[Federal Register Volume 64, Number 162 (Monday, August 23, 1999)]
[Rules and Regulations]
[Pages 45874-45877]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-21755]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8836]
RIN 1545-AW85
Capital Gains, Installment Sales, Unrecaptured Section 1250 Gain
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to the
taxation of capital gains on installment sales of depreciable real
property. The regulations interpret changes made by the Taxpayer Relief
Act of 1997, as amended by the Internal Revenue Service Restructuring
and Reform Act of 1998 and the Omnibus Consolidated and Emergency
Supplemental Appropriations Act of 1999. The regulations affect persons
required to report capital gain from an installment sale where a
portion of the capital gain is unrecaptured section 1250 gain and a
portion is adjusted net capital gain.
DATES: Effective Date: These regulations are effective August 23, 1999.
Applicability Date: These regulations apply to installment payments
properly taken into account after August 23, 1999.
FOR FURTHER INFORMATION CONTACT: Susan Kassell, (202) 622-4930 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to the Income Tax Regulations (26
CFR Part 1). On January 22, 1999, a notice of proposed rulemaking
relating to the taxation of capital gains on installment sales of
depreciable real property was published in the Federal Register (64 FR
3457). No comments were received from the public in response to the
notice of proposed rulemaking. No public hearing was requested or held.
The proposed regulations are adopted without substantive change by this
Treasury decision.
Explanation of Provisions
In 1997 Congress amended section 1(h) generally to reduce the
maximum capital gain tax rates for individuals. As amended, section
1(h) generally divides a taxpayer's net capital gain into several rate
groups. A maximum marginal rate of 28 percent applies to 28-percent
rate gain, which is not pertinent to these final regulations. A maximum
marginal rate of 25 percent applies to unrecaptured section 1250 gain
(25-percent gain), which is defined in section 1(h)(7)(A) as the amount
of long-term capital gain (not otherwise treated as ordinary income)
that would be treated as ordinary income if section 1250(b)(1) included
all depreciation and the applicable percentage under section 1250(a)
were 100 percent, reduced by any net loss in the 28-percent rate
category. A maximum marginal rate of 20 percent applies to adjusted net
capital gain (20/10-percent gain), defined in section 1(h)(4) as the
portion of net capital gain that is not taxed at the 28-percent or 25-
percent rates. A reduced rate of 10 percent is applied to the portion
of the taxpayer's adjusted net capital gain that would otherwise be
taxed at a 15-percent rate.
Under the final regulations, if a portion of the capital gain from
an installment sale of real depreciable property consists of 25-percent
gain, and a portion consists of 20/10-percent gain, the taxpayer is
required to take the 25-percent gain into account before the 20/10-
percent gain, as payments are received. In addition, an example in the
regulations illustrates that section 1231 gain from an installment sale
that is recharacterized as ordinary gain under section 1231(c) is
deemed to consist first of 25-percent gain, and then 20/10-percent
gain. Consistent with this treatment and with the general rule that 25-
percent gain is taken into account first, another example in the
regulations illustrates that, where there is installment gain that is
characterized as ordinary gain under section 1231(a) because there is a
net section 1231 loss for the year, the gain is treated as consisting
of 25-percent gain first, before 20/10-percent gain, for purposes of
determining how much 25-percent gain remains to be taken into account
in later payments.
The final regulations also provide that the capital gain rates
applicable to installment payments that are received on or after the
effective date of the 1997 Act from sales prior to the effective date
are determined as if, for all payments received after the date of sale
but before the effective date, 25-percent gain had been taken into
account before 20/10-percent gain. The regulations further
[[Page 45875]]
provide that, in the event the cumulative amount of 25-percent gain
actually reported in installment payments received during the period
between the effective date of section 1(h) and the effective date of
these regulations was less than the amount that would have been
reported using the front-loaded allocation method of the regulations,
the amount of 25-percent gain actually reported, rather than an amount
determined under a front-loaded allocation method, must be used in
determining the amount of 25-percent gain that remains to be reported.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and because
these regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding these regulations was submitted
to the Chief Counsel for Advocacy of the Small Business Administration
for comment on its impact on small business.
Drafting Information
The principal authors of these regulations are Susan Kassell and
Rob Laudeman, Office of Assistant Chief Counsel (Income Tax &
Accounting). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.453-12 is added to read as follows:
Sec. 1.453-12 Allocation of unrecaptured section 1250 gain reported on
the installment method.
(a) General rule. Unrecaptured section 1250 gain, as defined in
section 1(h)(7), is reported on the installment method if that method
otherwise applies under section 453 or 453A and the corresponding
regulations. If gain from an installment sale includes unrecaptured
section 1250 gain and adjusted net capital gain (as defined in section
1(h)(4)), the unrecaptured section 1250 gain is taken into account
before the adjusted net capital gain.
