Table of Contents
An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. If you realize a gain on an installment sale, you may be able to report part of your gain when you receive each payment. This method of reporting gain is called the installment method. You cannot use the installment method to report a loss. You can choose to report all of your gain in the year of sale.
-
The general rules that apply to using the installment method
-
Installment sale of a farm
Publication
-
523 Selling Your Home
-
535 Business Expenses
-
537 Installment Sales
-
538 Accounting Periods and Methods
-
544 Sales and Other Dispositions of Assets
Form (and Instructions)
-
4797 Sales of Business Property
-
6252 Installment Sale Income
See chapter 16 for information about getting publications and forms.
The installment sale of a farm for one overall price under a single contract is not the sale of a single asset. It generally includes the sale of real property and personal property reportable on the installment method. It may also include the sale of property for which you must maintain an inventory, which cannot be reported on the installment method. See Inventory , later. The selling price must be allocated to determine the amount received for each class of asset.
The tax treatment of the gain or loss on the sale of each class of assets is determined by its classification as a capital asset, as property used in the business, or as property held for sale and by the length of time the asset was held. (See chapter 8 for a discussion of capital assets and chapter 9 for a discussion of property used in the business.) Separate computations must be made to figure the gain or loss for each class of asset sold. See Sale of a Farm in chapter 8.
If you report the sale of property on the installment method, any depreciation recapture under section 1245 or 1250 of the Internal Revenue Code is generally taxable as ordinary income in the year of sale. See Depreciation recapture. , later. This applies even if no payments are received in that year.
An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. A farmer who is not required to maintain an inventory can use the installment method to report gain from the sale of property used or produced in farming. See Inventory , later, for information on the sale of farm property where inventory items are included in the assets sold.
If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method. See Electing out of the installment method , later, for information on recognizing the entire gain in the year of sale.
Each payment on an installment sale usually consists of the following three parts.
-
Interest income.
-
Return of your adjusted basis in the property.
-
Gain on the sale.
In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. You do not include in income the part that is the return of your basis in the property. Basis is the amount of your investment in the property for installment sale purposes.
-
A tax-free return of your adjusted basis in the property, and
-
Your gain (referred to as “installment sale income” on Form 6252).
1. | Enter the selling price for the property | ||
2. | Enter your adjusted basis for the property | ||
3. | Enter your selling expenses | ||
4. | Enter any depreciation recapture | ||
5. | Add lines 2, 3, and 4. This is your adjusted basis for installment sale purposes |
||
6. | Subtract line 5 from line 1. If zero or less, enter -0-. This is your gross profit |
||
If the amount entered on line 6 is zero, Stop here. You cannot use the installment method. | |||
7. | Enter the contract price for the property | ||
8. | Divide line 6 by line 7. This is your gross profit percentage |
-
Any money you are to receive.
-
The fair market value (FMV) of any property you are to receive (FMV is discussed at Property used as a payment under Payments Received or Considered Received ).
-
Any existing mortgage or other debt the buyer pays, assumes, or takes (a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property).
-
Any of your selling expenses the buyer pays.
-
Adjusted basis.
-
Selling expenses.
-
Depreciation recapture.
If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. See Depreciation Recapture Income in Publication 537.
-
The selling price, minus
-
The mortgages, debts, and other liabilities assumed or taken by the buyer, plus
-
The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes.
1. | Enter the reduced selling price for the property |
||
2. | Enter your adjusted basis for the property |
||
3. | Enter your selling expenses |
||
4. | Enter any depreciation recapture |
||
5. | Add lines 2, 3, and 4. | ||
6. | Subtract line 5 from line 1. This is your adjusted gross profit |
||
7. | Enter any installment sale income reported in prior year(s) |
||
8. | Subtract line 7 from line 6 | ||
9. | Future installments | ||
10. | Divide line 8 by line 9. This is your new gross profit percentage*. |
Example.
In 2009, you sold land with a basis of $40,000 for $100,000. Your gross profit was $60,000. You received a $20,000 down payment and the buyer's note for $80,000. The note provides for monthly payments of $1,953 each, figured at 8% interest, amortized over four years, beginning in 2010. Your gross profit percentage is 60%. You received total payments of $20,000.00 in 2009 and $23,436 in 2010. You reported a gain of $12,000 on the payment received in 2009 and $10,605 ($17,675 X 60% (.60)) in 2010.
In 2011, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2011, 2012, and 2013 are reduced to $1,483 a month amortized over the remaining three years.
