Rev. Rul. 79-292

Advice has been requested as to the amount realized by a taxpayer using the accrual method of accounting that receives long-term obligations on the sale of property under the circumstances described below.

Taxpayer, a domestic corporation using the accrual method of accounting, is in the business of constructing single family houses. On January 1, 1975, a home was sold for 40,000x dollars and in accordance with taxpayer's customary business practice, the buyer procured a first mortgage loan from a bank in the amount of 30,000x dollars with an interest rate of 8 percent the proceeds of which were paid over to taxpayer. The remaining contract balance was financed directly by the taxpayer with the buyer executing a second mortgage note in the face amount of 10,000x dollars with a 9 percent interest rate. The first payment of principal and interest on the second mortgage note is not due until all payments under the first mortgage have been made, a period of 15 years. Also, on January 1, 1975, the taxpayer sold equipment previously used in its construction business and as consideration received from that buyer a note in the amount of 15,000x dollars bearing interest at 9 percent payable in full on January 1, 1977. In each sale the buyers were solvent, the property was sold at its fair market value, and the collectibility of the notes involved at the time of their receipt was not doubtful.

Section 1001(b) of the Internal Revenue Code of 1954 provides, in part, that the amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.

Section 451(a) of the Code provides that the amount of any item of gross income shall be included in gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.

Section 1.451-1(a) of the Income Tax Regulations provides, in part, that under an accrual method of accounting, income is includible in gross income when all the events have occurred that fix the right to receive such income and the amount thereof can be determined with reasonable accuracy.

Rev. Rul. 74-607, 1974-2 C.B. 149, provides that all the events that fix the right to receive income under an accrual method of accounting occur when (1) the required performance occurs, (2) payment therefor is due, or (3) payment therefor is made, whichever happens first.

The provisions of section 1001 of the Code apply to any sale or other disposition of property. There are no indications either in this section or in its legislative history that its application was intended to be limited to a particular type of sale. The regulations specify that section 1001 covers sales in the ordinary course of a taxpayer's trade or business as well as casual sales. See section 1.61-6(a) of the regulations, which illustrates the application of section 1001 in the context of sales in the ordinary course of business by a dealer in real estate (Example (1)) and a casual sale of a filling station (Example (2)).

The specific question is how to determine the amount realized, within the meaning of section 1001(b) of the Code, by a taxpayer using the accrual method of accounting when a note is received by the taxpayer upon a sale in the ordinary course of business or a casual sale. This question requires an interpretation of the provision in section 1001(b) that the amount realized shall be the sum of any money received plus the fair market value of the property (other than money) received.

It is the view of the Service that treating a note received as property under section 1001(b) of the Code and valuing it at fair market value is inconsistent with the well-established principle that an accrual method taxpayer includes in income amounts which it has a right to receive. See Spring City Foundry Co. v. Commissioner, 292 U.S. 182 (1934) Ct. D. 829, XIII-1 C.B. 281 (1934). Under this principle, the fair market value of a note received from a solvent maker is irrelevant in determining the amount realized from the sale of property. The courts have consistently refused to allow accrual method taxpayers to accrue only the fair market value of notes received upon a sale of property, and have sustained the Commissioner's position that such taxpayers must accrue the face amount of notes received. See Jones Lumber Co. v. Commissioner, 404 F.2d 764 (6th Cir. 1968), George L. Castner Co. v. Commissioner, 30 T.C. 1061 (1958), and First Savings and Loan Association v. Commissioner, 40 T.C. 474 (1963) in which the Tax Court of the United States, interpreting section 1001(b), stated that an accrual basis taxpayer does not treat an unconditional right to receive money as property received, but rather as money received to the full extent of the face value of the right.

The "cash method" tax treatment specified by section 1001(b) of the Code, that is, amount realized from sale of property, is the sum of money received and the fair market value of property received, is appropriate unless the taxpayer's use of a method other than the cash method, for example, accrual method, prescribes a different period or manner for the inclusion of gross income derived from the sale of property. This concept that the provisions of section 1001(b) are subject to the taxpayer's method of accounting is a reiteration, although not specifically set forth in section 1001(b), of the general rule for the taxable year of gross income inclusion presented in section 451(a). The provisions of section 451(a) also require gross income inclusion for the taxable year of receipt "unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period." (Emphasis added.)

Further indication that the "cash method" tax treatment specified by section 1001(b) of the Code is subject to the taxpayer's method of accounting are the provisions of section 1.453-6(a)(1) of the regulations which have been interpreted as not being applicable to accrual basis taxpayers. That regulation, which deals with deferred payment sales of real property not on the installment method, provides in part in subparagraph (1) that the obligations of the purchaser received by the vendor are to be considered as an amount realized to the extent of their fair market value in ascertaining the profit or loss from the transaction. See Western Oaks Building Corporation v. Commissioner, 49 T.C. 365, 372 n. 4 (1968), nonacq., 1968-2 C.B. 3, where the court stated that section 1.453-6(a)(1) of the regulations is inapplicable to accrual method taxpayers.

Thus, in light of taxpayer's use of the accrual method of accounting, the amount realized from the sale of the home in determining gain or loss for the taxable year of the property sale is 40,000x dollars. This result is appropriate as the required performance has occurred for the taxable year of the sale, that is, the taxpayer has transferred to the buyer the right of possession and title to the property. The occurrence of this event fixes the taxpayer's right to receive the full purchase price of the property within the meaning of section 1.451-1(a) of the regulations.

The taxpayer's use of the accrual method prescribes a different period or manner for determining the amount realized from the sale of property than that which would be prescribed if the taxpayer used the cash method of accounting. Under the cash method the amount realized for the taxable year of the sale would be the amount of money received plus the fair market value of the 10,000x dollar mortgage note and gross income inclusion in subsequent years when payments on the note exceed the fair market valuation.

Similarly, with respect to the sale of the equipment, the amount realized under section 1001(b) of the Code for the taxable year of the sale is 15,000x dollars as taxpayer's right to this amount is fixed for this taxable year. Once again taxpayer's accrual method of accounting prescribes a different period or manner for determining the amount realized than that which would be derived from determining the amount realized by a fair market valuation of the note.

Under the circumstances described above, the amount realized under section 1001(b) of the Code by an accrual method taxpayer receiving long-term obligations on the sale of property is the principal or face amount of the notes received plus the sum of money, if any, received.