Couple Argues Installment Sale Transactions Qualify for Deferral

Nat S. Harty and April D. Harty,
Petitioners,
v.
Commissioner of Internal Revenue,
Respondent.

TABLE OF CONTENTS

I. Introduction

II. Factual Overview

III. Statement of Undisputed Material Facts

IV. ARGUMENT

V. CONCLUSION

TABLE OF AUTHORITIES

Cases

Aimero v. INS, 18 F.3d 757 (9th Cir. 1994)

Altria Group, Inc. v. U.S., 658 F.3d 276 (2d Cir. 2011)

Bank of N.Y. Mellon Corp. v. Comm'r, 801 F.3d 104 (2d Cir. 2015)

Bowen v. Comm'r, 78T.C. 55 (1982)

CNT Invs., LLC v. Comm'r, 144 T.C. 161 (2015)

Compaq Computer, Inc. v. Comm'r, 277 F.3d 778 (5th Cir. 2001)

Cottage Savings Association v. Commissioner, 499 U.S. 544 (1991)

Cowden v. Comm'r, 289 F.2d 20 (5th Cir. 1961)

FPL Grp. Inc. v. Comm'r, 116 T.C. 73-74-75, 2001 WL 85184 (2001)

GCM 39662 (September 16, 1987), 1987 WL 430215

Green Valley Investors LLC v. Comm'r, 159 T.C. No. 5, n.11 (2022)

Gregory v. Helvering, 293 U.S. 465 (1935)

Griffin v. Oceanic Contractors, Inc., 458 U.S. 564 (1982)

Griffith v. Commissioner, 73 T.C. 933 (1980)

Lustgarten v. Commissioner, 639 F.2d 1208 (5th Cir. 1981)

Nye v. United States, 407 F.Supp, 1345 (M.D.N.C. 1975)

Oden v. Commissioner, 56T.C. 569 (1977)

Pozzi v. Commissioner 49 T.C. 119 (1967)

Rauenhorst v. Comm'r, 119 T.C. 157 (2002)

Roberts v. Comm'r 643 F.2d 654 (9th Cir. 1981)

Roberts v. Comm'r, 643 F.2d 654 (9th Cir. 1981)

Rogers v. U.S., 281 F.3d 1138 (10th Cir. 2002)

Rogers v. U.S., 58 F.Supp. 2d 1235 (D.Kan. 1999)

Rushing v. Comm'r, 441 F.2d 593 (5th Cir. 1971)

Rushing v. Comm'r, 441 F.2d 593 (5th Cir. 1971)

Stewart v. United States, 7 39 F.2d 411 (9th Cir. 1984)

Stewart v. United States, 739 F.2d 411 (9th Cir. 1984)

Summa Holdings, Inc. v. Comm'r, 848 F.3d 779 (6th Cir. 2017)

Sundstrand Corp, v. Comm'r, 98 T.C. 518 1992 WL 88529 (1992), aff'd 17 F.3d 965 (7^th Cir. 1994)

Trivett v. Commissioner 611 F.2d 655 (6th Cir. 1979)

U.S. v. Coplan, 703 F.3d46 (2d Cir. 2012)

Warren Jones Co. v. Comm'r, 524 F.2d 788 (9th Cir. 1975)

Watson v. Commissioner, 69 T.C. 544 (1978)

Weaver v. Comm'r, 647 F.2d 690 (6th Cir. 1981), aff'g 71 T.C. 443 (1978)

Wrenn v. Commissioner, 67 T.C. 576 (1976)

Wrenn v. Commissioner, 67 T.C. 576 (1976)

Statutes

I.R.C. § 453

I.R.C. § 453(a)

I.R.C. § 453(b)(1)

I.R.C. § 453(b)(2)(A)

I.R.C. § 453(c)

I.R.C. § 453(f)(3)

I.R.C. § 453A

I.R.C. § 453A(d)

I.R.C. § 453A(d)(1)

I.R.C. § 453A(d)(4)

I.R.C. § 453A(e)(1)

I.R.C. § 453B

Pub. L. No. 111-152 Star. 1029 (March 30, 2010)

Rules

Tax Court Rule 121

Tax Court Rule 121(b)

Regulations

Temp. Treas. Reg. § 15a.45311(b)(3)(i)

Treas. Reg. § 1.1031(k)-1(j)(2)(ii)

Treas. Reg. § 1.6011-4(a)

Treas. Reg, § 15a.453-1(b)(3)(i)

Other Authorities

86 Fed, Reg. 51756

Bittker & Lokken: Federal Taxation of Income, Estates, and Gifts, ¶ 5.9 Effect of Taxpayer's Accounting Method — Constructive Receipt

David P. Hariton, Sorting Out the Tangle of Economic Substance, 52 Tax Law. 235 (1999)

Donald L. Korb, Remarks at the 2005 University of Southern California Tax Institute: The Economic Substance Doctrine in the Current Tax Shelter Environment (January 25, 2005)

Guidance for Examiners and Managers on the Codified Economic Substance Doctrine and Related Penalties, LB&I-4-0711-015 (July 15, 2011)

Internal Revenue Service Chief Counsel Memorandum 2012340IF (August 24, 2012) (https://www.irs.gov/pub/irs-lafa/20123401F.pdf)

Joseph Bankman, The Economic Substance Doctrine, 74 S. Cal. L. Rev. 5 (2000)

Otto Hetzel, Michael Libonata & Robert Williams, Legislative Law and Process (2d Ed, 1998)

Rebecca Rosenberg, Codification of the Economic Substance Doctrine: Agency Response and Certain Other Unforeseen Consequences, 10 Wm. & Mary Bus. L Rev. 199 (2018)

Richard R. Powell, Powell on Real Property § 10B.04[2] (2018)

S. Rep. No. 1000, 96th Cong., 2d Sess. 12-17 (1980), 1980-2 CB 494

U.S. Dept, of Treas., The Problem of Corporate Tax Shelters: Discussion, Analysis and Legislative Proposals (July 1999), available at https://home.treasury.gov/system/files/131/Report-Corporate-Tax-Shelters-1999.pdf

White, 570-4th T.M., Accounting Methods — General Principles, IV.B.2.b. Constructive Receipt

 

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Pursuant to Tax Court Rule 121, Petitioners, Nat S, Harty and April D. Harty, respectfully submit this Memorandum of Law in Support of their Motion for Partial Summary Judgment.

I. INTRODUCTION

This case is about the tax treatment of what the parties called “monetized installment sale” transactions entered into by petitioners Nat S. Harty and April D. Harty (“petitioners”) through their trust, of which Nat S. Harty was and is trustee. In this instance, the “monetized installment sale” occurred when petitioners sold an asset in exchange for an installment note and had prearranged to take out a loan that gave them approximately the same amount of cash they would have received if they had done a cash sale to the buyer. The Internal Revenue Code (“Code”) permits monetized installment sales (subject to important limitations). See Code section 453A(d). Also, the IRS has approved the concept in an important Chief Counsel Advice from 2012, See Internal Revenue Service Chief Counsel Memorandum 20123401F (August 24, 2012) (https://www.irs.gov/pub/irs-lafa/20123401F.pdf) (the “2012 CCA”).

II. FACTUAL OVERVIEW

The basic facts of petitioners' monetized installment sale transactions can be summarized as follows: Petitioners sold three real properties (collectively and severally herein, the “Property”) during 2016, the tax year in issue. For each sale, they sought to defer taxable gain on the sale by qualifying for installment sale treatment under section 453. In each case, petitioners had buyers who were willing to pay cash for the Property, and petitioners entered into a “Purchase and Sale Agreement” (or equivalent) with each of those respective buyers (the “End Buyers”). Receiving cash from those End Buyers would have prevented petitioners from qualifying for gain deferral under section 453, however. To solve that problem, they entered into agreements (each, an “Installment Sale and Purchase Agreement”) that in paragraph 2 assigned those Purchase and Sale Agreements to S.Crow Collateral Corp, (“SCCC”), unrelated to Petitioners, to purchase each Property from petitioners on installment terms and re-sell the same, on deeds executed by petitioners on behalf of SCCC, to each of those End Buyers. Those transactions characterized SCCC as a “qualified intermediary.” SCCC thereafter indeed sold the Property for cash to the End Buyers, who in the sale closing statements acknowledged the transactions as occurring that way.

As was arranged in advance, at or about the same time as the sale of each respective Property, petitioners entered into a loan agreement with the unrelated Alpha Holding Company, LLC. (“Lender”), pursuant to which Lender loaned petitioners an amount equal to approximately 95% of the selling price of that Property, less closing costs and any sale commission paid at closing. For each of the three installment purchases, an unfunded long-term installment escrow was established by petitioners and SCCC and into which the monthly installment payments made by SCCC were to be deposited, and were deposited as agreed. For each of the three loans, petitioners and Lender established one long-term escrow into which petitioners immediately paid the first month's loan interest and another long-term escrow through which Lender would receive each of petitioners' monthly loan interest payments. Petitioners arranged with the escrow holder (Alpha Lending, LLC) to transfer petitioners' money from the installment escrow as it comes in, to the escrow for the benefit of Lender. Lender was given no rights whatever in or to the installment escrow or the installment transaction.

III. STATEMENT OF UNDISPUTED MATERIAL FACTS

For purposes of this motion, we set forth the undisputed material facts as related to the installment sale of 430½ Acacia Avenue, one of the three transactions.

