Installment Sale?

[ahearn]

I have a financial planning client who has a ranch operated as a Sub S corporation. The S corp is on a cash basis and so is my client. This year the entire herd was sold for around $350,000 on an installment basis. The client is receiving 20% of the sale amount for the next five years and 7% per year as interest on the unpaid balance.

When the cows were sold my client's CPA told them that the entire sale would be subject to tax, even though they are only receiving 20% of the sale. This does not make any sense to me since they are cash-basis taxpayers. Anybody have any ideas why tax should be paid on the entire sale amount?

[Randall]

I'm not sure of all the facts of your situation. I don't have any cites off the top of my head, but generally, I would think an S Corporation could distribute the installment note to the S shareholder and he could continue to use the installment method. For a C corporation, the shareholder would normally not be allowed to continue the installment method but have to pay all the tax upfront.

[RoyDaleOne]

The sale of certain cattle can qualify for installment sale treatment. See the Farmers Pub.

Your posting does not contain sufficient information to answer specifically.

[michaelmars]

i don't know milk about cows but as a general rule i would keep the note open till the installment was paid off. just to keep the corp protection and to make collection easier if the buyer defaults. [i have a different answer if the corp was ever a C corp ]

[OldJack]

When the cows were sold my client's CPA told them that the entire sale would be subject to tax, even though they are only receiving 20% of the sale. This does not make any sense to me since they are cash-basis taxpayers. Anybody have any ideas why tax should be paid on the entire sale amount?

Publication 537, "Installment Sales", page 6:

>>Depreciation Recapture Income

If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. The recapture income is also included in Part I of Form 6252. However, the gain equal to the recapture income is reported in full in the year of the sale. Only the gain greater than the recapture income is reported on the installment method.

For more information on depreciation recapture, see chapter 3 in Publication 544.

The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. Determining gross profit is discussed under General Rules, earlier. <<

[OldJack]

I would think an S Corporation could distribute the installment note to the S shareholder and he could continue to use the installment method.

Yes, the S-corp could distribute the note, after recognizing any taxable gains, to the shareholder and continue the installment sale collection. However, since the tax gain must be reported and passed by 1120S-k1 the shareholder must pay any tax due as reported on the k-1. Therefore, assuming there were no gains above the depreciation amount recognized in the current year, the shareholder would be collecting the future note payments as tax-free income. Of course, if there were any installment sale capital gains after recapture, they would be taxable according to the amount calculated on the installment sale tax form as received.

[jainen]

>>I'm not sure of all the facts of your situation.<<

Your caution is appropriate. Ahearn posted this same question earlier on the 18th on a different forum. I guess he didn't like what I had to say over there about accounting methods and installment sales for inventory, because here in the ATX Community he has not mentioned that the cows were held for sale in the ordinary course of business.

[OldJack]

he has not mentioned that the cows were held for sale in the ordinary course of business.

Well... if the cows were held as inventory for sale assets I would revise my opinion. If said inventory was disposed of in a one complete block transaction and in liquidation of the corporation they would indeed be section 1231 assets (assets used in business, gain reported on form 4797 short-term ordinary income) and would qualify for recognition on the installment sale since there is no gain allocated to recapture. This because the assets, even though prior classified as inventory, were not sold in the ordinary course of business as inventory. :)

[jainen]

>>If said inventory was disposed of in a one complete block transaction and in liquidation of the corporation they would indeed be section 1231 assets<<

That may be so. Liquidation would be another previously undisclosed fact, but that is one of the fun things about this scenario. On the other forum I complained that the facts were being revealed piecemeal. Ahern responded that even he didn't the whole story since he had not yet gotten around to discussing it with the company's accountant.

With that kind of financial planning, it's a good guess that if the corporation is not in liquidation at this time it will be soon enough.