Gift-Installment Sale (Is it taxable?)
Eve L.
have, and I have gotten conflicting opinions from my tax
advisor and other people I have conferred with who are
knowlegeable in taxes.
Years ago, I sold my home to my son. He made a down payment
and has been paying me in annual installments on the
balance. I have paid tax on the amounts received each year.
Now, he has resold the house to a third party. I do not
want to collect the balance due to me from my son. I would
like to just write it off as a gift to him. I understand
that I will be required to file a gift tax return, but I am
told that the amount is small enough that I will not have to
pay any kind of gift tax.
Where my problem comes in is that some tell me that I now
have to pay income tax on the balance of the original house
sale. I don't see why, because if I made a gift of the
entire house originally, instead of sellling it, I would not
have had to pay income tax at that point. I did pay income
tax on what I collected. Is there any good reason why I
should now have to pay tax on money I will never collect?
A related question: Now that my son has sold the house,
what would be his cost-the amount I originally sold it to
him for, or the amounts he actually paid me?
Any help would be appreciated.
E.L.
Dale Collinson
Your gain was actually realized when you sold the house to
your son. Installment sales are simply a mechanism for
reporting the gain over the period you actually receive
payment. Under some circumstances cancellation of the
remaining payments can eliminate the remaining gain, but the
statute has a specific rule, section 453B(f)(2), that upon a
cancellation between related parties (such as you and your
son) the original seller is treated as receiving an amount
equal to the amount of the cancelled payments (and thus is
taxable on the remaining gain). Your son's basis would then
include the full amount of the original sales price in your
sale to him.
Dale Collinson
Drewremedy
> have, and I have gotten conflicting opinions from my tax
> advisor and other people I have conferred with who are
> knowlegeable in taxes.
>
> Years ago, I sold my home to my son. He made a down payment
> and has been paying me in annual installments on the
> balance. I have paid tax on the amounts received each year.
> Now, he has resold the house to a third party. I do not
> want to collect the balance due to me from my son. I would
> like to just write it off as a gift to him. I understand
> that I will be required to file a gift tax return, but I am
> told that the amount is small enough that I will not have to
> pay any kind of gift tax.
>
> Where my problem comes in is that some tell me that I now
> have to pay income tax on the balance of the original house
> sale. I don't see why, because if I made a gift of the
> entire house originally, instead of sellling it, I would not
> have had to pay income tax at that point. I did pay income
> tax on what I collected. Is there any good reason why I
> should now have to pay tax on money I will never collect?
>
> A related question: Now that my son has sold the house,
> what would be his cost-the amount I originally sold it to
> him for, or the amounts he actually paid me?
>
>
1. If you forgive the balance of the installments payments
due de facto you have lowered the net sales price and
whatever your profit would have been.
2. You forgiveness is a gift to the other person. (I'm
ignoring the prospect of forgiveness of debt as income some
debtors, but before you forgive the debt, make SURE you
haven't triggered phantom income to your son.)
3. Your forgiveness may or may not be taxable to you,
depending if it exceeds $10,000 per year and overallyour
lifetime gifts and estate total over $675,000(for $2000)
rising to $1 Million in 2006
4. There is a tricky provision if you make a sale below
fairmarket value that the item gets pulled back into your
estate for tax purposes. I do not know if that means it
also gets stepped up basis for you son. Sometimes such
defects can be intentianal and result in tax savings for
small estates--but you need to work thru your own set of
facts.
5. From the standpoint of ecomonics what you seek to do is
to convert a taxable income stream into a nontaxable stream
of $10,000 or so forgiveness steps. Somewhere I'd strongly
suspect the IRS has a rule against doing it that way.I
cannot put my finger on the rule--and that's the weak link.
YES, it is entirely possible that you could have conveyed
you home to your son tax free in gradual increments, but
that's not the mechanism you elected.
6. BY the way the various payments from your son over these
years on the installments are not all income to you, only
prorata based on the profit. (Unless your son fudged on what
he told the IRS they were) You can amend you past couple of
returns if you over reported your income.