A. The Sale

1. The Stowe Properties Trust (the “Trust”) owned certain real property located at 430% Acacia Avenue, Newport Beach, CA 92625 (the “Acacia Property”). See Declaration of Guy Glaser in Support of Motion for Partial Summary Judgment (Glaser Decl.) ¶ 14; see also Declaration of Nat S. Harty in Support of Partial Motion for Summary Judgment (Harty Decl.) ¶¶ 6, 7.

The Acacia Cash Sale

2. On June 7, 2016, the Trust entered into a California Residential Purchase Agreement (the “Acacia Cash Sale Agreement”), with Alison Cohen (“Cohen”), Trustee of the Lutzius/Cohen Trust, dated November 21, 1997 to sell the Acacia Property. Glaser Decl. Ex. A [Acacia Cash Sale Agreement].

3. Ultimately, the Trust agreed to sell the Acacia Property to Cohen for $1,345,000 (the “Acacia Cash Sale”). See Glaser Decl. ¶ 14 and Glaser Decl. Ex. B [Acacia Acknowledgement Escrow Instructions].

4. Under the Acacia Cash Sale Agreement, the Trust had the right, in certain circumstances, to decline to transfer the Acacia Property to Cohen at closing. Glaser Decl. Ex. A [Acacia Cash Sale Agreement] ¶ 14.D.

5. Among other circumstances, the Trust had the right to cancel the Acacia Cash Sale Agreement if Cohen failed to provide verification of sufficient funds to close the transaction or failed to return certain required disclosures. Glaser Decl. Ex. A [Acacia Cash Sale Agreement] ¶¶ 3.C, 1O.A(5), 14.D(1), 14.D(2).

The Acacia Installment Sale

6. On June 7, 2016, before the closing of the Acacia Cash Sale, the Trust entered into an Installment Sale and Purchase Agreement (the “Acacia Installment Agreement”) with S.Crow Collateral Corp. (“SCCC”), an Idaho corporation. Glaser Decl. Ex. C [Acacia Installment Agreement].

7. In the Acacia Installment Agreement, the Trust agreed to sell the Acacia Property to SCCC as a dealer-principal for resale to Cohen (the “Acacia Installment Sale”), and assigned the Acacia Cash Sale Agreement to SCCC. Glaser Decl. Ex. C [Acacia Installment Agreement] ¶¶ 1-2.

8. SCCC agreed to pay the Trust a purchase price (the “Total Purchase Price”) equal to (a) the net proceeds paid out to SCCC at closing of the Acacia Cash Sale, after closing costs (the “Sale Proceeds”) plus (b) the amount of the Trust's indebtedness secured by the Acacia Property that was paid by SCCC at closing of the Acacia Cash Sale (the “Acacia Indebtedness”). Glaser Decl. Ex. C [Acacia Installment Agreement] ¶ 4.

9. SCCC agreed to pay the Trust, with full-recourse liability, (a) the unpaid portion of the Total Purchase Price (the “Principal Amount,” which was equal to the Sale Proceeds) in a single payment at the end of a 30-year term, as well as (b) non-amortizing interest on the Principal Amount at a rate which produced fixed monthly interest payments of $6,069.00. Glaser Decl. Ex. C [Acacia Installment Agreement] ¶¶ 9, 10, 13.

10. SCCC and the Trust agreed that payments would be made through a long-term escrow, held by Alpha Lending, LLC (“Alpha Lending”), an Idaho limited liability company, (the “Acacia Installment Escrow Instructions”). Glaser Decl. Ex. C [Acacia Installment Agreement] ¶¶ 9, 20, Ex. M [Acacia Installment Escrow Instructions] Parts C, E.1, E.3.

11. There was no down payment. Glaser Decl Ex. C [Acacia Installment Agreement] ¶ 6.

12. SCCC is precluded from prepaying any or all of the Principal Amount, except in the event of a default by the Trust, or other limited circumstances, and the Trust cannot declare the Principal Amount due except in the event of a default by SCCC. Glaser Decl. Ex. C [Acacia Installment Agreement] ¶ 13.

13. If SCCC has made all interest payments and is not in default when the Principal Amount comes due, it will be entitled to a 5% price reduction. Glaser Decl. Ex. C [Acacia Installment Agreement] ¶ 38.

14. If the Trust suffers a capital loss (from any source) equal to 20% or more of the Principal Amount, the Trust may request that SCCC make a balloon payment on the Acacia Installment Agreement to cover such loss. Glaser Decl, Ex. C [Acacia Installment Agreement] ¶ 11.

15. In the event of such a balloon payment, there is no corresponding reduction in the Loan Amount (defined below).

16. The Trust is prohibited from assigning, encumbering, or pledging the Acacia Installment Agreement. Glaser Decl. Ex, C [Acacia Installment Agreement] ¶¶ 12, 30, 31.

17. Neither the Trust nor SCCC provided tax, legal, or investment advice to the other. Glaser Decl. Ex. C [Acacia Installment Agreement] ¶ 28.

18. The Trust agreed to keep confidential the precise text of the Acacia Installment Agreement but there is no prohibition on disclosing the substance of the agreement. Glaser Decl. Ex. C [Acacia Installment Agreement] ¶ 37.

The Acacia Cash Sale and Acacia Installment Sale Closings

19. On June 14, 2016, the parties closed on the Acacia Cash Sale and the Acacia Installment Sale. Glaser Decl. Ex. E [Seller's Closing Statement Final].

20. The total consideration paid by Cohen pursuant to the Acacia Cash Sale was $1,345,000. See Glaser Decl. Ex. E [Seller's Closing Statement Final].

21. At the time of closing, the Acacia Indebtedness was equal to $491,542.21, attributable to an outstanding third-party loan for which the Acacia Property was security. See Glaser Decl. Ex. E [Seller's Closing Statement Final].

22. SCCC disbursed $491,542.21 of the total consideration to pay off the Acacia Indebtedness. See Glaser Decl. Ex. E [Seller's Closing Statement Final].

23. SCCC was reimbursed by Alpha Holding Company, LLC (“Alpha Holding”), an Idaho limited liability company, for the amount disbursed. See Glaser Decl. Ex. G [Letter from SCCC acknowledging reimbursement].

24. After payoffs, adjustments, and closing costs, the Sale Proceeds were $776,970.08. See Glaser Decl. Ex. E [Seller's Closing Statement Final].

25. Thus, under the Acacia Installment Agreement, the Total Purchase Price was $1,268,512.20.

26. Pursuant to instructions entered into on June 7, 2016, by the Trust and Alpha Holding, (the “Closing Instructions”), the Sale Proceeds were paid into an escrow account for the benefit of SCCC. See Glaser Decl. Ex. D [Closing Instructions to First American Title & Escrow Company].

27. The Trust executed the instruments of transfer to Cohen explicitly on behalf of SCCC, and title to the Acacia Property was conveyed by the Trust directly to Cohen. See Glaser Decl. Ex. C [Acacia Installment Agreement] ¶¶ 2, 14, Ex. F [Grant Deed].

28. Alpha Holding is not a party to the Acacia Cash Sale Agreement or the Acacia Installment Agreement. See Glaser Decl. ¶ 24.

29. The Acacia Installment Agreement does not provide Alpha Holding with any right to enforce that Agreement or any right of collection against SCCC. See Glaser Decl. ¶25.

30. The Acacia Installment Agreement does not provide Alpha Holding with priority over other of the Trust's creditors to be paid money which SCCC pays into the Installment Escrow (defined below). See Glaser Decl. ¶26.

B. The Loan

The Acacia Loan

31. On June 7, 2016, the Trust and Alpha Holding entered into a loan agreement (the “Acacia Loan Agreement”) and a promissory note (the “Acacia Promissory Note”). Glaser Decl. Ex. H [Acacia Loan Agreement], Ex. I [Acacia Promissory Note].

32. In the Acacia Loan Agreement and the Acacia Promissory Note, Alpha Holding agreed to fund a loan (the “Acacia Loan”) to the Trust in the principal amount of $1,205,086.68 (the “Loan Amount”). Glaser Decl. Ex. H [Acacia Loan Agreement], Ex. I [Acacia Promissory Note] ¶ 1.

33. The Trust agreed to pay Alpha Holding, with full-recourse liability, (a) the unpaid portion of the Loan Amount at the end of a 30-year term, as well as (b) non-amortizing interest on the unpaid portion of the Loan Amount at a rate which produced fixed monthly interest payments of $6,069.00. See Glaser Decl. Ex. H [Acacia Loan Agreement] ¶ 22, Ex. J [Acacia Promissory Note] ¶ 1-2.

34. The Trust and Alpha Holding agreed that payments would be made through a long-term escrow, held by Alpha Lending. Glaser Decl. Ex. H [Acacia Loan Agreement] 24, Ex, I [Acacia Promissory Note] ¶¶ 1, 4, Ex. M [Acacia Installment Escrow Instructions] Parts C, E.1, E.3.

35. There is no right of setoff in connection with the Acacia Loan. Glaser Decl. Ex. I [Acacia Promissory Note] ¶ 6.

36. The Acacia Loan can be prepaid in whole or in part at any time by the Trust, Glaser Decl. Ex. I [Acacia Promissory Note] ¶ 7.

