General Rules(p2)

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 under Other Rules, later, for information on recognizing the entire gain in the year of sale.

If your sale results in a loss, you cannot use the installment method. If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale.

If your sale calls for payments in a later year and the sales contract provides for little or no interest, you may have to figure unstated interest, even if you have a loss. See Unstated Interest and Original Issue Discount (OID) under Other Rules, later.

You can use the following discussions or Form 6252 to help you determine gross profit, contract price, gross profit percentage, and installment sale income.

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.

You must report interest as ordinary income. Interest is generally not included in a down payment. However, you may have to treat part of each later payment as interest, even if it is not called interest in your agreement with the buyer. Interest provided in the agreement is called stated interest. If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. See Unstated Interest and Original Issue Discount (OID) under Other Rules, later.

After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if it were made up of two parts.

• A tax-free return of your adjusted basis in the property, and
• Your gain (referred to as installment sale income on Form 6252).

You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. When you have completed the worksheet, you will also have determined the gross profit percentage necessary to figure your installment sale income (gain) for this year.

The selling price is the total cost of the property to the buyer and includes any of the following.

• Any money you are to receive.
• The fair market value (FMV) of any property you are to receive (FMV is discussed in Property Used As a Payment under Other Rules, later).
• 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.

Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount.

Your adjusted basis is the total of the following three items.

• Adjusted basis.
• Selling expenses.
• Depreciation recapture.

Basis is your investment in the property for installment sale purposes. The way you figure basis depends on how you acquire the property. The basis of property you buy is generally its cost. The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently.

While you own property, various events may change your original basis. Some events, such as adding rooms or making permanent improvements, increase basis. Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. The result is adjusted basis.

For more information on how to figure basis and adjusted basis, see Publication 551. For more information regarding your basis in property you inherited from someone who died in 2010 and whose executor filed Form 8939, see Publication 4895.

Selling expenses relate to the sale of the property. They include commissions, attorney fees, and any other expenses paid on the sale. Selling expenses are added to the basis of the sold property.

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 under Other Rules, later.

Gross profit is the total gain you report on the installment method.

To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. If the property you sold was your home, subtract from the gross profit any gain you can exclude. See Sale of Your Home, later, under Reporting Installment Sale Income.

Contract price equals:

1. The selling price, minus
2. The mortgages, debts, and other liabilities assumed or taken by the buyer, plus
3. The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes.

A certain percentage of each payment (after subtracting interest) is reported as installment sale income. This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price.

The gross profit percentage generally remains the same for each payment you receive. However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes.

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.

Multiply the payments you receive each year (less interest) by the gross profit percentage. The result is your installment sale income for the tax year. In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. For a detailed discussion, see Payments Received or Considered Received under Other Rules, later.

If the selling price is reduced at a later date, the gross profit on the sale also will change. You then must refigure the gross profit percentage for the remaining payments. Refigure your gross profit using Worksheet B. You will spread any remaining gain over future installments.

In 2010, 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 four annual payments of $20,000 each, plus 8% interest, beginning in 2011. Your gross profit percentage is 60%. You reported a gain of $12,000 on each payment received in 2010 and 2011.

In 2012, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2012, 2013, and 2014 are reduced to $15,000 for each year.

The new gross profit percentage, 46.67%, is figured on Worksheet B.

You will report a gain of $7,000 (46.67% of $15,000) on each of the $15,000 installments due in 2012, 2013, and 2014.

Generally, you will use Form 6252 to report installment sale income from casual sales of real or personal property during the tax year. You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. See Schedule D (Form 1040) and Form 4797, later. If the property was your main home, you may be able to exclude part or all of the gain. See Sale of Your Home, later.

Use Form 6252 to report an installment sale in the year it takes place and to report payments received, or considered received because of related party resales, in later years. Attach it to your tax return for each year.

Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income.

Which part to complete depends on whether you are filing the form for the year of sale or a later year.

Complete lines 1 through 4, Part I, and Part II. If you sold property to a related party during the year, also complete Part III.

Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale.

If you sold a marketable security to a related party after May 14, 1980, and before January 1, 1987, complete Form 6252 for each year of the installment agreement, even if you did not receive a payment. (After December 31, 1986, the installment method is not available for the sale of marketable securities.) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Complete Part III unless you received the final payment during the tax year.

If you sold property other than a marketable security to a related party after May 14, 1980, complete Form 6252 for the year of sale and for 2 years after the year of sale, even if you did not receive a payment. Complete lines 1 through 4 and Part II for any year during this 2-year period in which you receive a payment from the sale. Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year.

Enter the gain figured on Form 6252 (line 26) for personal-use property (capital assets) on Schedule D (Form 1040), as a short-term gain (line 4) or long-term gain (line 11). If your gain from the installment sale qualifies for long-term capital gain treatment in the year of sale, it will continue to qualify in later tax years. Your gain is long-term if you owned the property for more than 1 year when you sold it.

An installment sale of property used in your business or that earns rent or royalty income may result in a capital gain, an ordinary gain, or both. All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. For trade or business property held for more than 1 year, enter the amount from line 26 of Form 6252 on Form 4797, line 4. If the property was held 1 year or less or you have an ordinary gain from the sale of a noncapital asset (even if the holding period is more than 1 year), enter this amount on Form 4797, line 10, and write "From Form 6252."

If you sell your home, you may be able to exclude all or part of the gain on the sale. See Publication 523 for information about excluding the gain. If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage.

If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures.

When you report interest income received from a buyer who uses the property as a personal residence, write the buyer's name, address, and social security number (SSN) on line 1 of Schedule B (Form 1040A or 1040), Interest and Ordinary Dividends.

When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions.

If either person fails to include the other person's SSN, a $50 penalty will be assessed.