Discussion:Opting Out of Installment Reporting

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Discussion Forum Index --> Advanced Tax Questions --> Opting Out of Installment Reporting


Discussion Forum Index --> Tax Questions --> Opting Out of Installment Reporting

Jdugancpa (talk|edits) said:

26 March 2010

Client sold stock in private company. Collected approximately 85% in 2009 with 5% remaining to be collected in each of 2010, 11 & 12. The sales agreement provides for a holdback from the final installment if receivables and WIP are less than fully realized. Based upon cap gain rates currently in the law, the 2011 and 2012 cap gains rate will go up to 20%. Therefore, opting out of installment sale reporting has the potential for saving $30,000, albeit it would need to be paid on his 2009 return to realize the savings.

My question is, in the event that the 2012 payment is reduced, if client elects out installment sale reporting, will the purchase price adjustment result in a 2012 capital loss, or would we be able to go back and amend the 2009 return to revise the gain originally reported in 2009?

Doug M (talk|edits) said:

27 March 2010
Would going on extension out to 10/15 give you a better crystal ball as to how the A/R and WIP may affect your decision?

I deleted the rest of my post!! Thanks again Kevin.

Kevinh5 (talk|edits) said:

26 March 2010
Doug, I think it is a stock sale.

Doug M (talk|edits) said:

27 March 2010
Ooops. I guess it always pays to read every word in the sentence. Thanks Kevin. I guess only the first sentence in my posting should be read. Trillium, can you delete my post, except for the first 13 words?

Kevinh5 (talk|edits) said:

27 March 2010
you can edit your own post

go to the top 'edit this page' tab, then delete the portions of your post which you no longer feel are appropriate.

this makes all people look like experts, as they can change their answers after finding out the correct answer. Of course, the history of changes is there for the knowledgable to read via the 'history' tab.


any way, I've found it useful when I've wanted to change a

'You can do this' post to a

'You can NOT do this' post

Jdugancpa (talk|edits) said:

27 March 2010
Yes, it is a stock sale, so it is all cap gain, no ordinary income involved. We've decided to extend the return paying the full tax assuming we will opt out of using installment gain reporting to provide us with greatest flexibililty. First installment payment is due 8/1, so Doug, you are correct, our crystal ball will be clearer as to the likelihood of taking a hit on the sales price. The biggest hit should be known by the 8/1/10 installment payment. (New information just gained since my original post). But it still begs the question, if we opt out of installment reporting, report a gain of one amount and the actual realized is a lesser amount, can we amend the 2009 return (it should still be open by 8/1/12) to reflect a reduce selling price, or must we treat it as a capital loss in 2012?

CATaxAtty (talk|edits) said:

27 March 2010
Okay so this sounds like a contingent payment sale (full sale price is not determinable by close of sale year). Your choices are:
  1. Elect out
  2. Apply the default rules
  3. Apply for a special ruling under the procedure in temp regs. 15A.453-1(c)(7)

I'm guessing there is no maximum sale price and we know the payment period is fixed. Under temp regs. 15A.453-1(c), the default rule is ratably basis recovery over the sale period. In other words, basis is divided into equal annual increments and allocated over the sale years (there are 4 in this case, 2009-2012)

The default rules would probably have you wind up with a nasty capital loss. So your option is to elect out, or apply for a ruling (proposing your own allocation) under the temp regs above. O the rulings published, 99% of the taxpayers (virtually all) had their request granted, and under these facts, I would almost guarantee the same result. But if this is too much hassle, you may just want to elect out.

Dennis (talk|edits) said:

27 March 2010
Ah, but the question is if electing out, how to treat a later adjustment. If you elect out you have to compute the fair market value of the right to contingent payments and pay tax on that. That essentially gives you basis in each of these payments and my understanding is that you then recognize gain or loss as the actual payments are received.

CATaxAtty (talk|edits) said:

27 March 2010
So if you elect out, here's my understanding of how it works-


1. You elect out under 453(d) on or before the due date for the sale-year return.

2. In the sale year, you report the FMV of all property received, including any installment obligations. Temp. Regs. 15A.453-1(d)

3. This means the dollar amount of any cash received, plus

4. The FMV of any installment obligations received.

5. If some of the installment obligations are contingent and some are not, the different obligations are treated as 2 separate sales (see regs 1.1275-4(c)(2) / Temp. Regs. 15A.453-1(d)(2))

6. The noncontingent component is treated as a separate debt instrument, the issue price of which is the lesser of the noncontingent principal payments or the sum of the present values of the noncontingent payments using the AFR as the discount rate. For guidance, see regs. ยง1.1274-2(g) / 1.1001-1(g) (*And a word of caution* - do NOT follow Temp Regs 15A.453-1(d)(2) here, which makes the treatment of the noncontingent payments dependent on the taxpayer's method of accounting. These temp regs are outdated, and in conflict with the newer regs.)