37. The Trust has the obligation to pay the Acacia Loan in accordance with its terms; nonpayment constitutes an Event of Default. Glaser Decl. Ex. H [Acacia Loan Agreement] ¶¶ 4(9), 8, Ex. I [Acacia Promissory Note] ¶ 8.

38. In any Event of Default, Alpha Holding may declare the entire unpaid Loan Amount and all unpaid interest to be immediately due and will have all rights and remedies provided for in the Acacia Loan Agreement and the Acacia Promissory Note. See Glaser Decl. Ex. H [Acacia Loan Agreement] ¶ 10, Ex. I [Acacia Promissory Note] ¶ 10.

39. If payments are not made on the Acacia Loan, Alpha Holding's ability to enforce the Trust's full-recourse liability is limited if and while the payments which the Trust receives from SCCC under the Acacia Installment Agreement are deficient. See Glaser Decl. Ex. H [Acacia Loan Agreement] ¶¶ 22.

40. If and while such payments are deficient, Alpha Holding will not compel payments from or begin collection proceedings against the Trust with respect to an amount greater than what is paid by SCCC under the Acacia Installment Agreement. Glaser Decl. Ex. H [Acacia Loan Agreement] ¶¶ 22.

41. Alpha Holding will not write off or discharge any portion of the Acacia Loan due to a deficiency under the Acacia Installment Agreement. Glaser Decl. Ex. H [Acacia Loan Agreement] ¶ 22.

42. In the event of any other default (such as a material adverse change in the Trust's ability to perform as required by the Acacia Loan Agreement, the Trust's becoming insolvent or filing bankruptcy, creditor proceedings being brought against the Trust, the Trust using the loan proceeds for non-business or investment purposes or violating a law pertaining to the Trust's business) which is not cured, or if money that was paid to the Trust into a long-term escrow is diverted, Alpha Holding has full-recourse collection rights against the Trust under the Acacia Loan, including to undertake proceedings to collect immediately the entire unpaid balance, notwithstanding any deficiency in payments received by the Trust under the Acacia Installment Agreement. Glaser Decl. Ex. H [Acacia Loan Agreement] ¶¶ 9, 22.

43. The Trust could assign its rights and obligations under the Acacia Loan with the consent of Alpha Holding. Glaser Decl. Ex. H [Acacia Loan Agreement] ¶ 17.

44. Before the time of the Acacia Loan closing, the Trust had the right to decline to receive funding under the Acacia Loan. See Glaser Decl. Ex. D [Closing Instructions to First American Title & Escrow Company].

Acacia Loan Closing

45. On June 17, 2016, Alpha Holding funded the Acacia Loan. See Glaser Decl. Ex. J [Borrower's Final Loan Settlement Statement].

46. Out of the Loan Amount, (a) Alpha Holding was paid a 1% loan fee; (b) Alpha Lending was paid its escrow set-up fee; (c) the Trust's first month's loan-interest payment was paid into Acacia Funding Escrow (defined below); (d) the loan-closing agent was paid its loan-closing fee; (e) SCCC was paid $491,542.21 as reimbursement for funds disbursed to pay off the Acacia Indebtedness; and (f) the remaining $694,394.60 (the “Loan Proceeds”) were paid to the Trust, See Glaser Decl. Ex. J [Borrower's Final Loan Settlement Statement].

47. On June 17, 2016, the Sale Proceeds were released to SCCC. See Glaser Decl. Ex. D [Closing Instructions to First American Title & Escrow Company]; Ex. K [Email from SCCC regarding release of funds from escrow].

48. Neither SCCC nor Cohen was a party to the Acacia Loan. See Glaser Decl. ¶ 30.

49. Neither the Acacia Loan Agreement nor the Acacia Promissory Note provide that SCCC or Cohen would guarantee the Acacia Loan. See Glaser Decl. ¶ 31.

50. Neither the Acacia Loan Agreement nor the Acacia Promissory Note provide that the Acacia Loan would be secured by any payment due under the Acacia Installment Agreement. See Glaser Decl. ¶ 32.

51. The Trust, Cohen, SCCC, and Alpha Holding are all unrelated. See Glaser Decl. ¶33.

C. The Escrows

52. On June 7, 2016, the Trust, SCCC, and Alpha Lending executed long-term escrow instructions (herein before referred to as the “Acacia Installment Escrow Instructions”). See Glaser Decl. Ex. M.

53. On June 7, 2016, the Trust, Alpha Holding, and Alpha Lending executed two sets of long-term escrow instructions (the “Acacia Funding Escrow Instructions” and the “Acacia Loan Escrow Instructions”). Glaser Decl. ¶ 35.

54. Under the Acacia Funding Escrow Instructions, the Trust was required to deposit an amount equal to one monthly interest payment under the Acacia Promissory Note into a long-term escrow (the “Acacia Funding Escrow”), held by Alpha Lending. See Glaser Decl. Ex. N [Acacia Funding Escrow Instructions] Parts C, D.1.

55. Under the Acacia Installment Escrow Instructions, SCCC was required to make any interest or principal payments pursuant to the Acacia Installment Sale into a long-term escrow (the “Acacia Installment Escrow”) held by Alpha Lending. See Glaser Decl. Ex. C [Acacia Installment Agreement] ¶¶ [ 9, 20, Ex. M [Acacia Installment Escrow Instructions] Parts C, E.1, E.3.

56. Under the Acacia Installment Escrow Instructions and the Acacia Funding Escrow Instructions, each time SCCC makes such a payment pursuant to the Acacia Installment Sale, Alpha Lending is required to transfer from the Acacia Installment Escrow into the Acacia Funding Escrow, an amount equal to the interest payment required under the Acacia Promissory Note on or before the due date under the Acacia Promissory Note. See Glaser Decl. Ex. M [Acacia Installment Escrow Instructions] Parts C, E.1, E.3, Ex. P [Acacia Funding Escrow Instructions] Parts C, E.1, E,3.

57. Under the Acacia Loan Escrow Instructions, each time Alpha Lending receives such a payment pursuant to the Alpha Promissory Note, Alpha Lending is required to pay or credit to Alpha Holding an amount equal to that payment. See Decl. Ex. Q [Acacia Loan Escrow Instructions] Parts C, E.2, G.2.a.

IV. ARGUMENT

Respondent has asserted that for various substantive reasons petitioners do not qualify for installment sale treatment under the Code. These can be characterized as technical arguments on the objective rules governing the tax treatment of the sale and subsequent loan. For the reasons explained, petitioners satisfy the statutory requirements to qualify for installment sale treatment. In addition to his technical arguments under the objective rules, respondent amended his answer on the eve of trial to assert that the codified economic substance doctrine (“CESD”) applies and petitioners are liable for the accompanying 40% strict liability penalty. As we explain below, petitioners satisfied the objective rules governing their monetized installment sales, and the CESD is not relevant.

After describing in Part A below the standard of review, we describe in Part B the objective rules that govern the tax treatment of petitioners' monetized installment sale and show that petitioners satisfied those objective rules. In Part C, we summarize the role of CESD and show that it is not relevant here as a matter of law. The role of CESD is to effectuate Congressional intent by setting aside the tax results established under the objective rules in the Code when those tax results are unreasonable and unwarranted in light of the statutory purpose. Respondent asserts in his pleadings¹ that CESD applies because petitioners had an opportunity to do a cash sale but chose instead to defer tax by entering into an installment sale with an intermediary and then took out a loan that gave petitioners approximately the same amount of cash they would have gotten if they had done a cash sale.² Despite his obligation to show that the economic substance doctrine is relevant, respondent makes no attempt to address how applying CESD can be reconciled with objective rules that permit taxpayers to receive installment notes from buyers instead of cash, to use intermediaries to accomplish installment sales, and to take out loans that give installment sellers a comparable amount of cash to that which they could have received from a cash sale. CESD cannot apply under those circumstances because, even if respondent's characterization of petitioners' actions were correct, the Code allowed petitioners to do what they did (either explicitly or as interpreted by the courts and respondent).

A. Standard of Review

Full or partial summary judgment may be granted where the pleadings and other materials show that there is no genuine dispute as to any material fact and that a decision may be rendered as a matter of law. Rule 121(b); Sundstrand Corp. v. Comm'r, 98 T.C. 518,520, 1992 WL 88529 (1992), aff'd 17 F.3d 965 (7^th Cir. 1994). The burden is on the moving party to demonstrate that there is no genuine dispute as to any material fact and that he or she is entitled to judgment as a matter of law. FPL Grp. Inc. v. Comm'r, 116 T.C. 73-74-75, 2001 WL 85184 (2001).

B. Petitioners' Monetized Installment Sales Met the Statutory Requirements for Deferral Under Section 453

1. The Objective Rules Governing the Treatment of Petitioners' Monetized Installment Sales

Section 453(a) allows a taxpayer to report “income from an installment sale” by using the “installment method.” “The term 'installment sale' means a disposition of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs.” Section 453(b)(1). Under the “installment method,” a seller recognizes as income “that proportion of the payments received in that year which the gross profit bears to the total contract price,” Section 453(c). Thus, rather than recognize all the gain in the year of a disposition, section 453 allows the taxpayer to defer recognition of gain until the installment buyer makes payments of principal, and when that happens the taxpayer recognizes only a percentage of the payment as gain (i.e., the same percentage as his profit margin in the overall sale).

