[Federal Register Volume 64, Number 162 (Monday, August 23, 1999)]
[Rules and Regulations]
[Pages 45874-45877]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-21755]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8836]
RIN 1545-AW85


Capital Gains, Installment Sales, Unrecaptured Section 1250 Gain

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
taxation of capital gains on installment sales of depreciable real 
property. The regulations interpret changes made by the Taxpayer Relief 
Act of 1997, as amended by the Internal Revenue Service Restructuring 
and Reform Act of 1998 and the Omnibus Consolidated and Emergency 
Supplemental Appropriations Act of 1999. The regulations affect persons 
required to report capital gain from an installment sale where a 
portion of the capital gain is unrecaptured section 1250 gain and a 
portion is adjusted net capital gain.

DATES: Effective Date: These regulations are effective August 23, 1999.
    Applicability Date: These regulations apply to installment payments 
properly taken into account after August 23, 1999.

FOR FURTHER INFORMATION CONTACT: Susan Kassell, (202) 622-4930 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR Part 1). On January 22, 1999, a notice of proposed rulemaking 
relating to the taxation of capital gains on installment sales of 
depreciable real property was published in the Federal Register (64 FR 
3457). No comments were received from the public in response to the 
notice of proposed rulemaking. No public hearing was requested or held. 
The proposed regulations are adopted without substantive change by this 
Treasury decision.

Explanation of Provisions

    In 1997 Congress amended section 1(h) generally to reduce the 
maximum capital gain tax rates for individuals. As amended, section 
1(h) generally divides a taxpayer's net capital gain into several rate 
groups. A maximum marginal rate of 28 percent applies to 28-percent 
rate gain, which is not pertinent to these final regulations. A maximum 
marginal rate of 25 percent applies to unrecaptured section 1250 gain 
(25-percent gain), which is defined in section 1(h)(7)(A) as the amount 
of long-term capital gain (not otherwise treated as ordinary income) 
that would be treated as ordinary income if section 1250(b)(1) included 
all depreciation and the applicable percentage under section 1250(a) 
were 100 percent, reduced by any net loss in the 28-percent rate 
category. A maximum marginal rate of 20 percent applies to adjusted net 
capital gain (20/10-percent gain), defined in section 1(h)(4) as the 
portion of net capital gain that is not taxed at the 28-percent or 25-
percent rates. A reduced rate of 10 percent is applied to the portion 
of the taxpayer's adjusted net capital gain that would otherwise be 
taxed at a 15-percent rate.
    Under the final regulations, if a portion of the capital gain from 
an installment sale of real depreciable property consists of 25-percent 
gain, and a portion consists of 20/10-percent gain, the taxpayer is 
required to take the 25-percent gain into account before the 20/10-
percent gain, as payments are received. In addition, an example in the 
regulations illustrates that section 1231 gain from an installment sale 
that is recharacterized as ordinary gain under section 1231(c) is 
deemed to consist first of 25-percent gain, and then 20/10-percent 
gain. Consistent with this treatment and with the general rule that 25-
percent gain is taken into account first, another example in the 
regulations illustrates that, where there is installment gain that is 
characterized as ordinary gain under section 1231(a) because there is a 
net section 1231 loss for the year, the gain is treated as consisting 
of 25-percent gain first, before 20/10-percent gain, for purposes of 
determining how much 25-percent gain remains to be taken into account 
in later payments.
    The final regulations also provide that the capital gain rates 
applicable to installment payments that are received on or after the 
effective date of the 1997 Act from sales prior to the effective date 
are determined as if, for all payments received after the date of sale 
but before the effective date, 25-percent gain had been taken into 
account before 20/10-percent gain. The regulations further

[[Page 45875]]

provide that, in the event the cumulative amount of 25-percent gain 
actually reported in installment payments received during the period 
between the effective date of section 1(h) and the effective date of 
these regulations was less than the amount that would have been 
reported using the front-loaded allocation method of the regulations, 
the amount of 25-percent gain actually reported, rather than an amount 
determined under a front-loaded allocation method, must be used in 
determining the amount of 25-percent gain that remains to be reported.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because 
these regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the 
notice of proposed rulemaking preceding these regulations was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business.

Drafting Information

    The principal authors of these regulations are Susan Kassell and 
Rob Laudeman, Office of Assistant Chief Counsel (Income Tax & 
Accounting). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.453-12 is added to read as follows:


Sec. 1.453-12  Allocation of unrecaptured section 1250 gain reported on 
the installment method.

