Imputed interest on installment sales

I sent all of your information to my lawyer. He says I must have failed to tell you that I was treating it as an installment sale rather than paying taxes on the entire sum in the year of the sale. As such it does not, for tax purposes, become my money until it is actually paid to me; and imputed interest in necessary, despite my getting fair market return on it.

Since the subject line is "imputed interest on installment sales" I obviously told you.

Do you disagree with him about the concept of the money not being mine until I am obligated to pay taxes on it?

I read through your citations, but they might as well have been written in Swedish; so I don't know if they address this issue.

Back in June you said your lawyer and accountant couldn't even agree if it was indeed an installment sale. Comments here indicated it's probably not an installment sale.

-Mark Bole

how does he calculate imputed interest? seems it would be fair market return LESS what is actually received, which in your case would be zero.

How would he handle a clear cut installment sale, where in year two the seller receives $5,000 plus interest? Would he impute interest somehow? Or treat the $5,000 as sales proceeds and treat the "plus interest" as interest? Obviously it should be the latter.

My lawyer says there are three options:

1) An installment sale 2) Opt out of installment sales and pay taxes on the whole thing 3) Treat it as an open transaction

1) Requires imputed interest

2) Requires paying taxes immediately, and on paying them on funds I may never get (and can't reasonably deduct as expenses) 3) IRS would never accept it, as open transactions effectively don't exist anymore.

The best, however bad it is, is #1. Hence my question about imputed interest on installment sales.

Since you do not believe the professionals you have hired, consult another. I still feel uncomfortable giving a good answer without seeing the documents. Something that may seem of no importance to you could make the entire transaction taxable now and not an installment sale.

For my purposes I will assume the following:

Sale for $xxxx but $xx is put in an escrow. The balance is paid to you immediately and the escrow qualfies for installment treatment.

In this case, the escrow account is the buyer's and he/she should pay the interest on what it earns. An aside, this is where your facts don't jive. If the interest earned by the escrow account is taxable to you, then it seems you do not have an installment sale.

You would have imputed interest income (although that is not quite the right name as far as I am concerned. What you do is enter the payment amounts, payment dates, and applicable federal rate into your favorite present value software (Excel works great) and calculate the actual principal amount of the deferred payment. So lets say the sale was in September 2009. Payment of $5,000 per year are due for 5 years on the anniverssary of the sale. The AFR for mid-term loans from September

2009 with an annual payment requirement is 2.87%.

Excel gives us a principal value today of is $22,983.78. The balance of the payments $25,000.00-$22,983.78=$2,061.22 is interest income. Formula is (PV,0.0287,5,5000). Run an amortization schedule to get the interest per year.

Drew Edmundson, CPA Cary, NC

According to the OP, there is a loan - the deferred installment payments due in future years is considered a loan.

Drew Edmundson, CPA Cary, NC

Numbers 1 and 2 are options if it qualifies as an installment sale. But I am not sure it does. Number 3 is not an option unless there is something else you have not told us. If there is something else, then it is not an installment sale and "options" 1 and 2 are off the table.

Drew Edmundson, CPA Cary, NC

Mark, excellent point. Since the escrow is an investment account, I do not see how the transaction qualifies for installment reporting.

Drew Edmundson, CPA Cary, NC

First of all, you first came in asking if you could treat it as an installment sale or not. I don't recall your saying that it had been treated in that way, and I'm still not sure we have enough information to properly advise you on that point.

Seems to me that your lawyer would be right except for one thing - the code allows an installment sale treatment even when all the money has been earned by you at one time. You are earning actual interest on the money, not just that part of the money you have claimed as taxable income.

I imagine also that the person who paid you has deducted all the money from his taxes, not just the part that you recognize for tax purposes.

Now, this is an unusual situation, and I suppose it's possible that some IRS agents might agree with your lawyer. But in any case even if you decided to treat some of it as imputed interest, it would only mean recognizing that part in excess of the actual interest you receive as ordinary income rather than capital gain.

Base on what you said, it's your money, subject to having to give some back. It's earning interest or some other kind of income, and that's all treated as yours, right? It is improper to assign income. If it's not a loan to you, the fact that the income is yours means the principal is yours. Either that or someone improperly assigned you that income, and they should recognize it instead of you.

As I said, it's an unusual situation, and I have been able to find no case directly on point. My citations get at the principles involved.

Imputed interest is based on minimum interest requirements published by the IRS each month. It is based on market conditions and the length of the loan term.

In the latest pronouncement, in Rev. Rul 2009-40, it says that the minimum short term interest rate is .75%, mid-term rate is 2.66% and long term rate is 4.10%. I think I'm looking at the right table - you can find the ruling at:

A loan from whom? It was paid to him as the purchase price, and he recognizes the taxable income from it. It's held in escrow because of a dispute, but it's still his.