7. Trying to compute your son's basis in the home is a bit
tricky too. One's basis in a gift is your old low cost.
One's basis in a purchase is one;'s actual purchase cost.
Since the law changed in mid 97, for a couple the first
$500,000 of gain in a house owned and occupied for 2+ years
as a principle residence is tax free--that alone may make
the actual basis computation moot.
Steve Bentley
The main reason for the difference in treatment is because
the Code addresses dispositions of installment obligations
directly. You have to remember that once you sold the
house, the installment loan no longer had a connection to
it. You are right, if you had gifted the house, you would
not report the gain. But then, your son would have had a
lower basis. In response to the last part of your question,
your son retains a cost equal to the original purchase
price. The price to be paid for this is your reporting the
rest of the installment gain due. It's just like you have
received the payoff from him, and given the money to him as
a gift (in the eyes of the tax code). Here is IRC Sec
453B(a) for reference:
SECTION 453B. GAIN OR LOSS DISPOSITION OF INSTALLMENT OBLIGATIONS
(a) GENERAL RULE
If an installment obligation is satisfied at other than its
face value or distributed, transmitted, sold, or otherwise
disposed of, gain or loss shall result to the extent of the
difference between the basis of the obligation and--
(1) the amount realized, in the case of satisfaction at
other than face value or a sale or exchange, or
(2) the fair market value of the obligation at the time
of distribution, transmission, or disposition, in the
case of the distribution, transmission, or disposition
otherwise than by sale or exchange.
any gain or loss so resulting shall be considered as
resulting from the sale or exchange of the property in
respect of which the installment obligation was received.
*********************************************
Now, where you may salvage a little benefit is the "fair
market value of the obligation at the time of ....
disposition". If you can argue that the fair market value
of the balance owed by your son was less than the face
value, you can save some of the income. This, by the way,
is a determination you need to make to properly report the
gift as well.
Steve Bentley, MBT, CFO
Better Business Systems
Drewremedy
> to convert a taxable income stream into a nontaxable stream
> of $10,000 or so forgiveness steps. Somewhere I'd strongly
> suspect the IRS has a rule against doing it that way.I
> cannot put my finger on the rule--and that's the weak link.
> YES, it is entirely possible that you could have conveyed
> you home to your son tax free in gradual increments, but
> that's not the mechanism you elected.
Thanks to another alert reader you got the specific NO that
the IRC has already provided. You are stuck as to reporting
the income, whether you get it or not.
(If your son were insolvent or bankrupt there might be some
bad debt wiggle room but I doubt that is your case
especially if you could have been paid of of the sale
proceeds in the first place!)
I don't know who told you to convey the house that way in
the first place. But if you have any remaining assets or
otherwise might have a taxable estate, I certainly would get
fresh more competent counsel to review your picture.
Eve L.
Now I'm really mixed up.
I have a small estate, and I do not expect to ever pay gift
taxes or estate taxes. That's not a problem. The only
question would seem to be whether or not I can get out of
paying capital gains tax on the balance of the original sale
if I now gift the remaining mortgage balance to my son. I'm
sorry I just didn't set it up as a gift originally.
That brings up another question. Even though it's 14 years
later, can I go back and amend the tax return I filed for
the year of the sale and explain that it was actually
intended to be a gift? (I don't care about getting back any
taxes I paid on the collections along the way. All I want
is out of this big tax right now).
E.L.
Drewremedy
collect upon a mortgage note or to allow a loan to
intentionally run beyond the statutue of limitations
as to collectability is itself a gift.
So you could get double whammed, first for the full sale
price of the installment sale collected or not and then
for any gift consequences of any forgotten debt.
Before you invest in a lot of legal opinions, wouldn't it
be far cheaper for your son to merely pay off the debt as
agreed? There is nothing that says you cannot make
unrelated bonafide gifts of up to $10,000 per person per
year to him and his family. If you son is unwilling to pay
off the debt as agreed, then there is something more to your
problem?
