Timeshare seller could not choose a separate AFR for each payment

Plain-English summary

A timeshare developer financed customer purchases and reported the sales under the special installment method for timeshare dealers. IRC § 453(l)(3) required it to add interest to its tax liability as installment payments were received. The taxpayer asked to select a separate applicable federal rate for each payment based on the time from sale to that payment. The IRS rejected that approach because the customer note was itself an installment obligation with partial principal payments before maturity. The applicable federal rate had to be selected using the note's weighted average maturity as its term under the § 1274 regulations.

Ruling snapshot

• Question: Could the timeshare seller determine a separate applicable federal rate for each installment payment?
• Outcome: Denied, the rate must use the obligation's weighted average maturity
• Key authorities: IRC §§ 453(l)(3), 1273, and 1274; Treas. Reg. §§ 1.1273-1(e) and 1.1274-4

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201622007                                             Third Party Communication: None
Release Date: 5/27/2016                                       Date of Communication: Not Applicable
Index Number: 453.13-01
                                                              Person To Contact:
----------------------                                        -------------------, ID No. ----------------
-------------------                                           Telephone Number:
-------------------------------------------------------       --------------------
-----------------------                                       Refer Reply To:
----------------------------------------------                CC:ITA:B04
 -------------------------------                              PLR-128319-15
                                                              Date:
                                                              February 22, 2016




LEGEND

Taxpayer          = --------------------------------------------------------------
                  ---------------------------------------------

B                 = ---



Dear -------------:

This is in reply to Taxpayer’s request for a private letter ruling that in determining the
calculated interest under § 453(l)(3) of the Internal Revenue Code for an installment
obligation, the Taxpayer will use an applicable Federal rate (AFR) determined
separately for each payment due under the installment obligation rather than a single
AFR based on the term of the obligation.

FACTS

Taxpayer develops, markets, sells, and manages timeshares and related products.
Taxpayer generates most of its revenues from four primary sources, including selling
timeshare interests, and financing consumer purchases of timeshare interests.
Taxpayer sells timeshare interests for a fixed purchase price that is either paid in full at
closing, or financed with a loan provided by Taxpayer. Financing typically involves a
loan with a period of B years, with payments due on a monthly basis.

Taxpayer recognizes income associated with its financed timeshare sales using the
installment method under § 453(l)(2)(B). In accordance with § 453(l)(3), Taxpayer
increases its federal income tax liability each year a payment is received on the
PLR-128319-15                                2

installment obligation (other than the year of sale) by an amount of calculated interest.
The amount of the calculated interest is determined based on the amount of tax due for
the year that is attributable to the payments on the installment obligation received during
the year from the date of sale to the date of each payment received, by using the
applicable Federal rate (AFR) under § 1274 in effect at the time of the sale.

Taxpayer requests a ruling that in computing interest under § 453(l)(3), Taxpayer will
use an AFR determined separately for each payment due under the installment
obligation, based on the time period between the date of sale and the date of each
payment.

LAW AND ANALYSIS

Section 453(a) of the Internal Revenue Code provides that, except as otherwise
provided in this section, income from an installment sale shall be taken into account for
purposes of this title under the installment method.

Section 453(b)(1) defines the term “installment sale” to mean a disposition of property
where at least one payment is to be received after the close of the taxable year in which
the disposition occurs.

Section 453(b)(2)(A) states that dealer dispositions do not qualify as installment sales.
Dealer dispositions of real property are defined in § 453(l)(1)(B) as any disposition of
real property which is held by the taxpayer for sale to customers in the ordinary course
of the taxpayer’s trade or business. Section 453(l)(2)(B), which provides an exception
to this rule specific to timeshares, excludes sales of timeshares from the definition of
dealer dispositions if the taxpayer elects to apply § 453(l)(3). Timeshare sales include
the sale of a timeshare right to use or a timeshare ownership interest in residential real
property for not more than 6 weeks per year.