7. Anywho, for the contingent component, the taxpayer reports the FMV of the obligations if they are reasonably ascertainable. See 1.1001-1(g)(2)(ii) (if you want to take the position that they are not reasonably ascertainable, see below).

8. The FMV of the contingent obligation (in your case, the final payment) will be its present value, using the applicable AFR as the discount rate.

9. And finally, the adjustment issue. What happens if they don't receive the final payment?

10. Basically you have two choices on this. Either -


A. You report the FMV of the contingent payment and then wait. If the payment will not be made, then at the appropriate time under the worthless debts rules, you can take a bad debt deduction.

B. If you decide that the FMV of the contingent payment is not reasonably ascertainable, then it may be possible to report this component using the open transaction method. However, the regs caution that this is only to be done in 'rare and extraordinary cases.' 1.1001-1(g)(2)(ii) / 15A.453-1(d)(2). So this approach is somewhat risky.

C. You could also apply for a special ruling under the procedure in 15A.453-1(c)(7). Here you would propose your own basis allocation. However, this is expensive and time consuming, and there is a time-crunch issue (since you have a short window before your ability to elect out of the installment method expires).


Hope this helps..

Dennis (talk|edits) said:

27 March 2010
Nasty set of calculations to opt out. So basis established is cumulative and all has to be used up before any recognition. And when AFR is less than installment note rate you pay tax on more than you are going to get but still have to recognize interest income per note. Ooooh.

CATaxAtty (talk|edits) said:

27 March 2010
Yea, that's right (I think we're on the same page). All cash and the present value of all installment obligations are reported in Year 1. In later years, imputed interest will be paid on the deferred payments (unless the agreement provides for adequate stated interest). In such case, the noncontingent payments will be treated as a zero coupon bond. Or at least, that's my understanding. Imputed interest on the contingent payment is controlled by regs 1.1275-4, which even I don't understand.

Anyway, if it was me, I would probably elect out. By not electing out, you risk blowing the deadline to elect out, then blowing the deadline to get the special ruling, and then winding up having the default rules apply (ratable basis recovery). The result could be terrible, especially since the bulk of the payments are to be received up front.

So I would do this.

1. Elect out.

2. Report all gain, recapture income, etc.

3. Report the present value of the installment obligations on the basis that you will receive all.

4. Report the interest income as you go along.

5. Take the wait and see approach for the final payment. If it doesn't pan out, deduct as a bad debt.

Jdugancpa (talk|edits) said:

27 March 2010
Thank you. Very helpful discussion. Points me in the right direction.


CONN CHRIS (talk|edits) said:

18 August 2010
I have stumbled accross the back end of what Jdugancpa was contemplating.

New client.

  1. Elected out on a 2007 asset sale (S-corp).
  2. The only paper taken by seller was a final principle payment to be made in 2010
  3. Note was distributed to the 2 shareholders, S-corp liquidated and disolved
  4. Former shareholders have received and reported interest on the note (2008,2009)
  5. When note ballooned (2010) the sellers / former shareholders agreed to take 50% of face value.

It seems to me that the only option is to report this as a loss in 2010 pro-rating based on character of the underlying sale in 2007 (ordinary and capital loss)

I don't see that amending 2007 to reflect a reduced sales price or to revoke the opt out election are options. They opted out apparently simply because they had the cash at the time and wanted to 'be done with it'.

CONN CHRIS (talk|edits) said:

18 August 2010
Does anyone think there could be justification for amending the 2007 returns to reflect what is in effect a reduced sales price? I tend to think that this is a current loss on an asset (the note) rather than a reduction of the price agreed to three years ago. The agreement that they signed to acept 50% of the face value only references the note itself and not the underlying sale.

Waynecpa (talk|edits) said:

18 August 2010
I had a client that had to pay back part of what they received on their 2007 business sale. After getting advice here, I amended the 2007 returns. Made the most sense to me since this was the financial reality of the transaction (although not an installment sale).

CONN CHRIS (talk|edits) said:

20 August 2010
That is similar but in my case, the original price was not really reduced (parties to that sale were S-corp and buyer); instead, the former shareholders re-negociated a note that was distributed to them. It seems that amending the now-defunct S-corp return and then in-turn the 1040s could be an option but not amending the 1040s alone as it all was pass-through activity.

Waynecpa (talk|edits) said:

20 August 2010
That is what I did - amended the S-corp and 1040 returns.

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