The new gross profit percentage, 47.32%, is figured in Example — Worksheet 10-2 .
You will report a gain of $6,878 (47.32% of $14,535) in 2011, $7,449 (47.32% of $15,742) in 2012, and $8,067 (47.32% of $17,048) in 2013.
1. | Enter the reduced selling price for the property |
85,000 | |
2. | Enter your adjusted basis for the property |
40,000 | |
3. | Enter your selling expenses |
-0- | |
4. | Enter any depreciation recapture |
-0- | |
5. | Add lines 2, 3, and 4. | 40,000 | |
6. | Subtract line 5 from line 1. This is your adjusted gross profit |
45,000 | |
7. | Enter any installment sale income reported in prior year(s) |
22,605 | |
8. | Subtract line 7 from line 6 | 22,395 | |
9. | Future installments | 47,325 | |
10. | Divide line 8 by line 9. This is your new gross profit percentage*. |
47.32% |
chapter 9.
You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale.
In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. However, as discussed later, the buyer's assumption of your debt is treated as a recovery of basis, rather than as a payment, in many cases.
Example.
You sell property with an adjusted basis of $19,000. You have selling expenses of $1,000. The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 8% interest) in each of the next 4 years).
The selling price is $25,000 ($15,000 + $10,000). Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). The contract price is $10,000 ($25,000 − $15,000 mortgage). Your gross profit percentage is 50% ($5,000 ÷ $10,000). You report half of each $2,000 payment received as gain from the sale. You also report all interest you receive as ordinary income.
Example.
The selling price for your property is $9,000. The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Your adjusted basis in the property is $4,400. You have selling expenses of $600, for a total installment sale basis of $5,000. The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). This amount is included in the contract price and treated as a payment received in the year of sale. The contract price is $4,000:
Selling price | $9,000 | |
Minus: Mortgage | (6,000) | |
Amount actually received | $3,000 | |
Add difference: | ||
Mortgage | $6,000 | |
Minus: Installment sale basis | 5,000 | 1,000 |
Contract price | $4,000 |
Your gross profit on the sale is also $4,000:
-
Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes.
-
Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased.
-
The FMV of the property on the date you receive it if you use the cash method of accounting,
-
The face amount of the obligation on the date you receive it if you use an accrual method of accounting, or
-
The stated redemption price at maturity less any original issue discount (OID) or, if there is no OID, the stated redemption price at maturity appropriately discounted to reflect total unstated interest. See Unstated interest , later.
Example.
You sold real estate in an installment sale. As part of the down payment, the buyer assigned to you a $50,000, 8% third-party note. The FMV of the third-party note at the time of the sale was $30,000. This amount, not $50,000, is a payment to you in the year of sale. The third-party note had an FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable return of capital. The remaining 40% is interest taxed as ordinary income.
-
The contract price is reduced by the FMV of the like-kind property received in the trade.
-
The gross profit is reduced by any gain on the trade that can be postponed.
-
Like-kind property received in the trade is not considered payment on the installment obligation.
Example.
You sell property at a contract price of $6,000 and your gross profit is $1,500. Your gross profit percentage is 25% ($1,500 ÷ $6,000). After subtracting interest, you report 25% of each payment, including the down payment, as installment sale income from the sale for the tax year you receive the payment. The remainder (balance) of each payment is the tax-free return of your adjusted basis.
On January 3, 2011, you sold your farm, including the home, farm land and buildings. You received $50,000 down and the buyer's note for $200,000. In addition, the buyer assumed an outstanding $50,000 mortgage on the farm land. The total selling price was $300,000. The note payments of $25,000 each, plus adequate interest, are due every July 1 and January 1, beginning in July 2011. Your selling expenses were $15,000.
If you sell depreciable business property, prepare Form 4797 first in order to figure the amount to enter on line 12 of Part I, Form 6252.
Selling price | $190,000 |
Minus: Installment basis | (108,740) |
Gross profit | $81,260 |
Gain reported in 2011 (year of sale) | $35,778 |
Gain reported in 2012: | |
$50,000 × 47.70% | 23,850 |
Gain reported in 2013: | |
$50,000 × 47.70% | 23,850 |
Gain reported in 2014: | |
$50,000 × 47.70% | 23,850 |
Gain reported in 2015: | |
$25,000 × 47.70% | 11,925 |
Total gain reported | $119,253 |
More Online Publications |