In addition to the basic rule of section 453(a), there are exceptions and other limitations to section 453 that cover a wide range of circumstances: dealer dispositions ((b)(2)(A)); dispositions of inventory ((b)(2)(B)); sales to related persons ((e)(1)); sales of stock to issuing corporation ((e)(6)(A)); involuntary conversions of property acquired by a related person ((e)(6)(B)); dispositions at death ((e)(6)(C)); dispositions of marketable securities to related persons ((f)(2)); installment sales in the context of like-kind exchanges ((f)(6)); sales of depreciable property to a controlled entity ((g)); use of installment method by shareholders in liquidations ((h)); dispositions of property under revolving credit plans ((k)(1)); dispositions of property used or produced in farming ((1)(2)(A)); and dispositions of timeshares and residential lots ((1)(2)(B). None of those exceptions applies here.

Installment sale reporting has been available to taxpayers since 1918. Richard R. Powell, Powell ON Real Property § 10B.04[2] at 3 (2018). Since 1954, the statute has been amended seventeen times, including a major restructuring in 1980 in which it was broken into three code sections: 453, 453A,³ and 453B. It has been the subject of litigation in hundreds of tax cases. Despite its long history and repeated statutory amendments, on the obvious question whether a taxpayer may qualify for installment sale treatment even when a buyer is willing to pay cash, Congress has never imposed limits on taxpayers choosing to do an installment sale instead. In 1973, the IRS issued a ruling clarifying that a taxpayer may qualify for installment sale treatment when taking an installment note from a person who would have been willing to pay cash. See Rev. Rul. 73-396, 1973-2 C.B. 160.

For taxpayers who want to have the tax deferral of an installment sale while gaining access to cash, one obvious but indirect solution that was available before 1980 was to enter into an installment sale with a related person who would then sell the asset to a buyer for cash. In other words, the taxpayer used a related person as an intermediary to gain installment sale treatment. The case law has included spouses, trusts for children of the taxpayer, and entities owned by the taxpayer. That strategy does not get the taxpayer direct access to cash, since the cash must go to and be controlled by the related-party intermediary, but it brings the cash within the control of persons or entities that are related to the taxpayer.

In his pleadings with this court, respondent cited a case (Wrenn v. Commissioner, 67 T.C. 576 (1976)) in which respondent prevailed over such arrangements, see Amendment to Answer ¶ 7.vvv., but he omits reference to the many cases he lost. See, e.g., Stewart v. United States, 739 F.2d 411 (9th Cir. 1984) (installment sale of stock to closely held corporation followed by transfer in satisfaction of corporation's debt to bank); Roberts v. Comm'r, 643 F.2d 654, 656 (9th Cir. 1981) (installment sale of stock to family trust followed by trust immediately selling stock); Weaver v. Comm'r, 647 F.2d 690 (6th Cir. 1981), aff'g 71 T.C. 443 (1978) (installment sale of stock to trusts for benefit of children followed by liquidation of company); Rushing v. Comm'r, 441 F.2d 593, 597 (5th Cir. 1971) (installment sale of stock to trust followed by the trust's liquidating the company); Bowen v. Comm'r, 78 T.C. 55 (1982) (wife sold stock to husband who then sold stock). In fact, in one IRS General Counsel Memorandum, the Chief Counsel's Office summarized respondent's litigation record on the issue as follows: “(T)he Government's efforts in litigating these positions under pre-1980 law [that is, prior to the 1980 statutory amendment preventing installment sales to related persons who promptly re-sell] have generally been unsuccessful.” GCM 39662, 1987 WL 430215, at *6.

Congress intervened in 1980, however, and placed limits on the use of related-party intermediaries — but it did not forbid them. Nor were the limits particularly onerous. Those statutory limits require the related-person intermediary to hold the acquired property for two years before selling it to the cash buyer. If the related person sells the property before the required two-year holding period, the installment seller is treated as having received payment equal to the sales price of the sale made by the related person. Congress did not place any limits on the use of unrelated intermediaries. Furthermore, regulations promulgated under section 453 explicitly allow an installment seller to receive an installment note from a “qualified intermediary.” Temp. Treas. Reg. § 15a.453-1(b)(3)(i) (installment sale to a qualified intermediary not deemed to cause installment seller's constructive receipt of sale proceeds that intermediary receives on subsequent sale). SCCC was designated as a qualified intermediary in the parties' sale closing statements. Petitioners' use of an intermediary to qualify for installment sale treatment is not inconsistent with the plain intent of section 453.⁴

Another obvious strategy for installment sellers who want to have the tax deferral of an installment sale while gaining access to the cash foregone from not doing a cash sale is to take out a loan and then repay the loan with the installment payments. Congress addressed that strategy as well with detailed rules. Section 453A, which was added to the Code in 1980, applies to “any obligation which arises from the disposition of any property under the installment method, but only if the sales price of such property exceeds $150,000.” Section 453A(b)(1). Among other things, section 453A sets forth detailed rules (known as the “pledge rule”) setting limits on the relationship between an installment obligation and any borrowing by an installment seller. Section 453A(d). Under the pledge rule, “if any indebtedness (hereinafter in this subsection referred to as 'secured indebtedness') is secured by an installment obligation to which this section applies, the net proceeds of the secured indebtedness shall be treated as a payment received as of the later of — (A) the time the indebtedness becomes secured indebtedness, or (B) the time the proceeds of such indebtedness are received by the taxpayer.” Section 453A(d)(1). In other words, if a taxpayer obtains “secured indebtedness,” the loan proceeds are treated as payment on the installment note. Indebtedness is “secured indebtedness” to the extent that “payment of principal or interest on such indebtedness is directly secured (under the terms of the indebtedness or any underlying arrangement) by any interest in such installment obligation.” Section 453A(d)(4). The final sentence of that subsection states, “A payment shall be treated as directly secured by an interest in an installment obligation to the extent an arrangement allows the taxpayer to satisfy all or a portion of the indebtedness with the installment obligation.” Id.

To the extent there is any ambiguity regarding the meaning of an arrangement that allows the taxpayer to satisfy the indebtedness “with the installment obligation,” the legislative history indicates that Congress intended to prohibit transactions in which the lender could become the owner of the installment obligation:

The provision modifies the pledge rule to provide that entering into any arrangement that gives the taxpayer the right to satisfy an obligation with an installment note will be treated in the same manner as a direct pledge of the installment note. For example, a taxpayer disposes of property for an installment note. The disposition is properly reported using the installment method. The taxpayer only recognizes gain as it receives the deferred payment. However, were the taxpayer to pledge the installment note as security for a loan, it would be required to treat the proceeds of such loan as a payment on the installment note, and recognize the appropriate amount of gain. Under the provision, the taxpayer would also be required to treat the proceeds of a loan as payment on the installment note to the extent the taxpayer had the right to “put” or repay the loan by transferring the installment note to the taxpayer's creditor. Other arrangements that have a similar effect would be treated in the same manner.

S. Rept. No. 106-201 (P.L. 106-170), p. 39.

Except for the explanation in the Senate Report, there are no regulations or other authorities interpreting this provision. The Senate Report interprets the pledge rule's limit against “an arrangement [that] allows the taxpayer to satisfy all or a portion of the indebtedness with the installment obligation” with three examples: (1) a taxpayer may not pledge the installment note to (directly) secure the loan; (2) a taxpayer must not have the right to “put” or repay the loan by transferring the installment note to the lender; and (3) the parties may not enter into an arrangement that has a “similar effect” as pledging the installment note or having the right to “put” or repay the loan by transferring the installment note to the lender. The explicit language in the Senate Report confirms that Congress sought to limit arrangements that allow an installment seller to satisfy his loan by transferring his installment note to the lender.⁵

The pledge rule thus explicitly addresses in detail the circumstance in which an installment seller may take out a loan without the loan proceeds being viewed as a payment of sales proceeds. Under the pledge rule, any installment seller can walk out of a closing in which he sells property for an installment note and enter the bank across the street to take out a loan for the same amount of cash that he just deferred in the installment sale. He can even enter into a direct deposit arrangement that allows the bank to withdraw the loan repayment funds from the same account into which the installment buyer deposits the installment payments, since that would not violate the pledge rule.⁶

In 1988, Congress authorized the Secretary of the Treasury to issue regulations “disallowing the use of the installment method in whole or in part for transactions in which the rules of [453A] otherwise would be avoided through the use of related persons, pass-thru entities, or intermediaries.” Section 453A(e)(1). No regulations have been issued under section 453A(e)(1), and instead the Secretary of the Treasury issued Temp. Treas. Reg. § 15a.453-1(b)(3)(i) (installment sale to a qualified intermediary not deemed to cause installment seller's constructive receipt of sale proceeds that intermediary receives on subsequent sale).

2. Petitioners Qualify for Installment Sale Treatment

Because petitioners agreed to receive installment payments after the close of the taxable year in which each disposition of Property occurred, petitioners' sales were “installment sales” under section 453(b)(1). Paragraphs 7, 9 and 10 of each Installment Sale and Purchase Agreement. Petitioners were thus eligible to report income from the installment sales using the installment method. See section 453(a).

