ESTATE WILL RECOGNIZE GAIN ON INSTALLMENT OBLIGATION CANCELLED BECAUSE OF PAYEE'S DEATH

Rev. Rul. 86-72

ISSUE

Is gain recognized when an installment obligation terminates because of the death of the payee, and, if so, is the gain recognized by the payee or the payee's estate.

FACTS

On July 1, 1981, A, an individual taxpayer, sold property and accepted a cash downpayment and an installment note providing for payment in annual installments over 4 years, plus interest at 11 percent on the unpaid balance. Both the sales agreement and the installment note provided that all sums due on the note were automatically extinguished and cancelled at A's death. A reported the gain on the sale on the installment method of accounting under section 453 of the Internal Revenue Code.

On the date of the sale, A's acturial life expectancy was 21 years, as determined by reference to Table 1. -- Ordinary Life Annuities -- One Life -- Expected Return Multiples, in section 1.72-9 of the Income Tax Regulations. A died 2 years after the sale, with 2 installment payments outstanding.

LAW AND ANALYSIS

Section 453 of the Code permits the transferor in an installment sale to take into account ratably over the period during which the installment payments are received, any gain resulting from the sale. Section 453B(a) provides generally that gain or loss shall result from the disposition of an installment obligation. Section 453B(f)(1) treats the cancellation of an installment obligation as a taxable disposition. Section 453B(c) provides that, except as provided in section 691, the disposition rules of section 453B do not apply to the transmission of installment obligations at death.

Section 691(a)(2) of the Code provides that if a right to receive an amount is transferred by the estate of the decedent, there shall be included in the gross income of the estate for the taxable period in which the transfer occurs the fair market value of such right at the time of such transfer plus the amount by which any consideration for the transfer exceeds such fair market value.

Section 691(a)(5) of the Code provides that, for purposes of 691(a)(2), in the case of an installment obligation held by the decedent before the decedent's death and reportable by the decedent under section 453, any cancellation of the obligation at the death of the decedent shall be treated as a transfer by the decedent's estate.

In the present case, A's death cancelled the installment obligation with 2 payments outstanding. Because A reported the gain from the sale on the installment method of accounting, recognition of the portion of the gain represented by the outstanding payments was deferred during A's lifetime.

The legislative history indicates that section 691(a)(5) of the code was enacted to clarify prior law, so that the installment obligation disposition rules would apply to obligations that are cancelled or become unenforceable by reason of death of the holder of the obligation. S. Rep. No. 96-1000, 96th Cong., 2d Sess. 26 (1980), 1980-2 C.B. 494, 508.

HOLDING

Under sections 691(a)(2) and 691(a)(5), gain is recognized by and includible in the gross income of A's estate.