9053 / What special accounting rules apply in the installment sale context if the sale involves related parties?

Under IRC Section 453(e)(1), if a taxpayer (“first seller”) disposes of property to a related person in an installment sale (“first sale”), and the related party in turn sells the property in a second sale before the first seller receives all payments under the first sale, the amount realized in the second sale will be treated as received by the first seller. This is the case even though the first seller has actually not received all payments due with respect to the first sale.¹

Essentially, the payments received from the second sale are treated as though they were used to pay off the first sale even if, in reality, the second seller has made no payments. The purpose of this treatment is to prevent a taxpayer from improperly deferring gain on the sale of property by using the installment method of accounting.

In order for the related party rules to apply, the second sale must occur within two years of the first sale unless the property at issue consists of marketable securities.²

For purposes of the installment sale rules, “related party” includes the seller’s siblings, ancestors, lineal descendants, certain controlled corporations (see Q 8964) and estates, trusts and partnerships in which the seller has an interest.³

If the second sale occurs as a result of an involuntary conversion under IRC Section 1033 (see Q 8670), the second sale will not be treated as a “second sale” under these rules if the first sale was made before the threat of the involuntary conversion arose.⁴ Further, a second sale will not be deemed to have occurred for purposes of these rules if the sale occurs after the death of either the first seller or the related party who acquires the property in the first sale.⁵ If the parties are able to prove that the sales were not motivated by tax avoidance, the related party rules will not apply.⁶