Section 453(f)(3) goes on to state, “Except as provided in paragraph (4), the term 'payment' does not include the receipt of evidence of indebtedness of the person acquiring the property (whether or not payment of such indebtedness is guaranteed by another person.” Nothing therein or elsewhere precludes installment treatment for a seller who sells to an unrelated party who immediately resells without retaining the asset for use or in pursuit of appreciation in value. (To contend otherwise would be to (a) invent a proposition that no one has previously found in the history of installment treatment since 1918, (b) say that one may not enjoy installment reporting on a sale to a dealer — an especially odd conclusion in light of section 453(b)(2)(A), which deals with sales by dealers — and (c) contradict Temp. Treas. Reg. § 15a.453-1(b)(3)(i), cited above.)

Petitioners' loan from Lender complied with the pledge rule. Petitioners did not pledge the installment contract and do not have the right to “put” or repay the Loan by transferring the installment contract to Lender. Nor did petitioners enter into any “similar arrangement” as a pledge or put, i.e., an arrangement in which petitioners could “satisfy all or a portion of the indebtedness with the installment obligation.” In fact, the installment contract explicitly prohibits the petitioners from pledging, encumbering, or voluntarily assigning the agreement. Installment Sale and Purchase Agreement ¶ 31.

The use of escrows to receive and disburse the installment payments does not violate the pledge rule. The escrow arrangement does not offer Lender any way of gaining ownership of, or control over, the installment obligation or any ability to prevent other creditors of petitions from asserting claims against either (i) the installment obligation itself or (ii) payments received pursuant to the Installment Sale and Purchase Agreement. The escrows do not enable Lender to compel SCCC to make installment payments or to collect from SCCC if SCCC doesn't make payments or any payment at all. The escrow arrangement thus does not have a “similar effect” as a pledge or a put or right to “repay the loan by transferring the installment note to the taxpayer's creditor.” Indeed, all that the escrow arrangement here does is to direct that such installment payments as SCCC makes to petitioners be deposited into one escrow and then, per petitioners' instruction, be transferred by the escrow agent to another escrow account owned by petitioners, from which petitioners will pay Lender. A directed payment that is conditional on the presence of funds supplied by an installment buyer does not even slightly resemble a pledge or a put and does not “directly secure” the Loan. Moreover, the escrow into which SCCC makes its monthly payments is unfunded except for the brief period each month when SCCC deposits its monthly payments. So even if that escrow were incorrectly viewed as “directly securing” the Loan, the amount of security would be zero.

C. The Economic Substance Doctrine Is Not Relevant

1. Overview of the Economic Substance Doctrine

The CESD was added to the Code in 2010. Pub. L. No. 111-152, 124 Stat. 1029 (March 30, 2010). Although it codified the answers to some questions about the common law economic substance doctrine, it left many others unresolved and even raised new ones, most importantly the question of when the economic substance doctrine is relevant. Comments on Notice 2010-62 at 2 (January 18, 2011) (“ABA Comment Letter”), https://www.taxnotes.com/tax-notes-today-federal/corporate-taxation/aba-members-seek-more-guidance-codification-economic-substance-doctrine/2011/01/19/vq4p?highlight=%22joint%20committee%22%20%22in%20c ombination%20with%22%20%22Patient%20protection%22. Despite pleas from taxpayers and practitioners for guidance on the many unanswered questions, the IRS has left most questions to be resolved by the courts.

Courts must address when the economic substance doctrine is “relevant.” See Section 7701(o)(1) (CESD applies “only in the case of any transaction to which [the doctrine] is relevant”). The CESD provides: “The determination of whether the economic substance doctrine is relevant to a transaction shall be made in the same manner as if [subsection 7701(o)] had never been enacted.” Section 7701(o)(5)(C). Thus, the statute recognizes that there are situations in which CESD is not relevant, and pre-codification case law addressing the scope and relevance of the economic substance doctrine determines those situations. Unfortunately, no court case decided prior to codification used “relevance” in analyzing whether to apply the economic substance doctrine in a particular case.⁷ See ABA Comment Letter at 9. That leaves taxpayers and the courts to look to those cases and infer guidelines from those cases as to when the doctrine is relevant.

As respondent does here, see Amendment to Answer, ¶ 7.nnn., many courts and commentators trace the origins of the economic substance doctrine to Gregory v. Helvering, 293 U.S. 465 (1935). In that case, Ms. Gregory relied on a transaction that in form met the requirements of a “reorganization,” but there was no intent to continue the underlying business that was “reorganized.” In denying Ms. Gregory the tax benefits she sought, the Supreme Court stated: “When [the Code section] speaks of a transfer of assets by one corporation to another, it means a transfer made 'in pursuance of a plan of reorganization' of corporate business; and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either, as plainly is the case here,” Gregory v. Helvering, 293 U.S. 465, 469 (1935). Thus, the Supreme Court interpreted the statutory phrase “in pursuance of a plan of reorganization” to require a connection to business goals of the businesses purportedly being reorganized. The appellate court in Gregory refused to accept the Commissioner's argument that it should “treat as inoperative” the relevant transactions. 69 F.2d 809, 811 (2d Cir. 1934). The “steps were real,” the court said, “their only defect was that they were not what the statute means by a 'reorganization,' because the transactions were no part of the conduct of the business of either or both companies . . ." Id. The core of the decision, therefore, was not that the transactions should be disregarded. Rather, it was that Congress did not intend for transactions like Ms. Gregory's to be treated as a “reorganization.”

If Gregory is, as respondent says, the progenitor of the economic substance doctrine, we can conclude, therefore, that that doctrine is rooted in the intersection between congressional intent and statutory construction. See Gregory, 293 U.S. at 469 (“the question for determination is whether what was done, apart from tax motive, was the thing which the statute intended”). One court has described the economic substance doctrine as a “second look” to ensure that the tax benefits at issue in a case “comply with Congress's purpose in creating that benefit.” Bank of N.Y. Mellon Corp. v. Comm'r, 801 F.3d 104, 113 (2d Cir. 2015). The economic substance doctrine “allows the courts to override the literal words of the Code and regulations, in favor of Congressional intent.” Rebecca Rosenberg, Codification of the Economic Substance Doctrine: Agency Response and Certain Other Unforeseen Consequences, 10 Wm. & Mary Bus. L Rev. 199, 205 (2018).

While the quotes above suggest that the goal in applying the economic substance doctrine is to effectuate “congressional intent,” that language is shorthand and does not fully capture the role of the doctrine. The doctrine requires more analytical rigor than a revenue agent or a judge simply asking himself or herself whether Congress would have intended a particular result if it had considered it. Such vague and open-ended inquiry would be an invitation for the IRS or the courts to substitute their own intuition and preferences for the objective rules in the statutory text. One commentator described posing “the counterfactual question of what an enacting legislature that did not think of the issue at hand would have intended had they thought of that issue.” See Joseph Bankman, The Economic Substance Doctrine, 74 S. Cal. L. Rev. 5, 14 (2000). Using this kind of counterfactual, imaginative analysis as a basis for setting aside objective statutory outcomes is problematic, especially given how difficult it can be to discern legislative intent.⁸ Our self-reporting tax system has been developed for taxpayers to be able to rely on the objective tax results produced by the statutory text, as interpreted by cases and administrative guidance, so those results should be set aside only when it is clear there is a problem with the outcome:

It is precisely because of our commitment to [our "objective,” rule-based method of determining tax liabilities] that we are loathe to overturn the “technical results” which arise from the application of complex rules to complex business transactions. The taxpayer, we believe, is entitled to rely on the rules and the answers to which those rules give rise. She should not be denied beneficial tax results which she stumbles upon, or even seeks out, in the course of her legitimate business dealings, even if those results are obviously unanticipated, unintended, or even downright undesirable.

David P. Hariton, Sorting Out the Tangle of Economic Substance, 52 Tax Law. 235, 237 (1999) (the “Hariton Article”).⁹ Because CESD is difficult to apply, sets aside the objective rules in the Code, and now includes a 40% strict liability penalty, the standard for determining when CESD is relevant should be more specific and limiting than one person's intuition about the intent of Congress.¹⁰ Fortunately, the language of Gregory gives a clue as to the appropriate guideline for determining when CESD is “relevant”: “. . . the transaction upon its face lies outside the plain intent of the statute . . .” 293 U.S. at 469 (emphasis added).

Gregory's reference to “plain intent” calls to mind the rule of statutory construction involving the “plain meaning” of the statute: “Where the statute's language is unambiguous, its plain meaning controls except in those 'rare cases where literal application 'will produce a result demonstrably at odds with the intentions of the drafters.”” Almero v. INS, 18 F.3d 757, 760 (9th Cir. 1994)) (quoting Griffin v. Oceanic Contractors, Inc., 458 U.S. 564,571 (1982)). Under this rule, courts do not need to consult evidence of purpose (e.g., legislative history or policy arguments) when the statutory language is unambiguous.

