposes of this subsection, the term
"related persons" has the meaning given to such term by section
1239(b), except that such term shall include 2 or more partnerships having
a relationship to each other described in section 707(b)(1)(B).
Section 1239 concerns itself with sales of depreciable property between
commonly controlled entities. The restrictions of Section 1239 (and hence
the restrictions of Section 453(g)) are entirely inapplicable to sales between
individuals as in this case.
Discussion: Depreciation Recapture
It seems to me that depreciation recapture is whatever it is. The various
depreciation recapture rules are highly mechanical: once the selling price
of a particular asset is determined, depreciation recapture is simply a
computational matter. Clearly, the selling price determination is the only
opportunity to affect the outcome.
Based on the rules of Section 1060 and the regulations thereunder, one
is required to allocate selling price based on the total fair market value
of the assets included in various classes. Thereafter, one is required to
allocate the selling price attributable to a given class to the specific
assets in that class based on the relative fair market values of the assets
contained in that class. It has been my experience that in many cases, the
fair market value of depreciable personal property is often rather close
to the tax basis of such property thus significantly mitigating the effect
of the depreciation recapture provisions. I suggest starting with the premise
that fair market value equals tax basis as a working hypothesis. This hypothesis
may or may not be viable based on the specific circumstances of this sale.
The hypothesis must be tested on an asset-by-asset basis. In the end, it
is critical that the taxpayers understand that the determination of the
fair market value of each asset sold is a question of fact. The taxpayers
have the burden of proving whatever values they ultimately assign to each
asset. In addition, the taxpayers can expect an extra layer of scrutiny
because the sale is between related parties.
Discussion: Section 1060
I know of no reason that Section 1060 and its related regulations should
not apply to this transaction. Section 1060 does not restrict its scope
to exclude related party sales. In fact, it seems to me that because the
parties are related, that is all the more reason that Section 1060 should
apply. After all, Section 1060 creates purchase price allocation restrictions
based on ascertainable standards, i.e., relative fair market value. Related
party sales above all others should be subject to some objective outside
Discussion: Use of an LLC
It seems to me that an LLC would not help us.
-First, in order for an LLC to be an option it must be treated as a
valid partnership for federal tax purposes. This requires more than one
participant. We have only one participant.
-Second, even if we assume away the one-man LLC problem for purposes
of this discussion, an LLC does not solve the basic problems we face here.
If the assets of the sole proprietorship were put into an LLC and sold
therefrom, the result would be essentially the same as that set forth above.
In the alternative, if the LLC interest itself were sold, we still have
the same basic problems. Through operation of Section 453(i)(2) and Section
751, the seller of a partnership interest still faces immediate gain recognition
with respect to his share of partnership depreciation recapture.
Discussion: Other Alternatives
The seller's problems could easily be solved by incorporating the assets
of the sole proprietorship and then selling the stock to the son. If that
option were deemed attractive, care should be taken to insure that the incorporation
transaction is consummated separately and well prior to the sale of stock.
It would be extremely critical to avoid any kind of contractual interdependence
between the incorporation and the sale. Otherwise, the sale could be treated
as an asset sale to by individual proprietor notwithstanding the legal form
in which the sale was cast.
The obvious problem with selling stock is the carry over basis issue.
Such a sale would deny the buyer the benefit of stepping up the acquired
assets to fair market value.
Collateral Issue: Sale of Inventory
It would be easy to overlook the fact that the taxpayer in this case is
selling inventory as part of this sale, and any profit therefrom is not
reportable on the installment method.
Collateral Issue: Section 197
Have you considered whether Section 197 amortization will be available to
the son given the related party status of this sale? Consider also the impact
this determination might have on the attractiveness (or the lack thereof)
of the option of selling stock rather than assets.