As far as installment treatment, based on information supplied recently I'm not sure that it's proper. But even if it is, I'm not convinced that it's not all his from a legal standpoint, and that no imputed interest is necessary.

At this point my question is, how much interest is the fund actually earning? Even if there were imputed interest, it would only be the difference between what is actually earned and the Applicable Federal Rate.

Well, it has to be something. If it is NOT an installment sale, then I have to pay tax on the money paid directly to me (which I have done) and also on the money paid into the escrow account (which I hae not done.) I can't say it isn't an installment sale and also refuse to pay tax on the money in the escrow account. Can I? I would love to do that, but it I can't see any argument for it.

As my lawyer see it I have the choice of claiming it is an installment sale, as allowed by P537 (escrow account with substantial restriction) or saying it is not an installment sale.

In the second it is not my money and I have to pay imputed interest.

In the first it is my money, but I have pay capital gains on the money in the escrow account. Since I will not get some of the money, that is difficult.

In questions 4 months ago, I asked if it was an installment sale or not. My recollection is that the consensus was that it was an installment sale. My question now was if I had to pay imputed interest on an installment sale; accepting it as an installment sale.

I am sorry if that was unclear.

Naturally I hope I don't have to; but if paying capital gains on the money as it is put in the escrow account or pay imputed interest are my only choices, I will take the later. Opting out of the installment sale would be crazy as I would be paying taxes on money I never get.

I don't necessarily agree - it's an unusual and complicated point. But based on the information that has been disclosed recently, I don't think he's necessarily wrong, either.

Exactly how much interest are you receiving/paying tax on for the escrow funds? Even if you decide to impute interest, it should deduct the interest actually received.

As to the balance, it would convert some of the capital gain to ordinary income. But to the extent you pay imputed interest, you don't also have to pay capital gain tax on the same amount.

Because of issues related to deferred capital losses, the penalties and interest would be huge if the IRS sees it his way; so I will have to do it his way rather than trying to avoid the imputed interest.

But I appreciate your help.

He appears to think it is a purchase money loan. If his interpretation is correct, then he has loaned money to the buyer to finance part of the purchase price. For example, I sell a lot to you for $50,000. You give me $10,000 down and promise to pay me $1,000 a month for 40 months. I have effectively loaned you the balance of the purchase price as far as IRS is concerned. Thus I need to consider part of each $1,000 payment as interest and part as principal. Using the AFR and Excel I can calculate the adjusted selling price and use that, the AFR, the payment, and the term to calculate an amortization schedule.

Based on other things he has said, I agree with you that he does not have an installment sale.

This is part of the problem. If he has enough control of the escrow that the interest it earns is taxable to him, then I think he has enough control that the sale is complete and there is no installment due in a later year.

Drew Edmundson, CPA Cary, NC

Based on what you have told us, I think you need to pay tax on the entire thing in 2008. You report any loss in the year it occurs.

You either have an installment sale or you do not. You cannot "elect" to have an installment sale. But you can have an installment sale and elect to report it all in the year of the sale.

The only alternative I see is that the interest earned by the escrow account is taxable to the buyer, then you might have an installment sale. But without the legal documents, I just do not know. Note, this is not an election or choice. Either the documents suppor this alternative or they do not.

You still have not answered why you will not consult, and pay, another professional to look at the question.

Drew Edmundson, CPA Cary, NC

Publication 537 says that if all the money is put in an escrow account it cannot be treated as escrow account unless there is a substantial restriction on the money, in which case it can be an installment sale.

I cannot access the money for any purpose until the escrow account is liquidated, and will certainly never get all of it; I might not get any of it. Not ever getting the money is the ultimate restriction.If an escrow arrange- principal purposes of the sale.in an installment obligation to the extent an ar-ment imposes a substantial restriction on yourrangement allows you to satisfy all or part of theright to receive the sale proceedsIf an escrow arrange- principal purposes of the sale.in an installment obligation to the extent an ar-ment imposes a substantial restriction on yourrangement allows you to satisfy all or part of theright to receive the sale proceeds

Please try that one again. Too many words jumbled together.

If the escrow is so restricted that it counts as an installment sale, then the earnings of the escrow account are taxable to the buyer. You cannot have it both ways - escrow income taxable to you but it is an installment sale. I believe you said at one point that the escrow account is invested in various stocks, etc. and investment decisions are made by you. That is enough control to make the transaction not an installment sale.

You also need to know that Publication 537 is not an authority. You have to refer to the Code, Regulations, official rulings (e.g. Revenue Rulings), and court cases for the law. I am certainly not going to look those up without a copy of the legal documents in front of me.

I still do not see a response to why you will not consult a third paid professional.

Drew Edmundson, CPA Cary, NC