5.25 Contingent Payment Sales

Where the final selling price or payment period of an installment sale is not fixed at the end of the taxable year of sale, you are considered to have transacted a “contingent payment sale.” Special rules apply where a maximum selling price may be figured under the terms of the agreement or there is no fixed price but there is a fixed payment period, or there is neither a fixed price nor a fixed payment period.

Stated maximum selling price.

Under IRS regulations, a stated maximum selling price may be determined by assuming that all of the contingencies contemplated under the agreement are met. When the maximum amount is later reduced, the gross profit ratio is recomputed.

Fixed period.

When a stated maximum selling price is not determinable but the maximum payment period is fixed, basis—including selling expenses—is allocated equally to the taxable years in which payment may be received under the agreement. If, in any year, no payment is received or the amount of payment received is less than the basis allocated to that taxable year, no loss is allowed unless the taxable year is the final payment year or the agreement has become worthless. When no loss is allowed in a year, the basis allocated to the taxable year is carried forward to the next succeeding taxable year.

No stated maximum selling price or fixed period.

If the agreement fails to specify a maximum selling price and payment period, the IRS may view the agreement as a rent or royalty income agreement. However, if the arrangement qualifies as a sale, basis (including selling expenses) is recovered in equal annual increments over a 15-year period commencing with the date of sale. If in any taxable year no payment is received or the amount of payment received (exclusive of interest) is less than basis allocated to the year, no loss is allowed unless the agreement has become worthless. Excess basis not recovered in one year is reallocated in level amounts over the balance of the 15-year term. Any basis not recovered at the end of the 15th year is carried forward to the next succeeding year, and to the extent unrecovered, carried forward from year to year until basis has been recovered or the agreement is determined to be worthless. The rule requiring initial level allocation of basis over 15 years may not apply if you prove to the IRS that a 15-year general rule will substantially and inappropriately defer recovery of basis.

In some cases, basis recovery under an income forecast type of method may also be allowed.

Caution

Contingent Sales

An example of a contingent sale in which the selling price cannot be determined by the end of the year of the sale is a sale of your business where the selling price includes a percentage of future profits. You and your tax advisor should consult the technical rules in IRS regulation 15A.453-1(c) for details on reporting such sales.

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