J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

5.26 Using Escrow and Other Security Arrangements

When you sell property on the installment basis, the remaining sales proceeds (plus interest) may be placed in an escrow account pending the possible occurrence of an event such as the approval of title or your performance of certain contractual conditions. If the escrow account is irrevocable or there are no escrow restrictions preventing you from receiving immediate payment, the IRS does not allow installment reporting. It considers the buyer’s obligation paid in full when the balance of the proceeds are deposited into the unrestricted escrow account. If in a year after the year of the installment sale an escrow account is set up as a substitute for unpaid notes or deeds of trust, the IRS considers the escrow funds as payment in full, assuming there are no substantial restrictions on your right to the proceeds.

EXAMPLES

1. Anderson sold stock and mining property for almost $5 million. He agreed to place $500,000 in escrow to protect the buyer against his possible breaches of warranty and to provide security for certain liabilities. The escrow agreement called for Anderson to direct the investments of the escrow fund and receive income from the fund in excess of $500,000.

The IRS claimed that in the year of sale Anderson was taxable on the $500,000 held in escrow on the ground that Anderson’s control of the fund rendered the fund taxable immediately. Anderson argued he was only taxable as the funds were released to him, and ...