As courts articulate standards for determining when the economic substance doctrine is “relevant” under CESD, the “plain meaning” rule for statutory construction can offer guidance for fashioning a rule that turns on the degree of ambiguity about the “plain intent” of the statute. For example, the CESD relevance test could be as follows: “When it is unambiguous (i.e., plain) that it would be inconsistent with the purpose of the statute for a taxpayer who cannot show business purpose and economic substance to claim tax benefits, CESD is relevant.” And what standard should apply for determining when it is unambiguous? The Hariton Article suggests that economic substance doctrine is limited to situations in which “the tax benefits are unreasonable and unwarranted in light of the objective rules which give rise to them.” Hariton Article at 241. That language echoes the language the Treasury used in a 1999 White Paper that discussed the economic substance doctrine:

[T]he IRS may argue that, while the facts are as the taxpayer has represented, the technical results produced by a literal application of the tax law to those facts are unreasonable and unwarranted, and therefore should not be respected. This second line of argument, which encompasses long-standing principles of business purpose and economic substance, is an important and essential gloss on our generally mechanical system of determining tax liabilities.

U.S. Dept, of Treas., The Problem of Corporate Tax Shelters: Discussion, Analysis and Legislative Proposals (July 1999), available at https://home.treasury.gov/system/files/131/Report-Corporate-Tax-Shelters-1999.pdf (“Treasury White Paper”) at 46 (emphases added). A useful framing of the relevance question, therefore, is as follows: Assuming the taxpayer cannot show business purpose or economic substance, would the technical results produced by a literal application of the tax law be unreasonable and unwarranted? If so, CESD is relevant, and the taxpayer can prevail only by showing that he can satisfy the business purpose and economic substance requirements.

In many cases, the text and legislative history were largely silent on whether it is consistent with the purpose of the statute to require a taxpayer to show business purpose and economic substance. The courts must draw their inferences on a tabula rasa. The Gregory court did that, for example. But sometimes the text or purpose of the statutory provision in issue affirmatively suggests that Congress intended for taxpayers to receive the tax benefits even when they cannot show business purpose or economic substance. In those cases, CESD is not relevant. See Technical Explanation of the Revenue Provisions of the “Reconciliation Act of 2010,” as Amended, in Combination with the “Patient Protection and Affordable Care Act,” Joint Committee on Taxation, March 21, 2010, JCX-18-10, p. 152 n.344 (“If the realization of the tax benefits of a transaction is consistent with the Congressional purpose or plan that the tax benefits were designed by Congress to effectuate, it is not intended that such tax benefits be disallowed.”); see also Joseph Bankman, The Economic Substance Doctrine, 74 S. Cal. L. Rev. 5,13 (2000) (“The doctrine cannot apply where a sensible reading of text, legislative intent, and purpose suggest it should not apply.”); see also See Summa Holdings, Inc. v. Comm'r, 848 F.3d 779, 787 (6th Cir. 2017) (“If the Code authorizes the 'formal' transactions the taxpayers entered into, then 'it is of no consequence that it was all an elaborate scheme to get rid of income taxes.”). As we explain below, in this case there is affirmative support for petitioners' position that a taxpayer can (i) reject a cash buyer in favor of an installment sale, (ii) use an intermediary to effect the transaction, and (iii) borrow money to obtain comparable cash by doing an installment sale. Thus, a sensible reading of section 453 indicates CESD is not a valid basis for disallowing petitioners' installment sale treatment.

2. The Codified Economic Substance Doctrine is Distinct from the Substance-Over-Form Doctrine and other “Recharacterization” Principles.

The economic substance doctrine is only one of several judicial doctrines courts have applied to set aside the technical results sought by taxpayers. Others include “business purpose,” “sham transaction,” “substance over form,” and “step transaction.” Staff of the Jt. Comm, on Tax'n, 111^th Cong., Technical Explanation of the Revenue Provisions of the Reconciliation Act of 2010, as Amended, in Combination with the Patient Protection and Affordable Care Act JCX-10 (Comm. Print 2010). Courts have often blurred the lines between the doctrines and have been inconsistent with the terminology used in applying them. See CNT Invs., LLC v. Comm'r, 144 T.C. 161, 194 (2015). Pre-CESD there was little need to carefully differentiate between the various doctrines. CESD “puts new pressure on distinguishing between the various anti-abuse doctrines, which tend to overlap.” Rebecca Rosenberg, Codification of the Economic Substance Doctrine: Agency Response and Certain Other Unforeseen Consequences, 10 Wm. & MARY BUS. L Rev. 199, 204 (2018).

In Notice 2014-58, the IRS acknowledged that the substance-over-form doctrine and step transaction doctrines are distinct from the economic substance doctrine for CESD purposes and that it is not a “similar rule of law” for purposes of the strict liability penalty at section 6662(b)(6):

If the IRS does not raise section 7701(o) to disallow the claimed tax benefits and instead relies upon other judicial doctrines (e.g., the substance over form or step transaction doctrines) to support the underlying adjustments, the IRS will not apply a section 6662(b)(6) penalty (or otherwise argue that a transaction is described in section 6662(b)(6)) because the IRS will not treat the transaction as failing to meet the requirements of a similar rule of law.

Notice 2014-58, 2014-44 I.R.B. 746 (October 9, 2014). Thus, if respondent's positions here invoke the substance-over-form or step transaction doctrines or rely on recharacterizing the parties' interests, the economic substance doctrine is not involved. One basic description of the substance-over-form doctrine is that “standards must govern the factual characterization of relationships and arrangements to some extent, and the Commissioner must have the ability to challenge the taxpayer's description of the relevant facts — otherwise the taxpayer's advantage would be insurmountable.” Treasury White Paper at 47 (citing Hariton Article at 239).

The IRS's internal guidance for examiners distinguishes between the economic substance doctrine, on one hand, and other doctrines, such as substance-over-form and recharacterization of a taxpayer's transaction. Guidance for Examiners and Managers on the Codified Economic Substance Doctrine and Related Penalties, LB&I-4-0711-015 (July 15, 2011). These other approaches have been described as situations in which “the form of the transaction belies its substance (e.g., that purported debt is in fact “masquerading” as debt; that a purported disposition of property in fact continued ownership, etc.) and that the taxpayer is therefore applying the wrong objective rules in reaching her purported tax results.” Hariton Article at 238-39. When respondent makes those kinds of arguments, he is not relying on the economic substance doctrine.

3. The Economic Substance Doctrine is not Relevant to the Petitioners ' Monetized Installment Sale

In his amended answer, respondent gives various reasons for asserting CESD. Since the Code allows the petitioners to do what they did (assuming the substance of their actions are consistent with the form), respondent has no basis to assert that it would be unreasonable and unwarranted for petitioners to claim the tax benefits (fe., gain deferral under section 453). Thus, CESD is not relevant. See Summa Holdings, Inc. v. Commissioner, 848 F.3d 779, 784 (6th Cir. 2017) (“In assessing the Tax Court's decision, we “begin with a basic point: The Internal Revenue Code allowed [the taxpayers] to do what they did.”).

(1) A seller may defer gain if he receives an installment note in exchange for property, even if the buyer would have been willing to pay cash to purchase the asset.

To support his position that the economic substance doctrine applies, respondent states that petitioners had buyers “who were willing to pay the full price of the Properties” and that petitioners “could have sold the Properties directly to the ultimate buyers.” See Amendment to Answer, ¶ 7.aaaa. This implies that a seller structuring a transaction to receive an installment note when he or she could have received full payment instead (“the thing done” per the Gregory formulation) is inconsistent with “the thing the statute intended” (section 453).

That implication is wrong. As stated previously, respondent has provided decades-old guidance that an installment seller may use the installment method even if the buyer was willing to pay cash. Rev. Rul. 73-396, 1973-2 C.B. 160. Respondent's suggestions otherwise are invalid attempts to disavow his own revenue ruling. See Rauenhorst v. Comm'r, 119 T.C. 157, 173 (2002) (treating revenue ruling as IRS concession in case). Consequently, even if the petitioners intentionally arranged to receive an installment note so they could defer their tax liability when they could have sold for cash, the Code (as interpreted) allows him to do that. The revenue ruling belies the respondent's suggestion that there was something nefarious in his doing so. Thus, nothing about petitioners' arranging to receive an installment note implicates the economic substance doctrine.

This result is not surprising because installment sale treatment involves the only the timing of the realization of gain or loss from a sale. The Code is somewhat arbitrary regarding the timing rules, and therefore, timing is an issue where the economic substance doctrine — which would set aside those relatively arbitrary rules when applied — is less likely to be relevant. Hariton Article at 254-55 (“the timing of realization is essentially formalistic, and the proposition that taxpayers are getting away with something to which they are not properly entitled when they use transactions to alter the timing of realization is therefore dubious”); Bankman at 21 (“The realization doctrine is inherently arbitrary, and commonly manipulated by taxpayers, in above-board fashion.”)

Arguably for that reason, the Supreme Court permitted the taxpayer in Cottage Savings Association v. Commissioner, 499 U.S. 544 (1991), to claim a loss on the swap of economically equivalent mortgage portfolios, even though the swaps were tax-motivated, “were clearly not a means of accomplishing a non-tax-related business objective, and they lacked economic substance practically by definition.” Hariton Article at 254; see also Bankman at 21. In two Ninth Circuit cases involving an IRS challenge to the use of intermediaries to effect an installment sale, it was relevant to the court's decision for the taxpayers that the issue involved merely the timing of the gain:

At the outset it is important to note, as did the court in Rushing, what this appeal is not about. See Rushing, supra, at 597. The case does not involve an effort to convert what would be ordinary income into capital gain, nor is it an attempt by a taxpayer to shift the gain to another taxable entity so as to have the gain taxed at a lower rate. As in Rushing, the only question is whether the full amount of the gain is taxable in the year of the sale or whether the exemption provided by § 453 is available.

