Rev. Rul. 68-246

Advice has been requested whether, as a result of the transaction described below, the installment method of reporting income as provided by section 453 of the Internal Revenue Code of 1954 is applicable to the receipt of future payments on the notes of the purchaser.

A taxpayer sold real property and received therefor, in the year of sale, 30 percent of the selling price in cash and notes of the purchaser, bearing interest at the rate of six percent per annum, to be paid over a period of five years. The purchaser secured the notes by executing a deed of trust. The taxpayer elected to report the gain from this sale on the installment method of accounting.

Subsequent to the year of sale, the purchaser desired to clear title to the property by cancelling the deed of trust. Pursuant to a written agreement with the seller, an amount of money sufficient to cover and satisfy each remaining unpaid note in accordance with the original payment schedule was deposited with an escrow agent in consideration for the taxpayer's cancellation of the deed of trust. Subsequent note payments were paid out of the escrow account. The purchaser continued to be liable for the payment of the remaining installments when due and, in addition, recognized its tax liability for the income earned on this account. The escrow deposit is irrevocable, and no event or contingency will accelerate the time of the payment of the notes.

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) of the Code if, in the year of sale, the payments (exclusive of evidences of indebtedness of the purchaser) do not exceed 30 percent of the selling price. Section 453(a)(1) of the Code provides for the reporting of income on the installment method of accounting as the installment payments are actually received. However, if an escrow stands in the way of receipt by a vendor of his sale price, he may not be taxed as if he received the price directly. See Gibbs and Hudson, Inc. v. Commissioner, 35 B.T.A. 205 (1936), acquiescence, C.B. 1937-2, 11.

It is apparent that the escrow agreement described above stands in the way of taxpayer's receipt of the remaining unpaid portion of his sale price. These funds were not available to the taxpayer immediately but were released only in accordance with the installment obligation's original payment schedule. No event or contingency could accelerate the release of these funds. That the taxpayer does not have unqualified control over the funds in the escrow account is also indicated by the purchaser's right to the income earned thereon, as well as by the fact that the fund is utilized to discharge an obligation upon which the purchaser remained liable.

Accordingly, in the instant case, the substitution of the escrow deposit for the deed of trust as collateral for the installment sale obligation is not payment of the remaining unpaid balance due on the obligation, and the installment method of reporting income is applicable to the taxpayer's receipt of future payments on the notes of the purchaser.