    (a) General rule. Unrecaptured section 1250 gain, as defined in 
section 1(h)(7), is reported on the installment method if that method 
otherwise applies under section 453 or 453A and the corresponding 
regulations. If gain from an installment sale includes unrecaptured 
section 1250 gain and adjusted net capital gain (as defined in section 
1(h)(4)), the unrecaptured section 1250 gain is taken into account 
before the adjusted net capital gain.
    (b) Installment payments from sales before May 7, 1997. The amount 
of unrecaptured section 1250 gain in an installment payment that is 
properly taken into account after May 6, 1997, from a sale before May 
7, 1997, is determined as if, for all payments properly taken into 
account after the date of sale but before May 7, 1997, unrecaptured 
section 1250 gain had been taken into account before adjusted net 
capital gain.
    (c) Installment payments received after May 6, 1997, and on or 
before August 23, 1999. If the amount of unrecaptured section 1250 gain 
in an installment payment that is properly taken into account after May 
6, 1997, and on or before August 23, 1999, is less than the amount that 
would have been taken into account under this section, the lesser 
amount is used to determine the amount of unrecaptured section 1250 
gain that remains to be taken into account.
    (d) Examples. In each example, the taxpayer, an individual whose 
taxable year is the calendar year, does not elect out of the 
installment method. The installment obligation bears adequate stated 
interest, and the property sold is real property held in a trade or 
business that qualifies as both section 1231 property and section 1250 
property. In all taxable years, the taxpayer's marginal tax rate on 
ordinary income is 28 percent. The following examples illustrate the 
rules of this section:

    Example 1. General rule. This example illustrates the rule of 
paragraph (a) of this section as follows:
    (i) In 1999, A sells property for $10,000, to be paid in ten 
equal annual installments beginning on December 1, 1999. A 
originally purchased the property for $5000, held the property for 
several years, and took straight-line depreciation deductions in the 
amount of $3000. In each of the years 1999-2008, A has no other 
capital or section 1231 gains or losses.
    (ii) A's adjusted basis at the time of the sale is $2000. Of A's 
$8000 of section 1231 gain on the sale of the property, $3000 is 
attributable to prior straight-line depreciation deductions and is 
unrecaptured section 1250 gain. The gain on each installment payment 
is $800.
    (iii) As illustrated in the table in this paragraph (iii) of 
this Example 1., A takes into account the unrecaptured section 1250 
gain first. Therefore, the gain on A's first three payments, 
received in 1999, 2000, and 2001, is taxed at 25 percent. Of the 
$800 of gain on the fourth payment, received in 2002, $600 is taxed 
at 25 percent and the remaining $200 is taxed at 20 percent. The 
gain on A's remaining six installment payments is taxed at 20 
percent. The table is as follows:

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                                                                                                         Total
                                        1999       2000       2001       2002       2003    2004-2008     gain
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Installment gain...................        800        800        800        800        800       4000       8000
Taxed at 25%.......................        800        800        800        600  .........  .........       3000
Taxed at 20%.......................  .........  .........  .........        200        800       4000       5000
Remaining to be taxed at 25%.......       2200       1400        600  .........  .........  .........  .........
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    Example 2. Installment payments from sales prior to May 7, 1997. 
This example illustrates the rule of paragraph (b) of this section 
as follows:
    (i) The facts are the same as in Example 1 except that A sold 
the property in 1994, received the first of the ten annual 
installment payments on December 1, 1994, and had no other capital 
or section 1231 gains or losses in the years 1994-2003.
    (ii) As in Example 1, of A's $8000 of gain on the sale of the 
property, $3000 was attributable to prior straight-line depreciation 
deductions and is unrecaptured section 1250 gain.
    (iii) As illustrated in the following table, A's first three 
payments, in 1994, 1995, and 1996, were received before May 7, 1997, 
and taxed at 28 percent. Under the rule described in paragraph (b) 
of this section, A determines the allocation of unrecaptured section 
1250 gain for each installment payment after May 6, 1997, by taking 
unrecaptured section 1250 gain into account first, treating the 
general rule of paragraph (a) of this section as having applied 
since the time the property was sold, in 1994. Consequently, of the 
$800 of gain on the fourth payment, received in 1997, $600 is taxed 
at 25 percent and the remaining $200 is taxed at 20 percent. The 
gain on A's remaining six installment payments is taxed at 20 
percent. The table is as follows:

[[Page 45876]]



