CHANGE IN LAW WILL NOT JUSTIFY LATE ELECTION OUT OF INSTALLMENT REPORTING OF GAIN ON REAL ESTATE SALE.

Rev. Rul. 90-46

ISSUE

If a taxpayer fails to make a timely election out of the installment method of reporting gain from an installment sale of property, will the Internal Revenue Service ("IRS") grant permission for the taxpayer to make late election out of the installment method in the situations described below?

FACTS

SITUATION 1. In 1985, taxpayer A sold real estate for cash and an installment note. Under the terms of the note, A is to receive monthly payments until 1995. On A's 1985 federal income tax return, A used the installment method to report only part of the gain from the sale. A reported this gain as a long-term capital gain.

In the Tax Reform Act of 1986, Congress eliminated the 60 percent net capital gain deduction and reduced the maximum effective tax rate on the taxable income of individuals to 28 percent. These two changes, in combination, raised the maximum effective tax rate on net capital gains from 20 percent to 28 percent. These two changes, in combination, raised the maximum effective tax rate on net capital gains from 20 percent to 28 percent. Because of this increase in the maximum effective tax rate, A in 1987 properly requested permission from the IRS to elect out of the installment method of reporting the gain on the 1985 sale and to report the entire gain from that sale on an amended 1985 federal income tax return.

SITUATION 2. In 1985, taxpayer B sold a personal residence for cash and a 10-year installment note. On B's 1985 federal income tax return, B used the installment method to report only part of the gain from the sale. In 1986, B properly requested permission from the IRS to report the remainder of the gain on B's 1986 federal income tax return. B based the request on a desire to simplify income tax reporting.

SITUATION 3. In 1985, C, an individual taxpayer, sold real property for cash and a five-year installment note. On January 15, 1986, C sent a letter to D, an accountant, who prepared C's 1985 federal income tax return. In the letter, C instructed D to elect out of the installment method for the sale of real property and to report all the gain from such sale on C's 1985 federal income tax return. C also sent D a power of attorney to sign the return as C's agent because C was going to be out of the United States for at least the 60 days prior to the due date for C's 1985 return. D signed and timely filed C's return, but mistakenly did not elect out of the installment method for the sale of a real property, and mistakenly used the installment method to report only part of the gain from such sale.

On returning to the United States in May 1986, C discovered D's mistake on C's 1985 return. Shortly thereafter, C requested permission from the National Office of the IRS to file an amended 1985 return to elect out of the installment method of reporting the gain on the 1985 sale of real property and to report all the gain from such sale on C's amended 1985 return. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request.

LAW AND ANALYSIS

Section 453(a) of the Internal Revenue Code of 1986 (the "Code") provides that income from an installment sale shall be taken into account under the installment method.

Section 453(b)(1) of the Code provides that an installment sale is a disposition of property where at least one payment is to be received after the close of the taxable year in which the disposition occurs.

Section 453(c) of the Code provides that the term "installment method" means a method under which the income recognized for any taxable year from a disposition is that proportion of the payments received in that year which the gross profit (realized or to be realized when payment is completed) bears to the total contract price.

Section 453(d)(1) of the Code provides that the installment method shall not apply to any sale if the taxpayer elects not to have the installment method apply to the sale. Section 453(d)(2) of the Code provides that, except as otherwise provided by regulations, an election out of the installment method may be made only on or before the due date prescribed by law (including extensions) for filing the taxpayer's return for the taxable year of the sale.

Section 15a.453-1(d)(2)(i) of the Temporary Income Tax Regulations ("temporary regulations") provides that a taxpayer who elects not to report an installment sale on the installment method must recognize gain on the sale in accordance with the taxpayer's method of accounting.

Section 15a.453-1(d)(3)(ii) of the temporary regulations provides that elections out of the installment method after the due date (including extensions) for filing the taxpayer's return for the taxable year in which the sale occurs will be permitted only in those rare circumstances when the IRS concludes that the taxpayer had good cause for failing to make a timely election.

A request for permission to make an election out of the installment method, if made after the due date (including extensions) for filing the taxpayer's return for the taxable year in which the sale or other disposition occurs, must be mailed to the National Office of the IRS. In addition, such request must be in accordance with the applicable administrative procedures for requesting a private letter ruling that are in effect at the time of the request.

In SITUATION 1, when A reported gain from the sale of real estate in 1985 using the installment method on A's 1985 federal income tax return, A may have based the decision on the then existing tax law. Moreover, A may not have considered the possibility that Congress would subsequently amend the tax law to eliminate the 60 percent net capital gain deduction and thus raise the maximum effective rate of tax on net capital gains. Congress made such an amendment to the tax law in 1986. As a result, A's circumstances changed so that A could save tax by electing out of the installment method and reporting the entire gain from the sale of real property on an amended 1985 return. For purposes of section 15a.453- 1(d)(3)(ii) of the temporary regulations, however, the IRS does not consider a subsequent change in circumstances or law to be a good cause for failing to make a timely election out of the installment method. Thus, the Service will not grant A permission to elect out of the installment method.

In SITUATION 2, B reported the sale of a personal residence using the installment method on B's 1985 federal income tax return. B would have had simpler income tax reporting if B had elected out of the installment method and had reported all the gain from the sale on B's 1985 return. In 1986, B wanted to simplify income tax reporting by reporting the remainder of the gain from the 1985 sale on B's 1986 federal income tax return. For purposes of section 15a.453-1(d)- (3)(ii) of the temporary regulations, however, the IRS does not consider a taxpayer's change of mind to be good cause for failing to make a timely election out of the installment method. Thus, the Service will not grant B permission to elect out of the installment method.

In SITUATION 3, when C's 1985 federal income tax return was timely filed, C intended to elect out of the installment method for reporting gain from the real property C sold in 1985. C's agent, however, mistakenly did not make the timely election out of the installment method on C's 1985 federal income tax return. Upon learning of the mistake and within a reasonable time after the return was filed, C properly requested permission from the National Office of the IRS to make the election out of the installment method of reporting the gain on the 1985 sale of real property. Such request was in accordance with the applicable administrative procedures for requesting a private letter ruling that were in effect at the time of the request.

If a taxpayer's intention to timely elect out of the installment method is thwarted by a mistake and the taxpayer makes a timely effort to correct the mistake, the Service may consider this one of the rare circumstances in which the taxpayer has good cause for failing to make a timely election out of the installment method. In SITUATION 3, C had written documentation, executed before C's timely filed 1985 federal income tax return, that showed that C intended to timely elect out of the installment method of reporting the gain on 1985 sale of real property. Thus, subject to the discretion of the Commissioner and after considering all of the relevant facts, the Service may grant C permission to elect out of the installment method by filing an amended 1985 federal income tax return.

HOLDING

In SITUATIONS 1 and 2, the Service will not grant permission for the taxpayers to make a late election out of the installment method. In SITUATION 3, the Service may grant permission for the taxpayer to make a late election out of the installment method.

DRAFTING INFORMATION

The principal author of this revenue ruling is James A. Orefice of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Orefice at (202) 566-3637 (not a toll-free call).