Installment Sale

An investor sells her entire interest in a passive DPP carrying suspended losses, but structures the sale as an installment sale, receiving payments and recognizing gain over several years rather than all at once. How does this affect the release of her suspended passive losses compared with a single, fully taxable cash sale?

1. A.It has no effect; the full amount of suspended losses is released in the year of sale regardless of whether the sale is structured as an installment saleWrong. An installment sale spreads the release of suspended losses over the years gain is recognized, rather than releasing them all at once.
2. B.The suspended losses are permanently forfeited because an installment sale does not qualify as a complete disposition for purposes of the passive-loss release ruleWrong. An installment sale still qualifies as a complete disposition; it simply spreads the release over the years gain is recognized rather than forfeiting the losses.
3. C.The suspended losses are released entirely in the final year the last installment payment is received, rather than spread across the payment yearsWrong. The release tracks the gain recognized each year, not a single release concentrated in the final payment year.
4. D.The suspended losses are released in proportion to the gain recognized each year under the installment method, rather than being freed all at once in the year of saleCorrect. The release of suspended losses follows the installment method's year-by-year gain recognition.

Why: The suspended losses are released in proportion to the gain recognized each year under the installment method, rather than being freed all at once in the year of sale.

Fabian Ostrowski sells a parcel of investment land with a $200,000 adjusted basis for $1,000,000. He receives $200,000 in cash at closing and the buyer's note for the remaining $800,000, payable in four equal annual principal installments plus market-rate interest. Fabian does not elect out of installment reporting. The gain he reports in the year of sale is:

1. A.$160,000 of capital gain, with any interest received on the note reported separately as ordinary income.Correct. The gross profit ratio is $800,000 / $1,000,000 = 80%, applied to the $200,000 of principal received in the year of sale, and interest is always reported separately.
2. B.$800,000 of capital gain, the full profit, in the year of sale.Incorrect. That is the result of electing OUT of the installment method. Fabian did not elect out, so gain is spread across the collection period.
3. C.$200,000 of capital gain, equal to the entire down payment received at closing.Incorrect. This ignores basis recovery. Every payment is part return of capital and part gain, in the proportion set by the gross profit ratio.
4. D.$0, because no gain is recognized under the installment method until the note is paid in full.Incorrect. Installment reporting recognizes gain as principal is collected, beginning with the down payment - it does not defer everything to the final payment.

Why: Under the installment method, gain is recognized proportionately as principal is collected. Gross profit is $1,000,000 - $200,000 = $800,000. The contract price is $1,000,000. The gross profit ratio is therefore $800,000 / $1,000,000 = 80%. In the year of sale Fabian receives $200,000 of principal, so he reports 80% of it, or $160,000, as capital gain. Interest on the note is not part of this computation at all; it is reported separately as ordinary interest income in the year received.