Ed Zollars
> Where my problem comes in is that some tell me that I now
> have to pay income tax on the balance of the original house
> sale. I don't see why, because if I made a gift of the
> entire house originally, instead of sellling it, I would not
> have had to pay income tax at that point.
If you had burned it down, you wouldn't have paid tax either
(although arson investigators probably would have wanted to
talk to you <grin>). But that's not what you *DID*--instead,
you sold the property to your son. You could have gifted
it, but you didn't. That was your choice at the time, and
you have to live with it now.
> I did pay income tax on what I collected. Is there any
> good reason why I should now have to pay tax on money I
> will never collect?
Yes--because you elected (or, more properly, didn't elect
not) to use the installment method to defer tax on the gain
on sale. Having taken advantage of that provision to not
pay tax in the year of sale, you now can't undo the issue
years later by gifting a portion of the note. Note that if
you had gifted the house many years ago, it's very likely
that *would* have required a gift tax return--so that may
have influenced why you didn't make the gift. Or, perhaps,
you needed the cash flow at the time from the note. But
whatever the reason, you made an affirmative choice at that
time about how you were going to transfer the property to
your son.
Steve mentioned potential valuation issues. While I'd
normally agree, I would note that in this case it's going to
be *EXTREMELY* hard to justify any significant discount.
Your son had just sold the home and you had the right to
force a payoff of the note for the face amount. It seems
difficult to justify why, in that case, there would be any
discount allowed--the note seems just about as good as cash
at that point.
---
Ed Zollars, CPA (AZ)
ezo...@primenet.com
http://www.hmtzcpas.com
Ed Zollars
> It looks like I'm getting even more conflicting opinions.
> Now I'm really mixed up.
Except for one answer that was taken back by the original
person posting it, the answers have been extremely
consistent--YOU PAY THE TAX.
> That brings up another question. Even though it's 14 years
> later, can I go back and amend the tax return I filed for
> the year of the sale and explain that it was actually
> intended to be a gift?
No. The statute is closed on that year and you are not
allowed at this point to change how you interpreted the
situation because you now realize that it would have been
less costly to have treated the transaction in another
manner. Second, this isn't exactly an election--you either
sold the property or you gifted it. You can't retroactively
change the transaction from one mode to the other.
Drewremedy
> later, can I go back and amend the tax return I filed for
> the year of the sale
You can only go back 3 years.
You might want to discuss with your own private legal
counsel the ramifications of just doing NOTHING.
Gene E. Utterback
> It looks like I'm getting even more conflicting opinions.
> Now I'm really mixed up.
>
> I have a small estate, and I do not expect to ever pay gift
> taxes or estate taxes. That's not a problem. The only
> question would seem to be whether or not I can get out of
> paying capital gains tax on the balance of the original sale
> if I now gift the remaining mortgage balance to my son. I'm
> sorry I just didn't set it up as a gift originally.
>
> That brings up another question. Even though it's 14 years
> later, can I go back and amend the tax return I filed for
> the year of the sale and explain that it was actually
> intended to be a gift? (I don't care about getting back any
> taxes I paid on the collections along the way. All I want
> is out of this big tax right now).
You can only amend returns back three years, so the answer
is a resounding NO - you are stuck with the gains.
Dale & Steve got it exactly right, IRC 453B lays it down in
black and white and I agree with them completely.
Have you considered collecting the balance from you son,
paying the taxes out of the proceeds and them gifting him
back the remainder? Seems to me that this would be the
thing for your son to do.
Good luck, and please let us know how this turns out.
Gene E. Utterback, EA
Ed Zollars
> You can only amend returns back three years, so the answer
> is a resounding NO - you are stuck with the gains.
I would also point out that even if we were within the three
year window, you can't simply go back and "throw out" the
notes you wrote on the sale. And it would seem difficult to
believe that you accidentally reported your transfer as a
sale on the original 1040 when you really meant for it to be
a gift.
Tiffany Costigan
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