Rev. Rul. 77-294

Advice has been requested whether the installment method of reporting income as provided by section 453 of the Internal Revenue Code of 1954 is applicable to a sale of real property under the circumstances described below.

A taxpayer, who reports income on the basis of a calendar year, sold real property in January 1976 for 100x dollars. The taxpayer received 10x dollars as a down payment and six notes, each for 15x dollars, secured by a deed of trust on the property. The notes together with interest thereon were due annually over the next six years.

In July 1976, because the purchaser desired to subdivide the property and sell individual lots, the taxpayer and the purchaser entered into an agreement whereby the purchaser deposited the remainder of the purchase price of the property with an escrow agent and the taxpayer cancelled the deed of trust. The agreement provides that the escrow agent will pay to the taxpayer, for the account of the purchaser, 15x dollars and interest thereon annually as the notes fall due. The purchaser continues to be liable for the payment of the installments when due and recognizes the tax liability for the interest earned on the amount placed in escrow. The escrow deposit is irrevocable and the payment schedule may not be accelerated by any party under any circumstances.

Section 453(b) of the Code provides, in part, that income from the sale of real property may be reported on the installment method of accounting in the manner prescribed in section 453(a), if, in the year of sale, there are no payments, or the payments (exclusive of evidences of indebtedness of the purchaser) do not exceed 30 percent of the selling price.

Rev. Rul. 68-246, 1968-1 C.B. 198, holds that the substitution of an escrow deposit for a deed of trust under a real property installment sale transaction in a year subsequent to the year of sale is not payment of the remaining unpaid balance due on the obligation, and the installment method of reporting income as provided by section 453(b) of the Code is applicable to the receipt of future payments on the notes of the purchaser.

Rev. Rul. 73-451, 1973-2 C.B. 158, holds that the installment method of reporting income under section 453 of the Code does not apply to a sale of real property under a sales contract where the purchaser at the time of sale, pursuant to an escrow agreement, deposits the balance of the purchase price in escrow to be released in six yearly installments by the escrow agent. In that Revenue Ruling, the transaction was a completed sale since the seller did not regard the buyer as being indebted to the seller because the buyer's obligation was met in full when the buyer deposited the balance of the purchase price with the escrow. The seller was not relying on the installment obligation of the buyer but upon the escrow deposit for the payments in connection with the sale.

The material facts in Rev. Rul. 73-451 are not substantially different from the material facts in this case, except that the cash escrow for the balance of the purchase price was established independently of and subsequent to the sale. When the escrow was established, the taxpayer no longer relied on the obligation of the buyer but upon the escrow the taxpayer personally had arranged for the balance of the purchase price.

Accordingly, in the instant case, the sales transaction does not qualify for installment sale treatment under section 453(b) of the Code, since more than 30 percent of the sales price was received in the year of sale.

The material facts in Rev. Rul. 68-246 are also indistinguishable from those in this case, with the exception that the escrow deposit in Rev. Rul. 68-246 was not established in the year of sale. In that Revenue Ruling, it was concluded that the escrow deposit stood in the way of the taxpayer's receipt of the remaining unpaid portion of the sales price. Upon reconsideration, however, the Service now concludes that under the facts as stated in Rev. Rul. 68-246, the substitution of the escrow deposit for the deed of trust as collateral for the installment sale obligation represents payment of the remaining unpaid balance of the installment obligation so that the installment method of reporting income is not applicable to the remaining installment payments due.

If an escrow arrangement incident to a deferred payment sales transaction imposes a substantial restriction, in addition to the payment schedule, upon the seller's right to receipt of the sales proceeds, the Service will allow the seller to use the installment method of reporting income from the sale under section 453(b) of the Code assuming the sales transaction otherwise qualifies under that provision. See, for instance, Rebecca J. Murray, 28 B.T.A. 624 (1933), acq. XII-2 C.B. 10 (1933), where 75 percent of the purchase price of personal property was placed in escrow as security for the sellers' agreement to refrain from entering a competing business for a period of five years. One fifth of the escrow funds were to be delivered to the sellers annually, but if, at any time during the escrow period, they engaged in a competing business, they would forfeit all rights to the amount then held in escrow.

Rev. Rul. 68-246 is revoked.

Pursuant to the authority provided by section 7805(b) of the Code, this Revenue Ruling will not be applied to payments received from an escrow account where an escrow deposit was made in a year subsequent to the year of sale and on or before August 22, 1977, the date this Revenue Ruling is published in the Internal Revenue Bulletin.