What are the limitations of Section 453 for sales of depreciable property to related parties?

Question

Tyler Smith · Accepted Answer

Section 453 installment sale treatment comes with specific limitations when depreciable property is sold to a related party, as outlined in Internal Revenue Code Section 453(g). The primary purpose of this restriction is to prevent taxpayers from using related-party transactions to obtain a basis step-up for depreciation purposes in the hands of the buyer, while the seller simultaneously defers the recognition of gain through an installment sale. This would otherwise create an unfair tax advantage.

Under Section 453(g), if a seller disposes of depreciable property to a related person, and that related person can claim depreciation deductions on the acquired property, the installment method generally cannot be used. Instead, all payments are treated as received in the year of the disposition. This means the seller must recognize the entire gain in the year of sale, even if they only receive a fraction of the sales price upfront. This effectively eliminates the deferral benefit that Section 453 typically offers.

For the purpose of this rule, 'related persons' are broadly defined and include, but are not limited to, an individual and a corporation in which the individual owns more than 50% of the value of the outstanding stock, two corporations that are members of the same controlled group, a grantor and a fiduciary of a trust, and certain other relationships specified in Section 1239(b) and (c). There is an exception if the seller can establish to the satisfaction of the IRS that the disposition did not have as one of its principal purposes the avoidance of federal income tax. However, this is a high bar to clear and is rarely applicable in practice. Therefore, sellers considering a related-party sale of depreciable assets must be aware that they will likely recognize the full gain immediately, negating the deferral benefits of Section 453.