Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 79-91

1979-1 C.B. 179

Section 453

IRS Headnote

Installment sales; funds in escrow account. A sale of realty ceases to qualify for the installment method of reporting income when the purchaser makes an escrow deposit in exchange for the release of the seller's security interest if the payment schedule is the only restriction on the seller's right to receipt of the total sales proceeds; Rev. Rul. 77-294 amplified.

Full Text

Rev. Rul. 79-91

ISSUE

Under the circumstances described below, may an individual continue to report the gain from the sale of real property on the installment method as provided by section 453 of the Internal Revenue Code of 1954?

FACTS

An individual taxpayer, A, sold unimproved real property to an unrelated purchaser, B, on January 2, 1975, for 100x dollars. Pursuant to the sales agreement A received a cash down payment of 10x dollars and B's purchase money promissory note in the amount of 90x dollars, payable in six equal annual installments of 15x dollars each, with interest thereon, on February 1 in each of the succeeding six years. B gave A a purchase money security interest in the real property. A elected to report the gain from the sale on the installment method under section 453 of the Code.

In 1976 and 1977, A received the installment payments then due on the note. In January 1978, because B desired to develop the property and required clear and unrestricted title to do so, the parties agreed that in consideration for A's release of A's security interest in the real property, B would place funds with an escrow agent, sufficient to pay each installment when due, with interest.

Pursuant to the terms of the escrow agreement, A has no right to, or interest in, the funds placed in escrow until and unless B defaulted on a payment due on the installment note. In the event of a default, A is entitled to an amount equal to the installment payment then due, and interest thereon. The escrow agreement also provides that as each installment payment is made by B, the escrow agent will release an amount equal to the payment including interest to B. B remains liable on the note.

LAW AND ANALYSIS

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), if, in the year of sale, there are no payments, or the payments (exclusive of evidences of indebtedness of the purchaser) do not exceed thirty percent of the selling price. Section 453(a)(1) provides for the reporting of income on the installment method of accounting as the installment payments are actually received.

Rev. Rul. 77-294, 1977-2 C.B. 173, holds that the substitution of an escrow deposit for a deed of trust under a real property installment sale transaction does not qualify for installment sale treatment under section 453 of the Code. The substitution of the escrow deposit for the deed of trust as collateral for the installment sale obligation represents payment of the remaining unpaid balance of the obligation.

Rev. Rul. 77-294 further provides, however, that if an escrow agreement incident to a deferred payment sales transaction imposes a substantial restriction, in addition to the payment schedule, upon the seller's right to receipt of the sales proceeds, the Service will allow the seller to use the installment method of reporting income from the sale under section 453(b) of the Code assuming the sales transaction otherwise qualifies under that provision. The Revenue Ruling cited Murray v. Commissioner, 28 B.T.A. 624 (1933), acq., XII-2 C.B. 10 (1933), in support of that proposition.

In order for an escrow arrangement to impose a substantial restriction, it must serve a bona fide purpose of the purchaser, that is, a real and definite restriction placed on the seller or a specific economic benefit conferred on the purchaser. In Murray, for example, receipt of payments from the escrow account was contingent on the sellers refraining from entering a competing business for a period of five years.

The provisions in the escrow agreement that restrict A's rights to and interest in the funds placed in escrow are not restrictions of the type illustrated by Murray. The provisions do not restrict payment of the installment obligation itself, but only affect the source from which the payment is to be made. Under no circumstances can the escrow agent set aside funds from the escrow account that would reduce the total payments to be received by A on the sale. Thus, A's ultimate enjoyment of the total remaining sales price is conditioned only upon the passage of a certain period of time.

HOLDING

The placing of the funds with the escrow agent represents payment of the unpaid balance of the installment obligation to A and A may not continue to report the gain from the sale on the installment method under section 453 of the Code as the remaining payments come due.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 77-294 is amplified.