(b) Installment payments from sales before May 7, 1997. The amount
of unrecaptured section 1250 gain in an installment payment that is
properly taken into account after May 6, 1997, from a sale before May
7, 1997, is determined as if, for all payments properly taken into
account after the date of sale but before May 7, 1997, unrecaptured
section 1250 gain had been taken into account before adjusted net
capital gain.
(c) Installment payments received after May 6, 1997, and on or
before August 23, 1999. If the amount of unrecaptured section 1250 gain
in an installment payment that is properly taken into account after May
6, 1997, and on or before August 23, 1999, is less than the amount that
would have been taken into account under this section, the lesser
amount is used to determine the amount of unrecaptured section 1250
gain that remains to be taken into account.
(d) Examples. In each example, the taxpayer, an individual whose
taxable year is the calendar year, does not elect out of the
installment method. The installment obligation bears adequate stated
interest, and the property sold is real property held in a trade or
business that qualifies as both section 1231 property and section 1250
property. In all taxable years, the taxpayer's marginal tax rate on
ordinary income is 28 percent. The following examples illustrate the
rules of this section:
Example 1. General rule. This example illustrates the rule of
paragraph (a) of this section as follows:
(i) In 1999, A sells property for $10,000, to be paid in ten
equal annual installments beginning on December 1, 1999. A
originally purchased the property for $5000, held the property for
several years, and took straight-line depreciation deductions in the
amount of $3000. In each of the years 1999-2008, A has no other
capital or section 1231 gains or losses.
(ii) A's adjusted basis at the time of the sale is $2000. Of A's
$8000 of section 1231 gain on the sale of the property, $3000 is
attributable to prior straight-line depreciation deductions and is
unrecaptured section 1250 gain. The gain on each installment payment
is $800.
(iii) As illustrated in the table in this paragraph (iii) of
this Example 1., A takes into account the unrecaptured section 1250
gain first. Therefore, the gain on A's first three payments,
received in 1999, 2000, and 2001, is taxed at 25 percent. Of the
$800 of gain on the fourth payment, received in 2002, $600 is taxed
at 25 percent and the remaining $200 is taxed at 20 percent. The
gain on A's remaining six installment payments is taxed at 20
percent. The table is as follows:
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Total
1999 2000 2001 2002 2003 2004-2008 gain
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Installment gain................... 800 800 800 800 800 4000 8000
Taxed at 25%....................... 800 800 800 600 ......... ......... 3000
Taxed at 20%....................... ......... ......... ......... 200 800 4000 5000
Remaining to be taxed at 25%....... 2200 1400 600 ......... ......... ......... .........
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Example 2. Installment payments from sales prior to May 7, 1997.
This example illustrates the rule of paragraph (b) of this section
as follows:
(i) The facts are the same as in Example 1 except that A sold
the property in 1994, received the first of the ten annual
installment payments on December 1, 1994, and had no other capital
or section 1231 gains or losses in the years 1994-2003.
(ii) As in Example 1, of A's $8000 of gain on the sale of the
property, $3000 was attributable to prior straight-line depreciation
deductions and is unrecaptured section 1250 gain.
(iii) As illustrated in the following table, A's first three
payments, in 1994, 1995, and 1996, were received before May 7, 1997,
and taxed at 28 percent. Under the rule described in paragraph (b)
of this section, A determines the allocation of unrecaptured section
1250 gain for each installment payment after May 6, 1997, by taking
unrecaptured section 1250 gain into account first, treating the
general rule of paragraph (a) of this section as having applied
since the time the property was sold, in 1994. Consequently, of the
$800 of gain on the fourth payment, received in 1997, $600 is taxed
at 25 percent and the remaining $200 is taxed at 20 percent. The
gain on A's remaining six installment payments is taxed at 20
percent. The table is as follows:
[[Page 45876]]
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Total
1994 1995 1996 1997 1998 1999-2003 gain
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Installment gain................... 800 800 800 800 800 4000 8000
Taxed at 28%....................... 800 800 800 ......... ......... ......... 2400
Taxed at 25%....................... ......... ......... ......... 600 ......... ......... 600
Taxed at 20%....................... ......... ......... ......... 200 800 4000 5000
Remaining to be taxed at 25%....... 2200 1400 600 ......... ......... ......... .........
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Example 3. Effect of section 1231(c) recapture. This example
illustrates the rule of paragraph (a) of this section when there are
non-recaptured net section 1231 losses, as defined in section
1231(c)(2), from prior years as follows:
(i) The facts are the same as in Example 1, except that in 1999
A has non-recaptured net section 1231 losses from the previous four
years of $1000.
