What is constructive receipt in an installment sale?

Hans Goldstein structures installment sales for sellers and works alongside their CPAs. Email hans@goldsteinco.net or call 213-340-2018.

What does the regulation actually say?

Treas. Reg. §1.451-2(a), in plain English:

• Income you have not physically received is still yours for tax purposes in the year it is credited to your account, set apart for you, or otherwise made available so you could draw on it at any time.
• It also counts if you could have drawn on it during the year by giving notice of intent to withdraw.
• It does not count if your control over receiving it is subject to substantial limitations or restrictions.

The test is access, not action. Choosing not to take money you are entitled to take does not defer the tax. An installment sale works only because the seller, after closing, has no right to the deferred money until each payment date.

Why is the structured sale schedule locked?

In a structured installment sale, the buyer pays the full price at closing. The structured portion goes to an assignment company, which takes over the obligation to pay you on the schedule written into the contract. It funds that obligation with a fixed annuity it owns. You never own the annuity and you have no account to draw on.

If the contract let you call for the money early, you would have a right to draw on it at any time, and the regulation would treat the whole balance as received. So the contract does not allow acceleration, commutation, borrowing against the payments or cashing out. That restriction is not a product feature; it is the substantial limitation that keeps the deferral intact.

What else is treated as a payment?

Two installment-sale rules sit next to constructive receipt and catch the same idea from other directions:

The common thread: if you hold something that is, in substance, cash or a claim to cash on demand, the tax treats you as paid.

Where do escrow arrangements go wrong?

Escrow is the usual trap. The questions that matter:

• Who controls the funds after closing? If sale proceeds sit in an escrow or account that you can direct, invest for your own benefit, or release on request, expect them to be treated as received.
• Is your deferred payment backed by that escrow? A buyer's note secured by cash held in escrow is a note secured by cash, which is a payment under Temp. Treas. Reg. §15a.453-1(b)(3)(i).
• Was the structure set before you had a right to the cash? Once the purchase agreement entitles you to the full price at closing and the money is in escrow for you, redirecting it into payments looks like receiving cash and then choosing to defer it. That is why an SIS must be set up before closing and cannot be added after closing.

A structured sale avoids this by routing the structured amount at closing to the assignment company under a purchase agreement or addendum signed beforehand. You never have the right to that money as a lump sum. Your CPA or attorney should still read the closing instructions; a sloppy escrow instruction can undo the drafting.

What does not cause constructive receipt?

• Choosing the schedule before closing. Picking the term, start date, step-ups or lump sums as part of the deal, before you have any right to the cash, is negotiating the terms of the sale. Once the contract is signed and funded, you have no option left to exercise.
• Naming a beneficiary. Designating who receives remaining payments if you die gives you no access to the money.
• Taking some cash at closing. Cash at closing is taxed at your gross profit ratio. It does not taint the structured portion.
• The assignment company owning an annuity. You are a payee and an unsecured general creditor, not the owner, so the annuity's value is not credited to you.

Illustrative numbers. A seller structures $1,500,000. If the contract let the seller withdraw the balance on 30 days' notice, the whole $1,500,000 could be treated as received in the year of sale, collapsing the deferral. Under a locked schedule of $150,000 of principal a year for 10 years, only each $150,000 (plus interest) is reported in the year it is paid.

Frequently asked

Q: Does picking my payment schedule cause constructive receipt? A: No, if you pick it before closing as part of the sale terms. After closing, the schedule is fixed and you have no right to change it, which is what preserves the deferral.

Q: Can I add a structured sale after the money is in escrow? A: No. Once you are entitled to the cash, redirecting it looks like receiving it and deferring it yourself. The structure must be in the purchase agreement or an addendum before closing.

Q: Is naming a beneficiary a problem? A: No. A beneficiary designation decides who gets remaining payments at death. It gives you no access to the money.

Q: What if the contract allowed early withdrawal on request? A: Then the balance would be available to you at any time, and under Treas. Reg. §1.451-2(a) it would be taxed as if received.

What should you read or run next?

• Can I speed up or borrow against the payments?
• When do I have to set it up, and how long does it take?
• Is a structured installment sale legal?
• Can a structured sale back up a failed 1031?
• Assignment company and §453 CPA guide
• Installment sale calculator
• All structured installment sale questions

Who wrote this?