Section 453(l)(3)(A) requires that a taxpayer increase its tax liability for a year in which
an installment payment is received by an amount of interest. Section 453(l)(3)(B)
provides that the amount of interest referred to in subparagraph (A) for any taxable year
shall be determined –
       (I) on the amount of the tax for such taxable year which is attributable to the
payments received during such taxable year on installment obligations to which this
subsection applies,
       (II) for the period beginning on the date of sale, and ending on the date such
payment is received, and
       (III) by using the applicable Federal rate under section 1274 (without regard to
subsection (d)(2) thereof) in effect at the time of the sale compounded semiannually.

Section 1274(d)(1) provides that, for purposes of section 1274, the applicable Federal
rate (“AFR”) in the case of a debt instrument with a term not over 3 years is the Federal
PLR-128319-15                                3

short-term rate; the AFR in the case of a debt instrument with a term over 3 years but
not over 9 years is the Federal mid-term rate; and the AFR in the case of a debt
instrument with a term over 9 years is the Federal long-term rate.

Section 1.1274-4(b) of the Income Tax Regulations provides that, except as otherwise
provided in Section 1.1274-4, the AFR for a debt instrument is based on the term of the
instrument (i.e., short-term, mid-term, or long-term). Section 1.1274-4(c) provides that if
a debt instrument is an installment obligation (as defined in section 1.1273-1(e)(1)), the
term of the instrument is the instrument's weighted average maturity (as defined in
section 1.1273-1(e)(3)).

Section 1.1273-1(e)(1) states that an installment obligation is a debt instrument that
provides for the payment of any amount other than qualified stated interest before
maturity. For example, an installment obligation is a debt instrument that provides for
one or more partial principal payments.

Section 1.1273-1(e)(3) states that the weighted average maturity of a debt instrument is
the sum of the following amounts determined for each payment under the instrument
(other than a payment of qualified stated interest): (i) the number of complete years
from the issue date until the payment is made; multiplied by (ii) a fraction, the numerator
of which is the amount of the payment and the denominator of which is the debt
instrument's stated redemption price at maturity.

In determining the AFR to be used under § 453(l)(3)(B)(i)(III) to determine the amount of
calculated interest for any taxable year, the seller must first determine the term of the
installment obligation between the buyer and the seller. Here, the obligation between
the buyer and seller is an installment obligation under § 1.1273-1(e)(1) because the
obligation provides for partial principal payments before maturity. As a result, the
weighted average maturity of such obligation must be determined under § 1.1273-
1(e)(3). The AFR to be used under § 453(l)(3)(B)(i)(III) to calculate the amount of
interest for any taxable year is determined under § 1274(d)(1) by treating such weighted
average maturity as the term of the installment obligation.

CONCLUSION

Based strictly on the information submitted and representations made, we conclude that
the AFR to be used under § 453(l)(3)(B)(i)(III) to calculate the amount of interest for a
taxable year is determined under § 1274(d)(1) by treating such weighted average
maturity as the term of the installment obligation.

This letter ruling is directed only to the taxpayer requesting it, and does not express or
imply an opinion on the federal tax consequences of any aspect of this transaction other
than that expressed in the preceding sentence. Section 6110(k)(3) provides that this
letter ruling may not be used or cited as precedent.
PLR-128319-15                                 4


The rulings contained in this letter are based upon information and representations that
Taxpayer submitted under penalties of perjury. While this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

Taxpayer must attach to any income tax return to which it is relevant a copy of this letter
or, if it files its returns electronically, include a statement providing the date and control
number of this letter ruling.

In accordance with the Power of Attorney on file with this office, we are sending a copy
of this letter to your authorized representative.


                                           Sincerely,



                                           Shareen S. Pflanz
                                           Senior Technician Reviewer, Branch 5
                                           Office of Associate Chief Counsel
                                           (Income Tax & Accounting)