How Tax Works: Episode 35

Topic: The Installment Method Under Section 453 of the Internal Revenue Code
Host: Matthew (Matt) Foreman, Co-Chair of Falcon Rappaport & Berkman’s Taxation Practice Group
Date: September 15, 2025

Episode Overview

This episode centers on demystifying the installment method under Section 453 of the Internal Revenue Code—a provision frequently encountered in structuring business and property sales. Matt Foreman translates the dense legalities into practical insights, focusing on eligibility, exceptions, calculation mechanics, and real-world planning considerations.

Key Discussion Points & Insights

1. What Is an Installment Sale?

• Definition: An installment sale permits deferral of gain until payment is actually or constructively received. Only gains (not losses) can be deferred under this method.
• Mechanics: Payments can be cash or property, and at least one must be received after the year of sale.
  • “It requires actual or constructive receipt and the payment can be in cash or other property. You can't use it to defer losses.” (03:05)
• Loss Treatment: Losses on installment sales must be recognized immediately in year one.

2. Election Out of Installment Method

• Taxpayers may elect out (Section 453(d)(1)), often to use losses immediately against gains or other income, especially to avoid limitations on Net Operating Loss (NOL) usage.
• Practical note: A formal promissory note is not required; even a handshake or email can evidence the necessary agreement.
  • “A handshake is more than sufficient. And email is wonderful. As I always point out, contracts don't have to be written.” (07:36)

3. Assets and Transactions Not Eligible for Installment Treatment

Matt outlines seven key exclusions (10:01), emphasizing that careful asset classification is essential:

• Inventory Sales: Only eligible if not in the ordinary course of business (e.g., to satisfy a tax lien).
• Dealer Dispositions: Excludes personal property sold by someone in the business of selling such property, with exceptions for farm property and certain timeshares.
• Publicly Traded Property
• Depreciable Property Sold to Related Persons: Notably, “related” means business relations, not family (13:37).
• Depreciation Recapture
• Sales Under Revolving Credit Plans
• Installment Note Sales or Pledges: Sale or collateralization of the note is deemed immediate payment.

4. Calculating Taxable Gain Each Year

• Formula:
  “The income for the year is the payment multiplied by the gross profit divided by the total contract price.” (14:35)
  • Payment x (Gross Profit / Total Contract Price) = Taxable Income
  • Recovery of basis occurs simultaneously as payments are applied.
• Gross Profit Ratio: Stays constant throughout payment years.

5. Special Asset Situations

• Multiple Assets in a Transaction: Allocation and calculation can become complex, requiring separate treatment of loss and gain assets (16:33).
  • Referenced: Revenue Ruling 68-13.
• Interest Component:
  • “Interest, which is always ordinary income…if there's no interest or insufficient interest charged, you must impute interest and lower the taxable portion.” (05:23)
  • Interest must be at least at the applicable federal rate (AFR).

6. Contingent Payment Sales (18:15)

• Applies when the total selling price cannot be determined at the close of the sale year.
• Three regulatory scenarios:
  • Maximum Price Known: Treat that as sale price.
  • Payment Period Known, Price Not: Use equal basis each year as payments are received.
  • Neither Known: Presumed 15-year period unless shown otherwise; if too indefinite, may be reclassified as rent or royalty.

7. Interest Charge under Section 453A

• To prevent indefinite tax deferral, interest charges must be paid to the IRS if obligations exceed both $150,000 individually and $5 million in aggregate.
  • “Congress was concerned...in order to defer it...they would just have very, very long of significant amounts for deferral.” (20:58)
• Calculation:
  • Applicable percentage x deferred tax liability x underpayment interest rate (23:17).
  • Applicable Percentage: (Aggregate obligations - $5 million) / Aggregate obligations.
  • Deferred tax liability = gain not yet recognized x maximum tax rate applicable.

8. Installment Sales & 1031 (Like-Kind) Exchanges (25:10)

• 1031 exchange portion is removed from 453 calculation.
• Basis in original property is allocated to new property (replacement property), with notes often receiving little or no basis.

Notable Quotes & Memorable Moments

• On music remixes and AI:
  “We actually got one and I am...not exaggerating this here. Someone did it with rap. Pretty sure it's AI rap...Even if you don’t like rap, I highly recommend listening to it, if only for the comedic value.” (00:56)
• On related parties:
  “The related persons are all business relations, not familial relative...I always find it fascinating that related under the Internal Revenue Code doesn't often mean what people in normal discussions say is related.” (13:37)
• On practicality:
  “You want to make sure in year one you have at least enough cash to pay the tax on all the assets that are not eligible for installment sale treatment.” (11:41)
• On calculation complexity:
  “The overall formula is the applicable percentage multiplied by the deferred tax liability multiplied by the underpayment interest rate. And that is about as helpful as a concrete slab to someone drowning in the ocean.” (23:17)

Timestamps for Key Segments

• Intro, podcast purpose, upcoming topics: 00:10 – 03:44
• Installment sale explained, basics: 03:44 – 07:00
• Electing out, requirements, and exceptions: 07:00 – 10:11
• Assets not eligible & exceptions: 10:11 – 13:40
• Calculation mechanics & formulas: 14:18 – 16:32
• Multiple asset sales and examples: 16:32 – 18:10
• Contingent payment sales: 18:15 – 20:58
• 453A interest charges: 20:58 – 25:10
• 1031 exchanges with installment method: 25:10 – 26:39

Conclusion & Closing

Matt recaps the value of understanding these rules for effective tax planning and hints at a future deep dive on 1031 like-kind exchanges. The episode wraps up with a humorous shoutout to the AI-generated rap remix, described as “You won’t be the same after...Not for better, not for worse, just different.” (26:36)

For Further Learning and Resources

Listeners are encouraged to visit the How Tax Works landing page for details on upcoming (free) advanced tax webinars, covering topics like 704(c) allocations, succession planning, stock/asset sales, and QSBS updates.

If you have questions or feedback, reach Matt directly at his FRB email. Stay tuned for Episode 36: Grouping Rules under Section 469!