Taxing the Sale of Property

Puhe Lift journal VOLUME 1980 JUNE NUMBER 3 TAXING THE SALE OF PROPERTY DENNIS S. KARJALA* I. INTRODUCTION ........................................... 419 II. AN ILLUSTRATIVE EXAMPLE-THREE TAXPAYERS A, B, AND C ................................................... 421 A. Taxation of A (isolated-salepurchaserobligation)-Ac- counting Method Governing .......................... 423 1. A on Accrual Method ............................ 423 2. A on Cash Method .............................. 423 (a) Contract is a cash equivalent ................ 423 (b) Contractis not a cash equivalent ............ 423 B. Taxation of A-Section 1001 Governing ............. 424 1. Contract Treated as Other Than Property ........ 424 (a) Amount realizedcalculated independently of accounting method ............................ 424 (b) Amount realized determined by accounting m ethod ..................................... 424 2. Contract Treated as Property.................... 424 (a) Fairmarket value not ascertainable......... 425 (b) Fair market value ascertainable ............ 425 C. Taxation of B (isolated-salethird-party obligation)... 426 * Associate Professor of Law, Arizona State University. B.S.E. 1961, Princeton University; M.S. 1963, Ph.D. 1965, University of Illinois; J.D. 1972, University of California (Berkeley). THE FOLLOWING CITATIONS WILL BE USED IN THIS ARTICLE: Treas. Release No. B-1758 (July 27, 1979) (statement of Harry L. Gutman, Deputy Tax Leg- islative Counsel, Department of the Treasury, before the Subcommittee on Select Revenue Meas- ures of the House Committee on Ways and Means) [hereinafter cited as Treas. Release No. B- 1758]; J. SEIDMAN, LEGISLATIVE HISTORY OF FEDERAL INCOME TAX LAWS 1938-1861 (1938) [hereinafter cited as J. SEIDMAN]; Ginsburg, Taxing the Salefor Future Payment, 30 TAX L. REV. 471 (1975) [hereinafter cited as Ginsburg]; References to the Internal Revenue Code of 1954, as amended (the Code), will be made by section number only. The Internal Revenue Service will be referred to as the "Service." DUKE LAW JOUR[10,4L [Vol. 1980:417 D. Taxation of C (regular-businesspurchaser obligation)........................................... 427 E. Summary ............................................ 427 III. STATUTORY DEVELOPMENT .............................. 427 A. Development of the Statutory Scheme ................ 427 1. Revenue Act of 1918 ............................. 428 2. Revenue Act of 1921 ............................. 430 3. Revenue Act of 1924 ............................. 431 4. Summary ........................................ 434 B. Interpreting the Current Statutory Framework ........ 435 IV. JUDICIAL INTERPRETATIONS .............................. 438 A. Third-Party Obligationsand Non-Sale-or-Exchange Cases Distinguished.................................. 439 1. Third-Party Obligations.......................... 439 2. Non-Sale-or-Exchange Cases .................... 442 B. JudicialApproaches in Purchaser-ObligationCases ... 444 1. LiteralApplication of Section 1001 ............... 445 2. No-Ascertainable-Fair-Market-Value Approach ... 447 3. Accounting-ProvisionApproach ................... 451 (a) Accrual-method taxpayers ................... 452 (b) Cash-method taxpayers ..................... 453 4. Mixed Approaches ............................... 456 (a) No 'property" received ...................... 456 (b) Expanded cash-equivalence approach ........ 457 C. Summary .............................................. 460 V. OPERATION OF THE SUGGESTED APPROACH .............. 462 A. General Operation ................................... 462 B. Denition of Isolated Transactions.................... 464 C. Valuation of PurchaserObligations ................... 465 1. Existence of a Market ........................... 466 (a) Formalmarkets ............................. 466 (b) Quasimarkets............................... 467 2. Absence of a Market ............................. 468 (a) Cash-methodapproach ...................... 469 (b) Accrual-method approach ................... 469 (c) Installment-methodapproach ................ 471 VI. IMPLICATIONS IN RELATED AREAS ....................... 473 A. Open/Closed TransactionDistinction ................. 473 B. Characterand Timing of the Discount Payments ...... 476 1. Character of the Discount-Discount Payments as OrdinaryIncome ................................ 478 (a) Fixed-price contracts ........................ 482 (b) Contingent-price contracts................... 485 Vol. 1980:417] TAXING THE SALE OF PROPERTY (c) Possible doctrinal basesfor capitalgain treatment of discount payments under contingent- price contracts .............................. 489 (i) Application of the Arrowsmith rule ......... 489 (ii) Distinguishingfixed-from contingent-price contracts through a modyfed open-transaction approach .................................. 