Loss on sale under installment method is deductible in year of loss

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Tax Hot TopicsIn a recent private letter ruling (PLR 201451004), the IRS said a partnership that reduced the maximum selling price of property below the property’s basis was able to claim a loss under Section 165 related to a contingent payment sale, and that the loss should be claimed in the year in which the events that led to the reduction in sales price occurred.

Under the facts of the PLR, the taxpayer sold stock of another company it held as an investment under an installment sale arrangement, where a certain amount was due at closing, and certain amounts, including a maximum earn-out based on several milestones, were due in subsequent years.

In the year of the sale, the taxpayer reported the transaction on the installment sale method under Section 453 as a contingent payment sale. The taxpayer determined a maximum selling price under this method and reported income based on proceeds received in year one. In year two, events occurred that reduced the maximum selling price, though the taxpayer did receive some proceeds, which were reported under the installment method. In year three, the earn-out period expired before the company achieved any milestones, reducing the maximum selling price to an amount less than the taxpayer’s basis in the stock sold. This changed the transaction to a loss transaction rather than a gain transaction. No proceeds were received in year three.

Section 453 requires that income from an installment sale be taken into account under the installment method. An installment sale is a disposition of property through which at least one payment is to be received after the close of the taxable year in which the disposition occurs. The IRS determined that the taxpayer correctly applied Section 453 and applied the installment method in the year of the sale and in year two. It wasn’t until year three that events occurred that changed the transaction to a loss transaction.

Under Section 165, a deduction is allowed for any loss sustained during the taxable year that is not compensated by insurance or otherwise. Furthermore, Treas. Reg. Sec. 1.165-1(d)(1) provides that a loss shall be allowed only for the year in which the loss is sustained. For these purposes, a loss is treated as sustained during a taxable year in which the loss occurs as evidenced by closed and completed transactions and fixed by identifiable events occurring during the year. Because the earn-out period expired in year three, which established the maximum remaining amount the taxpayer could receive under the installment sale, that is the year the identifiable event occurred and the loss should be taken.

The IRS ruled that the taxpayer’s original treatment of picking up income under the installment method in years one and two was correct and should not be changed to reflect the loss that occurred in year three. Instead, the loss is deducted in year three when the event that changed the transaction from a gain to a loss transaction occurred.

Sharon Kay
T +1 202 861 4140

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