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Taxpayer Improperly Used Installment Method to Report Mobile Home Sales

(Parker Tax Publishing January 2020)

The Tax Court held that a seller of land and mobile homes that provided financing to mobile home buyers improperly used the installment method under Code Sec. 453 because the taxpayer was a dealer of mobile homes. However, the court also held that the taxpayer was not required to include the notes it received in the sales in income because the notes were not cash equivalents and had no fair market value. Joyner Family Limited Partnership v. Comm'r, T.C. Memo. 2019-159.


Gary and Janel Joyner own the Joyner Family Limited Partnership (JFLP), an Arkansas business that sells land and mobile homes. JFLP offered affordable housing to low income buyers with poor credit and unstable employment histories who could not obtain traditional financing to purchase homes. Mr. Joyner determined the amount of the monthly payment based on what the customer could afford, and monthly payments ranged from $100 to $700. For each sale, JFLP executed a purchase agreement and a note. The agreement stated the sale price, the monthly payment amount, and the interest rate. JFLP typically did not collect down payments because the buyers could not afford to make them. JFLP retained legal title until the buyer paid the full sale price.

Usually JFLP would allow buyers to miss multiple payments before asking the buyers to vacate the property and at times allowed extended periods of missed payments if the buyers were in financial distress. When a buyer defaulted, JFLP never tried to collect the unpaid balance after the default, and it is unlikely that it could have done so given the typical buyer's financial situation. JFLP simply retook possession of the mobile home and offered it for sale or rent. There was no expectation by the buyers that they were indebted to JFLP for the full sale prices despite signing the notes. The buyers understood that the notes would not be enforced. JFLP also allowed buyers to convert their sales to rentals, effectively nullifying the notes. It even allowed buyers to convert to rentals after they had already defaulted on their notes. In addition, JFLP had outstanding mortgages on its land and sold lots subject to the mortgages.

Under Code Sec. 453, a seller that qualifies to use the installment method can defer gain recognition over the period of the installment payments rather than being taxed on the entire gain in the year of the sale or on the receipt of a debt instrument evidencing the installment sale. A dealer of real property cannot use the installment method, but a seller of unimproved residential property is excepted from the definition of a dealer and is permitted to use the installment method. When a cash method seller that does not use the installment method receives a debt instrument entitling it to a future income stream, the debt instrument is included in income if it the equivalent of cash. A note is a cash equivalent if the holder can sell it for an immediate cash value, even if that cash value is less than the notes' face value.

JFLP filed tax returns for 2010-2012 on which it checked the box indicating that it used the cash method of accounting. JFLP reported both its land-only and mobile home sales using the Code Sec. 453 installment method. JFLP did not report income from the receipt of the notes it received as payment for the mobile homes, but instead reported income as it received payments on the notes. In a notice of final partnership administrative adjustment (FPAA), the IRS asserted that JFLP was a dealer and therefore improperly used the installment method. The IRS also asserted that JFLP had to report the full face value of the notes in the year it received them. JFLP petitioned the Tax Court and after a trial, the IRS filed a brief in which it argued for the first time that JFLP was required to use the accrual method of accounting. JFLP conceded that it was a dealer with respect to the mobile home sales, but argued that the IRS did not timely exercise its authority to change JFLP's method of accounting. JFLP also argued that the IRS abused its discretion in determining that JFLP had to report income on receipt of the notes. According to JFLP, the notes were not marketable because of JFLP's business practices, including the lack of credit checks and the buyers' inability to obtain bank loans, the high default rates, and JFLP's outstanding mortgages on the land.

Tax Court's Analysis

The Tax Court found that JFLP was not a dealer with respect to its land-only sales because it did not make improvements to the lots, and therefore JFLP properly used the installment method to report those sales. However, as to JFLP's mobile home sales, the Tax Court noted that JFLP conceded that it was a dealer and therefore improperly reported those sales under Code Sec. 453. The court found that use of the installment method by a dealer was statutorily proscribed for JFLP and an industry standard could not condone the use of a method of accounting that was expressly prohibited by the Code. The Tax Court also found that the IRS did not timely exercise its authority to change JFLP's overall method of accounting to the accrual method and agreed with JFLP the IRS should be precluded from making the change on the basis of fairness and surprise. The court noted that the IRS did not assert in the FPAA that JFLP's cash method did not clearly reflect income, nor did it assert that position in its amended answer to JFLP's petition. The court explained that a taxpayer's entitlement to use the installment method does not depend on whether the method clearly reflects income, and the court therefore concluded that JFLP was unfairly surprised and prejudiced by the IRS's new position.

Next, the Tax Court found that JFLP did not have income on receipt of the notes because they were not cash equivalents. In the court's view, it was clear that JFLP could not have sold the notes or, if it had, the sale would have been at a deep discount. The court noted the financial risk posed by JFLP's customers, as well as the fact that JFLP did not perform credit checks - which made it difficult to determine the likelihood that any individual buyer would default. The court also observed that the notes did not state the number of payments required to pay the notes in full or the length of time it would take to pay them off. In addition, the court found that most of the buyers defaulted on the notes. According to the court, JFLP's business practices, including allowing buyers to miss multiple payments, further affected the marketability of the notes. The court noted that for the typical JFLP buyer, there was no reasonable expectation of full payment. Thus, the court concluded that there was no market for JFLP to sell the notes, and the notes were therefore not the equivalent of cash. The court concluded that the IRS's adjustments would result in more than $8 million of income to JFLP, which was far in excess of its actual cash receipts. The court said it was clear that JFLP did not generate sufficient receipts during the years at issue to pay the tax asserted as due, nor could it sell the notes.

For a discussion of the exclusion from the installment sale method for dealer dispositions, see Parker Tax ¶244,565.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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