491 (iii) Interrelationship with the installment method of reporting ................................ 492 (iv) Currentlyproposed legislative changes ...... 497 2. Timing of the Discount-Proratingthe Discount Following Closed Transactions ................... 503 3. Summary ........................................ 506 C. Other Limitations on Installment Reporting ........... 507 1. The 30%Initial Payment Limitation .............. 507 2. The Two-Payment Rule .......................... 509 3. Interaction of Section 453 with Other Nonrecogni- tion Provisions................................... 510 D. Reacquisitions of Property ........................... 512 1. ReacquisitionsFollowing Sales Under Section 453 ..................................... 512 2. Reacquisitions Outside Section 453 ............... 516 VII. CONCLUSION ............................................. 520 I. INTRODUCTION The federal income tax laws have always included gain from "dealings in property" as an item of gross income,' and probably only the payment of wages rivals the sale of property in fundamental impor- tance to taxpayers generally. Nevertheless, the courts and the Internal Revenue Service have yet to develop a consistent and rational approach to taxing the many sales transactions in which the seller takes some evidence of the purchaser's indebtedness in full or partial exchange for the underlying property. Four sections of the Internal Rev- enue Code are potentially applicable to these transactions: section 1001, dealing with gain from the disposition of property; sections 446 and 451, specifying permissible general accounting methods; and section 453, allowing the installment method of reporting gain from cer- tain types of property transactions. These sections yield inconsistent 1. The first income tax statute adopted after the passage of the sixteenth amendment defined income to include "gains, profits, and income derived from... sales, or dealings in property, whether real or personal .... Act of Oct. 3, 1913, ch. 16, § IIB, 38 Stat. 114. Current law provides that gross income includes "[glains derived from dealings in property." § 61(a)(3). 420 DUKE LAW JOURNAL (Vol. 1980:417 results, and despite fifty years of dealing with the statutes, 2 administra- tive and judicial interpretation of these interrelated provisions remains largely ad hoc. Indeed, few courts have even perceived the tension between the conflicting but potentially applicable statutes, and certainly no court has developed a coherent solution. The decisions instead are arrayed in separate lines of authority, using a wide variety of reasoning that has little or no basis in either policy or statutory language. Cases in each line usually show no awareness that alternative approaches ex- ist. The inevitable result can be expressed in a familiar litany-inconsistent tax treatment of particular taxpayers and great difficulty in tax planning. This Article argues that the accounting provisions under sections 446 and 451, the installment sale provisions under section 453, and the disposition-of-property provisions under section 1001 are all amenable to one consistent interpretation. The approach is simple, requiring only a distinction between sales of property in the regular course of business and isolated or casual sales. Sales in the regular course of business should be covered by the taxpayer's method of accounting, without ref- erence to section 1001. Section 1001 should apply to isolated sales, re- gardless of the taxpayer's method of accounting. These rules should be modified only when the installment sale provisions of section 453 are 3 both available and elected. This interpretation follows the apparent intent of Congress and gives meaningful but nonoverlapping operative scope to each provi- sion. It ends the inequity that has developed between cash-method and accrual-method taxpayers who engage in isolated-sale transactions by avoiding the logical inconsistency of applying their accounting methods to transactions unrelated to the regular business or employment for which such methods were adopted. Finally, the suggested interpretation provides a unifying theory that eliminates the uncertainty now fac- ing taxpayers about to enter into sale-of-property transactions. Part II of the Article sets the stage by considering a brief introduc- tory example. Part III reviews the statutory development and argues that the suggested interpretation was probably the one Congress in- tended when it adopted the predecessors of the current statutory provi- 2. These provisions have remained stable since the mid-1920s. Compare Revenue Act of 1926, ch. 27, §§ 202-203, 44 Stat. 10 (exchange of property),

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