Can a seller use Section 453 if the buyer is a related party, such as a family member or controlled entity, to defer capital gains?

Question

Tyler Smith · Accepted Answer

Yes, a seller can generally use Section 453 for sales to **related parties**, but specific rules and limitations apply to prevent abuse and immediate tax avoidance. The IRS has provisions to address related-party installment sales, primarily outlined in **Section 453(e)**.

## Related Party Rules for Depreciable Property

If you sell **depreciable property** to a related party, gain generally cannot be reported under the installment method if:

*   The related party buyer then disposes of the property within two years of the initial sale.
*   The property sold is depreciable in the hands of the buyer.

In such cases, the original seller would be required to recognize the remaining deferred gain at the time of the second disposition, even if they haven't received all installment payments. This rule aims to prevent situations where a related party sells an asset quickly to a third party, effectively "cashing out" the gain while the original seller still defers tax. Understanding these rules is crucial to avoid [common pitfalls and mistakes](/qa/common-pitfalls-to-avoid-with-section-453-installment-sales) in Section 453 sales.

## Who is Considered a Related Party?

For the purpose of these rules, **related parties** include:

*   **Family members**: Spouses, children, grandchildren, and parents.
*   **Controlled entities**:
    *   A corporation where more than 50% of the value of its outstanding stock is owned, directly or indirectly, by the seller.
    *   A partnership where more than 50% of the capital or profits interest is owned, directly or indirectly, by the seller.
    *   Trusts where the seller holds certain beneficial interests.

## Exceptions to the Two-Year Rule

There are exceptions where the two-year rule for second dispositions might not apply:

*   **Involuntary conversions**: For example, if the property is destroyed or condemned.
*   **Transfers after death**: If the second disposition occurs after the death of either the original seller or the related party buyer.
*   **No tax avoidance purpose**: If it can be shown to the satisfaction of the IRS that the second disposition did not have tax avoidance as one of its principal purposes. This exception can be difficult to prove.

It's imperative to structure such sales carefully and ensure proper documentation and intent to comply with IRS regulations and avoid accelerated gain recognition. For more on compliance, see [main compliance requirements and reporting obligations](/qa/what-are-the-main-compliance-requirements-for-a-section-453-installment-sale). Also, consider the [impact of recapture income](/qa/what-is-the-impact-of-recapture-income-on-a-section-453-installment-sale) when selling depreciable property.

## Related questions

*   [What are the main compliance requirements and reporting obligations for a Section 453 Installment Sale?](/qa/what-are-the-main-compliance-requirements-for-a-section-453-installment-sale)
*   [What are the common pitfalls and mistakes to avoid when structuring a Section 453 installment sale to ensure proper capital gains tax deferral?](/qa/common-pitfalls-to-avoid-with-section-453-installment-sales)
*   [What is the impact of recapture income on a Section 453 installment sale?](/qa/what-is-the-impact-of-recapture-income-on-a-section-453-installment-sale)
*   [How does Section 453 interact with state-level capital gains taxes on an installment sale?](/qa/how-does-section-453-interact-with-state-level-capital-gains-taxes-on-an-installment-sale)
*   [How does Section 453 handle deferred payment obligations from a business asset sale?](/qa/how-does-section-453-handle-deferred-payment-obligations-from-a-business-asset-sale)