For certain dispositions under the installment method, if an installment obligation is pledged as security on a debt; the net proceeds of the secured debt are treated as payment on the installment obligation. However, the amount treated as payment may not exceed the excess of the total installment contract price over any payments received under the contract before the secured debt was obtained.
An installment obligation is pledged as security on a debt to the extent that payment of principal and interest on the debt is directly secured by an interest in the installment obligation. For sales after December 16, 1999, payment on a debt is treated as directly secured by an interest in an installment obligation to the extent an arrangement allows you to satisfy all or part of the debt with the installment obligation.
The pledge rule applies to any installment sale after 1988 with a sales price of over $150,000 except:
- Personal use property disposed of by an individual,
- Farm property, and
- Timeshares and residential lots.
However, the pledge rule does not apply to pledges made after December 17, 1987, if the debt is incurred to refinance the principal amount of a debt that was outstanding on December 17, 1987, and was secured by nondealer real property installment obligations on that date and at all times after that date until the refinancing. This exception does not apply to the extent that the principal amount of the debt resulting from the refinancing exceeds the principal amount of the refinanced debt immediately before the refinancing. Also, the pledge rule does not affect refinancing due to the calling of a debt by the creditor if the debt is then refinanced by a person other than this creditor or someone related to the creditor.
See Publication 537 at www.IRS.gov for more information