Tax contrivance

[Snaggletooth]

Seller of $300,000 property with virtually no basis wants to avoid as much tax as he can.

He has a buyer for willing to pay him $300,000 on December 27, 2006. Seller would like to split this into two checks: one for $150,000 on December 27, 2006, and another for $150,000 on January 5, 2007. This keeps the seller OUT of the AMT for both years, and saves some $5,000 over the course of the transactions.

My question: Can the IRS void the installment sale treatment since there was no economic substance to splitting the dollars?(Other than tax avoidance) If so, what about adding $1000 worth of interest and making the second check payable later in the year??

[DonPriebe]

Without a mortgage?

I won't comment about the one week split check deal, but would you sell a $300,000 property to someone with only his word that he would pay half now and half "later next year"? A prudent seller would get a promissory note backed by a security interest in the property (aka a mortgage) when closing on the property. In that case it would actually be an installment sale, and not a contrivance.

[Snaggletooth]

No Problems

I'm hoping someone WILL comment based on the original question.

Actually, this is not blind trust. There are bankers, attorneys, realtors, etc. willing to write this up in any fashion. The buyer has already put down $20,000 in earnest money.

[Bees Knees]

You have to make it a promissory note to turn it into an installment sale. Just asking the guy to wait a week before giving him the second half is not enough, because under the constructive receipt rule, the seller would be entitled to the full payment in December of 2006. To defeat the constructive receipt rule, the terms of the sales agreement has to be in such a way that the seller is not entitled to full payment until 2007, and usually that means charging interest and having an actual loan agreement in place. It is easy enough to do. Nothing fancy. Just have it written into the sales agreement that the guy is going to pay half in December, and the other half plus normal interest on the balance due in January.

[OldJack]

I agree that the terms have to spell out that the payment crosses the tax year. Stating interest is not a required factor in the definition of an installment sale.

Also, a closing on the deal/property must be in the current year and not just earnest money down on a contract.

[jainen]

using that particular format

>>Can the IRS void the installment sale treatment since there was no economic substance to splitting the dollars?(Other than tax avoidance)<<

Snaggletooth, I don't know what you were doing up at four in the morning. Were you waiting in line at the mall for the 50% off sale at Mervyn's? Anyway, that's not the best time to think because you end up obsessing about obscure things like "economic substance."

Economic substance is not in the law. It's just one way to interpret laws. Actually there are several theories of interpretation that use that moniker. They all apply to abusive tax shelters, that is, transactions in which an investor claims an economic position (typically a loss) that does not actually exist.

In your original post, the transaction is a genuine sale. It might be structured in various ways, but when it is completed your client will have the money and not have the property. The tax code allows a taxpayer to make choices about the timing of a transaction. Since the tax consequences of an installment contract are spelled out in the code, there is no problem about using that particular format.

[Bees Knees]

Stating interest is not a required factor in the definition of an installment sale.

True, but not charging interest will get you in trouble with the imputed interest rules of section 7872. And since the goal is to avoid IRS from re-characterizing the transaction, it is advisable to charge interest. Lower the price for the amount of interest that needs to be charged, if the buyer doesn't want to pay the interest.

[Bees Knees]

Economic substance is not in the law. It's just one way to interpret laws. Actually there are several theories of interpretation that use that moniker. They all apply to abusive tax shelters, that is, transactions in which an investor claims an economic position (typically a loss) that does not actually exist.

Tax shelter losses are only one example.

Section 7872(c)(1)(D) says, "Tax avoidance loans. Any below-market loan 1 of the principal purposes of the interest arrangements of which is the avoidance of any Federal Tax."

If interest isn't charged on the loan, the IRS could say the ONLY reason for the loan was to avoid AMT tax by splitting it into two years. Section 7872(c)(1)(D) can only apply in a below market loan situation. Therefore, by charging interest at the going rate, that code section cannot apply.

So in other words, if you want to avoid Federal Tax by using the installment method, make sure it is not a below market loan.

[Joe Btfsplk]

True, but not charging interest will get you in trouble with the imputed interest rules of section 7872. And since the goal is to avoid IRS from re-characterizing the transaction, it is advisable to charge interest. Lower the price for the amount of interest that needs to be charged, if the buyer doesn't want to pay the interest.

Go ahead and charge the going rate of interest. If the final installment is only a month or less in the future the interest will be negligible. If it is of any concern, however, you could reduce the sales price accordingly. 6% per annum would only be ½% for one month, so for $100,000 you could change it to $99,502.48 ($99502.48 X 1.005=$100,000.
Douible those figures for $ 200,000, etc.