(ii) As illustrated in the table in paragraph (iv) of this
Example 3, in 1999, all of A's $800 installment gain is recaptured
as ordinary income under section 1231(c). Under the rule described
in paragraph (a) of this section, for purposes of determining the
amount of unrecaptured section 1250 gain remaining to be taken into
account, the $800 recaptured as ordinary income under section
1231(c) is treated as reducing unrecaptured section 1250 gain,
rather than adjusted net capital gain. Therefore, A has $2200 of
unrecaptured section 1250 gain remaining to be taken into account.
(iii) In the year 2000, A's installment gain is taxed at two
rates. First, $200 is recaptured as ordinary income under section
1231(c). Second, the remaining $600 of gain on A's year 2000
installment payment is taxed at 25 percent. Because the full $800 of
gain reduces unrecaptured section 1250 gain, A has $1400 of
unrecaptured section 1250 gain remaining to be taken into account.
(iv) The gain on A's installment payment received in 2001 is
taxed at 25 percent. Of the $800 of gain on the fourth payment,
received in 2002, $600 is taxed at 25 percent and the remaining $200
is taxed at 20 percent. The gain on A's remaining six installment
payments is taxed at 20 percent. The table is as follows:
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Total
1999 2000 2001 2002 2003 2004-2008 gain
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Installment gain................... 800 800 800 800 800 4000 8000
Taxed at ordinary rates under 800 200 ......... ......... ......... ......... 1000
section 1231(c)...................
Taxed at 25%....................... ......... 600 800 600 ......... ......... 2000
Taxed at 20%....................... ......... ......... ......... 200 800 4000 5000
Remaining non-recaptured net 200 ......... ......... ......... ......... ......... .........
section 1231 losses...............
Remaining to be taxed at 25%....... 2200 1400 600 ......... ......... ......... .........
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Example 4. Effect of a net section 1231 loss. This example
illustrates the application of paragraph (a) of this section when
there is a net section 1231 loss as follows:
(i) The facts are the same as in Example 1 except that A has
section 1231 losses of $1000 in 1999.
(ii) In 1999, A's section 1231 installment gain of $800 does not
exceed A's section 1231 losses of $1000. Therefore, A has a net
section 1231 loss of $200. As a result, under section 1231(a) all of
A's section 1231 gains and losses are treated as ordinary gains and
losses. As illustrated in the following table, A's entire $800 of
installment gain is ordinary gain. Under the rule described in
paragraph (a) of this section, for purposes of determining the
amount of unrecaptured section 1250 gain remaining to be taken into
account, A's $800 of ordinary section 1231 installment gain in 1999
is treated as reducing unrecaptured section 1250 gain. Therefore, A
has $2200 of unrecaptured section 1250 gain remaining to be taken
into account.
(iii) In the year 2000, A has $800 of section 1231 installment
gain, resulting in a net section 1231 gain of $800. A also has $200
of non-recaptured net section 1231 losses. The $800 gain is taxed at
two rates. First, $200 is taxed at ordinary rates under section
1231(c), recapturing the $200 net section 1231 loss sustained in
1999. Second, the remaining $600 of gain on A's year 2000
installment payment is taxed at 25 percent. As in Example 3, the
$200 of section 1231(c) gain is treated as reducing unrecaptured
section 1250 gain, rather than adjusted net capital gain. Therefore,
A has $1400 of unrecaptured section 1250 gain remaining to be taken
into account.
(iv) The gain on A's installment payment received in 2001 is taxed
at 25 percent, reducing the remaining unrecaptured section 1250 gain to
$600. Of the $800 of gain on the fourth payment, received in 2002, $600
is taxed at 25 percent and the remaining $200 is taxed at 20 percent.
The gain on A's remaining six installment payments is taxed at 20
percent. The table is as follows:
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Total
1999 2000 2001 2002 2003 2004-2008 gain
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Installment gain................... 800 800 800 800 800 4000 8000
Ordinary gain under section 1231(a) 800 ......... ......... ......... ......... ......... 800
Taxed at ordinary rates under ......... 200 ......... ......... ......... ......... 200
section 1231(c)...................
Taxed at 25%....................... ......... 600 800 600 ......... ......... 2000
Taxed at 20%....................... ......... ......... ......... 200 800 4000 5000
Net section 1231 loss.............. 200 ......... ......... ......... ......... ......... .........
Remaining to be taxed at 25%....... 2200 1400 600 ......... ......... ......... .........
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[[Page 45877]]
(e) Effective date. This section applies to installment payments
properly taken into account after August 23, 1999.
John M. Darymple,
Acting Deputy Commissioner of Internal Revenue.
Approved: August 9, 1999.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 99-21755 Filed 8-20-99; 8:45 am]
BILLING CODE 4830-01-U