See Roberts v. Comm'r, 643 F.2d 654, 656 (9th Cir. 1981); Rushing v. Comm'r, 441 F.2d 593, 597 (5th Cir. 1971).

(2) A seller may use an intermediary to arrange an installment sale

Respondent tries to support his reliance on CESD on the grounds that adding an intermediary “adds several layers of complexity without serving a business purpose independent of tax deferral”¹¹ and “the promoter serves no purpose as an intermediary other than to create the installment-escrow-loan structure which creates the tax benefit.” See Amendment to Answer, ¶ 7.zzz. While the use of, say, a related intermediary may cause a taxpayer to fail to meet a technical requirement for installment sale treatment, for several reasons a taxpayer's use of an unrelated intermediary does not mean that tax deferral is unreasonable and unwarranted in light of the plain intent of section 453. Consequently, respondent's attacks on the use of an intermediary per se to support applying CESD are unsupportable.

First, based on the limited role of the economic substance doctrine, as explained previously, to justify his position, respondent must be able to show that granting a taxpayer who used an unrelated intermediary gain deferral under section 453 would be so unreasonable and unwarranted in light of the statutory purpose of section 453 that a court should set aside the gain deferral even if the parties satisfy the literal requirements of the Code. That position is belied by respondent's own interpretation of section 453. Under Treas. Reg. § 15a.453-1(b)(3)(i), which cross-references the qualified intermediary rules under the section 1031 regulations, a seller is permitted to use a “qualified intermediary” to effect an installment sale under section 453. Because its role is to facilitate a like-kind exchange under section 1031 or, as permitted by the section 453 regulations, an installment sale under section 453, a “qualified intermediary” is entirely a creature of tax deferral. A fundamental premise of Treas. Reg. § 15a.453-1(b)(3)(i) is that it is not inconsistent with the “plain intent” of section 453 for a taxpayer to interpose an intermediary solely for the purpose of deferring gain from a sale. Thus, respondent cannot support his position that petitioners' use of an intermediary is unreasonable and unwarranted in light of the statutory purpose of section 453 that this Court should set aside the results even if they comply with the literal requirements of the Code.

Second, courts have allowed taxpayers to use intermediaries to effect an installment sale even though the buyers were related and had marginal purposes for buying. See Stewart v. United States, 739 F.2d 411 (9th Cir. 1984) (installment sale of stock to closely held corporation followed by transfer of stock to satisfy closely held corporation's debt to bank); Roberts v. Comm'r, 643 F.2d 654 (9th Cir. 1981) (installment sale of stock to family trust followed by trust immediately selling stock); Weaver v. Comm'r, 647 F.2d 690 (6th Cir. 1981) (installment sale of stock to trusts for benefit of children followed by liquidation of company); Rushing v. Comm'r, 441 F.2d 593 (5th Cir. 1971) (installment sale of stock to trust followed by trust liquidating company); Bowen v. Comm'r, 78 T.C. 55 (1982) (wife sold stock to husband who then sold stock); Nye v. United States, 407 F.Supp. 1345 (M.D.N.C. 1975) (wife sold stock to husband). In view of those cases, it cannot be the case that receiving an installment note from an unrelated intermediary that itself is seeking to earn business income would be unreasonable and unwarranted in light of the statutory purposes of section 453.

Third, as described previously, it is permissible for a seller to choose an installment sale even when a buyer does not want to enter into an installment agreement. It is thus difficult to see how the petitioners' using an intermediary to achieve a permissible goal (i.e., installment sale treatment when the buyer wants to pay cash) is so unreasonable and unwarranted in light of the “plain intent” of section 453 that this court should apply the economic substance doctrine to set aside a result that otherwise complies with the Code.¹²

Finally, decades ago Congress fashioned a response to taxpayer use of intermediaries to achieve installment sale treatment. Under section 453(e), if a seller enters into an installment sale with a “related party,” that seller will be treated as receiving the amount realized by the related party' if that related party sells the asset within two years of the installment sale. Section 453(e) was added to the Code in 1980, primarily “in response to the use by taxpayers of an installment sale to a related intermediary in order to defer the recognition of gain while at the same time effectively realizing appreciation on the property by means of a resale to a party outside the related group for an immediate payment.” GCM 39662 (September 16, 1987), 1987 WL 430215, citing S. Rep. No. 1000, 96th Cong., 2d Sess. 12-17 (1980), 1980-2 CB 494, 500-502. As noted in the GCM, “[t]he Government's efforts in litigating [its positions against the use of intermediaries] have generally been unsuccessful.” 1987 WL 430215 at *6.

Given that the objective rules under section 453 allow for “qualified intermediaries,” allow taxpayers to enter into installment sales even when the buyer wants to pay cash, and include a relatively generous Congressional response to the use of related parties, there is no plausible argument that granting tax deferral under section 453 to a taxpayer who used an unrelated intermediary to effect an installment sale would be unreasonable and unwarranted in light of the objective rules which give rise to tax deferral under section 453. CESD is not relevant to petitioners' choice to use an intermediary to effect an installment sale where the buyer wanted to pay cash.

(Even if CESD were relevant, the Court would be aware that in some instances a buyer wants the seller to agree to an installment sale, but the seller wants a cash sale, while in other instances a buyer wants to pay cash but the seller wants an installment sale for cash flow purposes as well as for tax deferral. It would be error simply to assume that only a tax motivation was at play for either party in either deal structure.)

(3) Congress has explicitly allowed a taxpayer to choose an installment sale plus a loan instead of a cash sale

The IRS describes the purpose of the “MIS transaction” as “to allow the buyer to be involved in a straight sale, give the seller installment sale treatment, but still give the seller nearly all of the purchase price in cash immediately via a loan from a related lender.”¹³ See Amendment to Answer, ¶ 7.a. To support his economic substance position, respondent goes on to say because the petitioners entered into “MIS transactions to delay recognition of gain without delaying the receipt of sales proceeds, without incorporating any risk, and for a modest fee,”¹⁴ the transaction is the “definition of a transaction lacking economic substance” because “it serves no purpose other than to change the tax treatment on a sale.” See Amendment to Answer, ¶ 7.www. It is clear that the gist of respondent's CESD position is that CESD applies because petitioners deferred their gain with an installment note and then obtained tax deferral. Thus, respondent contends that obtaining a tax benefit is proof that one should not be allowed to obtain the tax benefit.

Oddly, respondent makes no attempt to reconcile his position with the “pledge rule” of section 453A(d), which explicitly addresses the circumstances under which an installment seller can take out a loan while still qualifying for installment sale treatment. Under the pledge rule, an installment seller can receive loan proceeds without their being treated as payment of the installment note (and therefore taxable to the extent of any deferred gain from the installment sale) if the loan is not secured by the installment note. Section 453A(d)(1). To support his argument that CESD is relevant, respondent asserts that he has analyzed whether the transaction "is subject to a detailed statutory or regulatory scheme” and that it is not. See Amended Answer ¶ 7.aaaa. Because the pledge rule addresses the very thing respondent complains of, that statement in respondent's pleading is wrong on its face.

With the pledge rule, Congress explicitly considered and addressed in detail the situation of a taxpayer who enters into an installment sale and also borrows money. And Congress established explicit rules that circumscribe the nature of the relationship between the installment sale and the loan that will allow a taxpayer to qualify for installment sale treatment. Although respondent did not address it, the pledge rule is clearly a key to any consideration whether the economic substance doctrine is relevant here.

It is indisputable that under the pledge rule petitioners could have gone to a sale closing on the Property, entered into an installment agreement to sell the Property, and then walked straight to a bank or other financial institution such as the Lender here, and borrowed money equal or nearly equal to the sales proceeds from the installment sale, as long as that loan was not “secured indebtedness” within the meaning of the pledge rule.¹⁵ If respondent's problem here is that a “promoter” arranged for the loan rather than petitioners' finding a lender on their own on an ad hoc basis, that distinction has no bearing in the law on the application of the pledge rule or the determination whether the economic substance doctrine is relevant. It is therefore unclear how it is that respondent thinks that the economic substance doctrine has any relevance here. In other words, there are no grounds for respondent to contend that granting tax deferral under section 453 to a taxpayer who entered into an installment sale and then borrowed an amount approximately equal to the sales proceeds would be unreasonable and unwarranted in light of the pledge rule (i.e., the objective rules which permit tax deferral under section 453A even when a seller takes out a loan).

In the 2012 CCA¹⁶ cited above in the Introduction, the IRS issued a Chief Counsel Advice that approved a monetized installment sale. Although that CCA is not authority here, the analysis in the CCA supports petitioners' position that CESD is not relevant to this case, because monetized installment sales are not inherently unreasonable and unwarranted in view of the objective rules governing installment sales. Moreover, the IRS's approval of the transaction in the CCA belies any claim that petitioners' position is an unreasonable and unwarranted tax benefit under section 453 that requires this court to set aside petitioners' literal compliance with the Code.

Respondent may try to distinguish the 2012 CCA on the grounds that it involved farm property, and in the case of farm property the pledge rule includes an exception that allows taxpayers to secure a third-party loan with the installment note — but the character of the asset as farm property had no role in respondent's application of the judicial doctrines. The 2012 CCA summarizes the transaction as follows:

“Transaction” is an orchestrated series of transactions between several parties pursuant to a promoted transaction. Taken as a whole, the Transaction enables seller to (1) defer reporting sale proceeds and recognizing gain from the sale of Asset under the installment sales method of I.R.C. § 453, but (2) obtain cash roughly equal to the sales proceeds from a loan secured by the installment sale notes.

