How does Section 453 handle the sale of depreciable property between related parties, and what are the limitations?

Question

Tyler Smith · Accepted Answer

Section 453 imposes significant limitations on installment sales of depreciable property between related parties. Under Section 453(g), the installment method generally cannot be used for sales of depreciable property between related persons. Instead, all payments to be received from such a sale are treated as received in the year of the disposition. This means the seller must recognize all the gain in the year of sale, even if payments are structured over several years. The primary purpose of this rule is to prevent related parties from achieving a 'double benefit': the buyer gaining an immediate depreciation deduction on the stepped-up basis of the property, while the seller defers the related gain.

'Related persons' for this rule include a taxpayer and an 80-percent owned entity (e.g., corporation or partnership) and two 80-percent owned entities. There's an exception if the seller can establish to the satisfaction of the IRS that the avoidance of federal income tax was not one of the principal purposes of the disposition. However, this exception is rarely granted. Therefore, when depreciable property is sold between related parties, sellers should typically assume the full gain will be taxable in the year of sale, negating any deferral benefits of Section 453. This requires careful pre-transaction planning to understand the immediate tax consequences.