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                                                                                                         Total
                                        1994       1995       1996       1997       1998    1999-2003     gain
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Installment gain...................        800        800        800        800        800       4000       8000
Taxed at 28%.......................        800        800        800  .........  .........  .........       2400
Taxed at 25%.......................  .........  .........  .........        600  .........  .........        600
Taxed at 20%.......................  .........  .........  .........        200        800       4000       5000
Remaining to be taxed at 25%.......       2200       1400        600  .........  .........  .........  .........
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    Example 3. Effect of section 1231(c) recapture. This example 
illustrates the rule of paragraph (a) of this section when there are 
non-recaptured net section 1231 losses, as defined in section 
1231(c)(2), from prior years as follows:
    (i) The facts are the same as in Example 1, except that in 1999 
A has non-recaptured net section 1231 losses from the previous four 
years of $1000.
    (ii) As illustrated in the table in paragraph (iv) of this 
Example 3, in 1999, all of A's $800 installment gain is recaptured 
as ordinary income under section 1231(c). Under the rule described 
in paragraph (a) of this section, for purposes of determining the 
amount of unrecaptured section 1250 gain remaining to be taken into 
account, the $800 recaptured as ordinary income under section 
1231(c) is treated as reducing unrecaptured section 1250 gain, 
rather than adjusted net capital gain. Therefore, A has $2200 of 
unrecaptured section 1250 gain remaining to be taken into account.
    (iii) In the year 2000, A's installment gain is taxed at two 
rates. First, $200 is recaptured as ordinary income under section 
1231(c). Second, the remaining $600 of gain on A's year 2000 
installment payment is taxed at 25 percent. Because the full $800 of 
gain reduces unrecaptured section 1250 gain, A has $1400 of 
unrecaptured section 1250 gain remaining to be taken into account.
    (iv) The gain on A's installment payment received in 2001 is 
taxed at 25 percent. Of the $800 of gain on the fourth payment, 
received in 2002, $600 is taxed at 25 percent and the remaining $200 
is taxed at 20 percent. The gain on A's remaining six installment 
payments is taxed at 20 percent. The table is as follows:

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                                                                                                         Total
                                        1999       2000       2001       2002       2003    2004-2008     gain
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Installment gain...................        800        800        800        800        800       4000       8000
Taxed at ordinary rates under              800        200  .........  .........  .........  .........       1000
 section 1231(c)...................
Taxed at 25%.......................  .........        600        800        600  .........  .........       2000
Taxed at 20%.......................  .........  .........  .........        200        800       4000       5000
Remaining non-recaptured net               200  .........  .........  .........  .........  .........  .........
 section 1231 losses...............
Remaining to be taxed at 25%.......       2200       1400        600  .........  .........  .........  .........
----------------------------------------------------------------------------------------------------------------

    Example 4. Effect of a net section 1231 loss. This example 
illustrates the application of paragraph (a) of this section when 
there is a net section 1231 loss as follows:
    (i) The facts are the same as in Example 1 except that A has 
section 1231 losses of $1000 in 1999.
    (ii) In 1999, A's section 1231 installment gain of $800 does not 
exceed A's section 1231 losses of $1000. Therefore, A has a net 
section 1231 loss of $200. As a result, under section 1231(a) all of 
A's section 1231 gains and losses are treated as ordinary gains and 
losses. As illustrated in the following table, A's entire $800 of 
installment gain is ordinary gain. Under the rule described in 
paragraph (a) of this section, for purposes of determining the 
amount of unrecaptured section 1250 gain remaining to be taken into 
account, A's $800 of ordinary section 1231 installment gain in 1999 
is treated as reducing unrecaptured section 1250 gain. Therefore, A 
has $2200 of unrecaptured section 1250 gain remaining to be taken 
into account.
    (iii) In the year 2000, A has $800 of section 1231 installment 
gain, resulting in a net section 1231 gain of $800. A also has $200 
of non-recaptured net section 1231 losses. The $800 gain is taxed at 
two rates. First, $200 is taxed at ordinary rates under section 
1231(c), recapturing the $200 net section 1231 loss sustained in 
1999. Second, the remaining $600 of gain on A's year 2000 
installment payment is taxed at 25 percent. As in Example 3, the 
$200 of section 1231(c) gain is treated as reducing unrecaptured 
section 1250 gain, rather than adjusted net capital gain. Therefore, 
A has $1400 of unrecaptured section 1250 gain remaining to be taken 
into account.
    (iv) The gain on A's installment payment received in 2001 is taxed 
at 25 percent, reducing the remaining unrecaptured section 1250 gain to 
$600. Of the $800 of gain on the fourth payment, received in 2002, $600 
is taxed at 25 percent and the remaining $200 is taxed at 20 percent. 
The gain on A's remaining six installment payments is taxed at 20 
percent. The table is as follows:

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                                                                                                         Total
                                        1999       2000       2001       2002       2003    2004-2008     gain
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Installment gain...................        800        800        800        800        800       4000       8000
Ordinary gain under section 1231(a)        800  .........  .........  .........  .........  .........        800
Taxed at ordinary rates under        .........        200  .........  .........  .........  .........        200
 section 1231(c)...................
Taxed at 25%.......................  .........        600        800        600  .........  .........       2000
Taxed at 20%.......................  .........  .........  .........        200        800       4000       5000
Net section 1231 loss..............        200  .........  .........  .........  .........  .........  .........
Remaining to be taxed at 25%.......       2200       1400        600  .........  .........  .........  .........
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[[Page 45877]]

    (e) Effective date. This section applies to installment payments 
properly taken into account after August 23, 1999.
John M. Darymple,
Acting Deputy Commissioner of Internal Revenue.

    Approved: August 9, 1999.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 99-21755 Filed 8-20-99; 8:45 am]
BILLING CODE 4830-01-U