In addressing the substance-over-form doctrine,¹⁷ the 2012 CCA described the “question presented” as follows: “whether the substance of the Transaction was essentially a cash sale — shortly after the Asset sale Taxpayer obtained U% of the sales price in cash and an additional X% of the face value of the Purchase Note through loan proceeds, all while deferring most of the gain recognition and tax on the transaction for R years.” 2012 CCA at 9. In his amended answer, respondent states: “[Petitioners] entered into MIS transactions to delay recognition of gain without delaying the receipt of sales proceeds . . . First Amendment to Answer ¶ 7. www. The factual summaries in the 2012 CCA and respondent's Amended Answer are the same in substance. In the 2012 CCA, the IRS approved installment sale treatment. Here, respondent seeks to apply CESD and a 40% penalty. The 2012 CCA was correct. Regardless, it raises serious questions whether it is a plausible position that granting petitioners deferral from their installment sale even though they obtained loan proceeds for approximately the same amount as the installment sale would be so unreasonable and unwarranted in light of the plain intent of section 453 and especially the pledge rule of section 453A(d)(1) that this Court should apply CESD to set aside literal compliance with the Code.

4. Respondent's application of the economic substance doctrine contradicts the statutory pledge rule.

Respondent's use of the economic substance doctrine here requires that section 453A(d)(1)(4) be revised to read as follows:

(4) Secured indebtedness

For purposes of this subsection indebtedness is secured by an installment obligation to the extent that payment of principal or interest on such indebtedness is directly secured (under the terms of the indebtedness or any underlying arrangements) by any interest-in such installment obligation comes from money which the installment seller received from the installment buyer. A payment shall be treated as directly secured by an interest in an installment obligation to the extent an arrangement allows the taxpayer to satisfy all or a portion of the indebtedness with the installment obligation use money received from the installment buyer to make a payment on the indebtedness. (Inserted text in bold face.)

5. The cases cited by respondent to support his position the economic substance doctrine is relevant are inapposite and, in any event, do not involve the economic substance doctrine

In the section of his Amended Answer labeled “Economic Substance Doctrine is Relevant,” respondent cites five cases for the proposition that when a seller has effective control over the buyer or reserved to himself significant rights with respect to the proceeds of the buyer's later sale, “the courts have tended to find that the installment sale was a mere sham transaction, lacking economic reality and held that the installment sale was to be disregarded.” See First Amendment to Answer, ¶ 7.vvv. The five cases cited are easily distinguishable — four of them turned on the presence of buyer-funded escrow accounts or equivalent (the escrow accounts in this case were not funded) and one involved a spouse as a buyer who could not give a convincing purpose, business or personal, for buying from her husband.¹⁸ But setting aside that they are inapposite, the cases involve correctly labeling the economic reality of a transaction and applying the Code to that recharacterized reality: they do not implicate the economic substance doctrine (which involves a determination that despite compliance with the literal requirements of the Code it would not be consistent with Congressional intent to extend the tax benefits to the transaction).

Because the cases are so obviously distinguishable, respondent's reliance on these cases while alluding to the presence of an escrow agreement in the present cases suggests he does not understand that the escrows in this case are unfunded. For example, the first case respondent cited is Griffith v. Commissioner, 73 T.C. 933 (1980). The installment buyer established letters of credit from which the seller could collect payment. This Court treated the letters of credit as the equivalent of a funded escrow (which can be treated as payment on the installment note under the case law) and concluded the seller should be treated as having received the amount due under the installment note, 73 T.C. at 942. The facts in Griffith bear no resemblance to this case. While there are escrow accounts as part of the payment process in this case, they remain unfunded until each payment is due. If respondent believes Griffith is relevant because of the presence of the escrows in this case, it has failed to account for that critical factual distinction that renders Griffith inapposite.

But even if we were to assume for the sake of argument that Griffith were relevant factually, it is at most a substance-over-form case. It was not a case in which this Court concluded that the literal requirements of the Code were met but nonetheless tax benefits should be denied because they would conflict with the statutory intent of section 453. This Court concluded that the letters of credit were in substance payments to the seller. Griffith cited Watson v. Commissioner, 69 T.C. 544 (1978), a case decided on “economic benefits” grounds. Griffith, 73 T.C. at 943 (“We held that the letter of credit was the equivalent of cash and that, therefore, the taxpayer had received . . . income in 1973.”). And Griffith cited Oden v. Commissioner, 56 T.C. 569 (1977), which concluded that certificates of deposit that were labeled as collateral were actually intended as payment. Griffith, 73 T.C. at 943 (“We concluded . . . the seller expected to collect from the certificates of deposit which had been placed in escrow.”). Thus, Griffith is essentially a run-of-the-mill constructive receipt/cash equivalent/economic benefits case. There are dozens if not hundreds such cases in the case law and Griffith just happened to be in the context of an installment sale. They have never been regarded as economic substance cases. See, e.g., Bittker & Lokken: Federal Taxation of Income, Estates, and Gifts, ¶ 5.9 Effect of Taxpayer's Accounting Method — Constructive Receipt (no mention of economic substance or statutory intent); see also White, 570-4th T.M., Accounting Methods — General Principles, IV.B.2.b. Constructive Receipt (no mention of economic substance or statutory intent as considerations in applying doctrine). Respondent's reliance on Griffith indicates respondent does not understand the distinction between the economic substance doctrine and other judicial doctrines that rely on properly recharacterizing the substance of what the parties did.

The respondent repeats his mistake with the second case it cited to support the relevance of the economic substance doctrine. Lustgarten v. Commissioner, 639 F.2d 1208 (5th Cir. 1981). The court cited the following test: “a taxpayer is entitled to installment sale treatment only if he does not directly or indirectly have control over the proceeds from the sale or possess economic benefits therefrom.” 639 F.2d at 1210. The taxpayer failed that test because he had “constructive receipt in 1971 of the proceeds from the resale of the stock by his son.” Id. at 1211. Constructive receipt cases are not economic substance cases. Although the court did note that the taxpayer's “primary purpose” for the transaction with his son was to avoid immediate gain, see Id., that is not an economic substance analysis. It is part of the court's fact-finding role in ascertaining the substance of the transaction, i.e., whether the taxpayer had control over the funds.

In Trivett v. Commissioner, 611 F.2d 655 (6th Cir. 1979), the buyer provided certificates of deposit as collateral, which the buyer endorsed over to the taxpayer. 611 F.2d at 656. This is, again, a constructive receipt case. Another case cited by respondent, Pozzi v. Commissioner, 49 T.C. 119 (1967), also involved funded escrows. The court, with little explanation except that the escrows were funded at the seller's insistence, treated the seller as having received the full sale price.¹⁹ 49 T.C. at 128.

The one case cited by respondent that does not involve a funded escrow or its equivalent is Wrenn v. Commissioner, 67 T.C. 576 (1976). In that case, the taxpayer's wife was his installment buyer, and the court could not find that her purchase was bonafide. 67 T.C. at 582. The court acknowledged that, despite the close relationship, spouses could qualify as installment buyers, Id. at 584, and that a business purpose was not necessary because personal reasons would suffice. Id. at 583. The court simply could not find any purpose for the wife's purchase. Again, the court's consideration of whether the spouse had any purpose for buying the property is simply part of its fact-finding to determine if the purchase was bonafide. That is not an application of the economic substance doctrine, since nobody would question whether section 453 would apply when the purported purchase is not bonafide. Rather, the court is simply engaging in fact-finding to place the proper label on the parties' transaction.

Thus, none of the five cases cited by respondent comes close to supporting an inference that the economic substance doctrine is relevant here.

The IRS characterizes one legal principle to be derived from the five cases it cited as follows: “where it was shown that the seller, under the installment contract, (1) had effective control over the buyer, viz, the buyer was acting as an agent of the original seller in reselling the property . . . the courts have tended to find that the installment sale was a mere sham transaction, lacking economic reality and held that the installment sale was to be disregarded for income tax purposes.”²⁰ Respondent is blurring substance over form and recharacterization principles with the economic substance doctrine here. In fact, respondent's description of the law is contradicted by respondent's own internal guidance to examiners:

Does recharacterizing a transaction (e.g., recharacterizing debt as equity, recharacterizing someone as an agent of another, recharacterizing a partnership interest as another kind of interest, or recharacterizing a collection of financial products as another kind of interest) more appropriately address the noncompliance that is being examined? If so, recharacterization should be applied and not the economic substance doctrine.

Guidance for Examiners and Managers on the Codified Economic Substance Doctrine and Related Penalties, LB&I-4-0711-015 (July 15, 2011) (emphasis added). Again, the respondent is being inconsistent with positions the IRS has taken outside of litigating this case. In his pleading in this case, respondent says that the economic substance doctrine applies here if SCCC was acting as an agent of petitioners in reselling the Property. But in his guidance to IRS examiners, he says that recharacterizing someone as an agent of another is distinct from the economic substance doctrine. Respondent's advice to examiners is correct and his position in this case is wrong.

V. CONCLUSION