How does Section 453 handle the sale of depreciable property to a related person, and what are the limitations?

Question

Tyler Smith · Accepted Answer

Section 453 has specific, restrictive rules regarding the sale of depreciable property between related persons. The primary purpose of these rules is to prevent tax avoidance schemes where property is sold on an installment basis to a related party, who then takes immediate depreciation deductions on the stepped-up basis, while the seller defers capital gains tax.

Under Section 453(g), if depreciable property is sold to a "related person" on an installment basis, the installment method generally does not apply. Instead, all payments to be received are treated as received in the year of the sale. This means the entire gain from the sale becomes immediately taxable to the seller, even if actual cash payments are deferred. The definition of a "related person" for this rule is broad and includes, but is not limited to, a person and a controlled entity (e.g., a corporation where more than 50% of the stock is owned by the person, or a partnership where more than 50% of the capital or profits interest is owned by the person). It also includes two corporations that are members of the same controlled group.

There is a narrow exception: this immediate gain recognition rule does not apply 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 sale. However, proving this can be very difficult. Therefore, sellers should generally assume that installment sale treatment will be denied for sales of depreciable property to related persons. This provision ensures that taxpayers cannot exploit the installment method for tax deferral while the related buyer simultaneously enjoys accelerated depreciation deductions based on the higher acquisition cost.