Inherited Promissory Note from Parent's Business Sale - Tax Implications for Installment Sale

This is a complex situation with several moving parts. Let me address your questions one by one: Regarding distributing payments directly to beneficiaries: While your attorney's advice about real property passing directly to heirs is generally correct, a promissory note is considered personal property, not real property. The security interest (lien) on real property doesn't change the nature of what you inherited - which is the note itself. Technically, the note should have been part of the probate estate. However, since the estate has no debts and the beneficiaries are receiving what they would have received anyway, you likely don't need to recollect the funds. From a tax perspective, you should speak with your estate's accountant, but typically the income would be reported on either the estate's income tax return (Form 1041) or the beneficiaries' individual returns with a Schedule K-1 from the estate. Regarding step-up in basis: Unfortunately, you're correct in your understanding. Since the property was sold before death, what your father owned (and what you inherited) was the promissory note, not the property itself. The installment obligation doesn't receive a step-up in basis at death. The gain recognition continues as if your father were still receiving the payments. For reporting the income: You would report it as an installment sale, similar to how your father did. You'll need to determine your percentage of the note and report that portion of both the principal and interest. You'll report the gain portion of principal payments as capital gain (likely long-term) and the interest portion as ordinary income. I recommend consulting with a tax professional familiar with estates and installment sales to ensure everything is properly documented and reported.

I went through something very similar with my mom's estate last year. After weeks of confusion and conflicting advice, I found an amazing service that cleared everything up - https://taxr.ai - they specialize in analyzing complex tax documents and providing clear guidance. In my case, I uploaded my mom's promissory note, prior year tax returns, and the estate documents. Their analysis showed that in my state (different from yours), the installment note DID get a partial basis adjustment. I was originally going to overpay by thousands because I didn't understand how to calculate the adjusted basis portion correctly. The system showed me exactly how to report it on both the estate return and my personal return, and even explained how the transfer works once the estate closed. It was seriously like having a specialized tax attorney and accountant rolled into one, but way more affordable.

I was seriously skeptical about that taxr.ai site mentioned above, but I decided to try it after spending hours on the phone with three different CPAs getting conflicting advice about an inherited business interest. The system immediately identified that my situation involved Section 1014 basis issues and provided a detailed analysis with citations to relevant tax code. What really impressed me was that it flagged a special election that none of the CPAs had mentioned - something about alternate valuation dates that saved me a significant amount in capital gains. The documents they generated explaining my basis calculation would have cost me hundreds in billable hours from my attorney. For anyone dealing with complex inheritance tax situations, I'd definitely recommend giving it a try. Complete 180 from my initial skepticism.

When I was executor for my aunt's estate with a similar installment note situation, I ended up spending WEEKS trying to get someone at the IRS on the phone for guidance. After 12+ calls and hours on hold, I discovered Claimyr (https://claimyr.com). They have this system that gets you connected to an actual IRS representative, usually within 15-45 minutes instead of the typical 2+ hour wait or getting disconnected. I watched their demo video (https://youtu.be/_kiP6q8DX5c) and was skeptical but desperate enough to try. They actually got me through to an IRS estate tax specialist who walked me through exactly how to handle the promissory note tax reporting for both the estate and beneficiaries. The guidance was incredibly valuable and specific to my situation. The agent confirmed that in most cases, installment notes don't get full step-up treatment, but explained some specific exceptions I hadn't known about. Might be worth checking if any apply to your situation in WV.

I feel like I need to update my previous comment about Claimyr. After writing that skeptical reply, I was stuck in yet another IRS hold nightmare trying to resolve an inherited IRA distribution issue. After 4 disconnects and about 5 hours wasted over two days, I reluctantly tried the Claimyr service. To my genuine surprise, I got a call back in about 35 minutes saying I was connected to an IRS agent. They actually had an agent on the line! I was able to get my issue resolved in one call, and the agent even gave me her direct extension for follow-up questions. For anyone dealing with estate tax issues like the original poster, being able to actually speak with the IRS can make a huge difference. They walked me through the correct forms and even emailed me the relevant publication. Never thought I'd be saying this, but it was worth every penny just for the time saved and stress avoided.

One thing nobody has mentioned yet - if the property is in West Virginia but you're in North Carolina, you might have state tax complications too. I had a similar situation with property in Kentucky while living in Tennessee. For federal purposes, you're correct that the installment sale treatment continues after death. But check both states' rules on non-resident income. In my case, I had to file a non-resident return in Kentucky for the installment sale income since it was derived from property located there, even though I received the payments in Tennessee. Some states have special rules for income from installment sales of real property located within their borders.

Has anyone mentioned Form 6252 yet? You'll need to file this for the installment sale income. When I inherited part of my father's business note, I had to get a copy of his previous Form 6252 to see how he calculated the gross profit percentage. Also, don't forget that when you receive the 1099-INT from the payor for the interest portion, you need to make sure you're not double-reporting income. The interest goes on Schedule B, while the capital gain portion of each payment (calculated using the gross profit percentage) goes on the installment sale form.

Building on the excellent advice already given, I want to emphasize a few critical points that could save you significant headaches: First, regarding the estate vs. direct distribution issue - while technically the promissory note should have gone through probate as personal property, the practical impact may be minimal if beneficiaries are receiving their correct proportional shares. However, you should definitely consult with your estate attorney about whether to file a Form 1041 for the estate or issue K-1s to beneficiaries. This decision affects where the tax liability sits. Second, the step-up basis issue is unfortunately clear-cut - installment obligations don't receive step-up treatment under IRC Section 1014(c). The original sale created the installment obligation, and that's what was inherited, not the underlying property. Even with the security interest, you inherited the right to payments, not ownership of the real estate. For reporting, you'll need your father's final Form 6252 to determine the gross profit percentage that continues to apply. Each payment you receive will be split between: (1) return of basis (not taxable), (2) gain recognition (capital gains), and (3) interest (ordinary income). Given the multi-state complexity (NC/WV) and the estate administration questions, I'd strongly recommend getting professional help from a tax attorney or CPA experienced with installment sales and estate taxation. The potential tax savings from proper planning could easily justify the professional fees. One last note - make sure you're keeping detailed records of all payments received and how they're being distributed among beneficiaries. The IRS will want to see this documentation if they ever examine the returns.

I'm dealing with a somewhat similar situation right now with my mom's estate, and I wanted to share a few additional considerations that might help. One thing I learned from my estate attorney is that even though you've been distributing payments directly to beneficiaries, you might want to consider having the estate "adopt" those distributions retroactively through proper accounting entries. This can help establish a clear paper trail showing the estate received the income and then distributed it, which might be cleaner for tax reporting purposes. Also, regarding the WV/NC state tax issue - I'd definitely recommend checking if West Virginia has any special provisions for inherited installment obligations. Some states have different rules for inherited vs. original installment sales, and a few even provide partial basis adjustments in certain circumstances, though this is rare. From a practical standpoint, since you're the executor and dealing with monthly payments, consider setting up a dedicated estate account just for these transactions going forward. It makes the accounting much cleaner and gives you better documentation if the IRS ever questions the distributions. Have you considered whether it might make sense to accelerate the remaining payments or sell the note entirely? Sometimes the administrative burden and ongoing tax complexity of installment reporting makes it worth exploring other options, especially if the security interest gives you leverage with the buyer. The multi-state complexity alone probably justifies getting professional help, but don't let anyone tell you this is impossible to sort out - it's just a matter of getting the right guidance and documentation in place.