Publication 537
taxmap/pubs/p537-002.htm#en_us_publink1000221633The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. The following topics are discussed.
- Electing out of the installment method.
- Payments received or considered received.
- Escrow account.
- Depreciation recapture income.
- Sale to a related person.
- Like-kind exchange.
- Contingent payment sale.
- Single sale of several assets.
- Sale of a business.
- Unstated interest and original issue discount.
- Disposition of an installment obligation.
- Repossession.
- Interest on deferred tax.
If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you do not receive all the sale proceeds in that
year.
To figure the amount of gain to report, use the fair market value (FMV) of the buyer's installment obligation that represents the buyer's debt to you. Notes, mortgages, and land contracts are examples of obligations that are included at FMV.
You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. If you use the cash method of accounting, the FMV of the obligation will never be considered to be less than the FMV of the property sold (minus any other consideration received).
taxmap/pubs/p537-002.htm#en_us_publink1000221635You sold a parcel of land for $50,000. You received a $10,000 down payment and will receive the balance over the next 10 years at $4,000 a year, plus 8% interest. The buyer gave you a note for $40,000. The note had an FMV of $40,000. You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. The land cost $25,000, and you owned it for more than one year. You decide to elect out of the installment method and report the entire gain in the year of sale.
| Gain realized: | | |
| Selling price | $50,000 |
| Minus: | Property's adj. basis | $25,000 | |
| | Commission | 3,000 | 28,000 |
| Gain realized | $22,000 |
| Gain recognized in year of sale: | |
| Cash | $10,000 |
| Market value of note | 40,000 |
| Total realized in year of sale | $50,000 |
| Minus: | Property's adj. basis | $25,000 | |
| | Commission | 3,000 | 28,000 |
| Gain recognized
| $22,000 |
The recognized gain of $22,000 is long-term capital gain. You include the entire gain in income in the year of sale, so you do not include in income any principal payments you receive in later tax years. The interest on the note is ordinary income and is reported as interest income each year.
taxmap/pubs/p537-002.htm#en_us_publink1000221637To make this election, do not report your sale on Form 6252. Instead, report it on Form 8949, Form 4797, or both.
taxmap/pubs/p537-002.htm#en_us_publink1000221638Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place.
taxmap/pubs/p537-002.htm#en_us_publink1000221639If you timely file your tax return without making the election, you still can make the election by filing an amended return within 6 months of the due date of your return (excluding extensions). Write "Filed pursuant to section 301.9100-2" at the top of the amended return and file it where the original return was filed.
taxmap/pubs/p537-002.htm#en_us_publink1000221640Once made, the election can be revoked only with IRS approval. A revocation is retroactive. You will not be allowed to revoke the election if either of the following applies.
- One of the purposes is to avoid federal income tax.
- The tax year in which any payment was received has closed.
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 your basis rather than as a payment in many
cases.
taxmap/pubs/p537-002.htm#en_us_publink1000221642If the buyer pays any of your expenses related to the sale of your property, it is considered a payment to you in the year of sale. Include these expenses in the selling and contract prices when figuring the gross profit percentage.
taxmap/pubs/p537-002.htm#en_us_publink1000221643If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules
apply.
taxmap/pubs/p537-002.htm#en_us_publink1000221644If the buyer assumes a mortgage that is not more than your installment sale basis in the property, it is not considered a payment to you. It is considered a recovery of your basis. The contract price is the selling price minus the mortgage.
taxmap/pubs/p537-002.htm#en_us_publink1000221645You 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 12% 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.
taxmap/pubs/p537-002.htm#en_us_publink1000221646If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. The part of the mortgage greater than your basis is treated as a payment received in the year of sale.
To figure the contract price, subtract the mortgage from the selling price. This is the total amount (other than interest) you will receive directly from the buyer. Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). The contract price is then the same as your gross profit from the
sale.
 | If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be
100%. |
taxmap/pubs/p537-002.htm#en_us_publink1000221648The 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:
| Selling price | $9,000 |
| Minus: Installment sale basis | (5,000) |
| Gross profit | $4,000 |
Your gross profit percentage is 100%. Report 100% of each payment (less interest) as gain from the sale. Treat the $1,000 difference between the mortgage and your installment sale basis as a payment and report 100% of it as gain in the year of
sale.
taxmap/pubs/p537-002.htm#en_us_publink1000221651If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. You are considered to receive a payment equal to the outstanding canceled
debt.
taxmap/pubs/p537-002.htm#en_us_publink1000221652Mary Jones loaned you $45,000 in 2008 in exchange for a note mortgaging a tract of land you owned. On April 4, 2012, she bought the land for $70,000. At that time, $30,000 of her loan to you was outstanding. She agreed to forgive this $30,000 debt and to pay you $20,000 (plus interest) on August 1, 2012, and $20,000 on August 1, 2013. She did not assume an existing mortgage. She canceled the $30,000 debt you owed her. You are considered to have received a $30,000 payment at the time of the
sale.
taxmap/pubs/p537-002.htm#en_us_publink1000221653If the buyer assumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of
sale.
If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Compare the debt to your installment sale basis in the property being sold. If the debt is less than your installment sale basis, none of it is treated as a payment. If it is more, only the difference is treated as a payment. If the buyer assumes more than one debt, any part of the total that is more than your installment sale basis is considered a payment. These rules are the same as the rules discussed earlier under
Buyer Assumes Mortgage. However, they apply only to the following types of debt the buyer assumes.
- 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.
If the buyer assumes any other type of debt, such as a personal loan or your legal fees relating to the sale, it is treated as if the buyer had paid off the debt at the time of the sale. The value of the assumed debt is then considered a payment to you in the year of sale.
taxmap/pubs/p537-002.htm#en_us_publink1000221654If you receive property rather than money from the buyer, it is still considered a payment in the year received. However, see
Like-Kind Exchange, later.
Generally, the amount of the payment is the property's FMV on the date you receive it.
taxmap/pubs/p537-002.htm#en_us_publink1000221655If the property the buyer gives you is payable on demand or readily tradable, the amount you should consider as payment in the year received
is:
- 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 the 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 and Original Issue Discount (OID), later.
Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. This is true even if the debt is guaranteed by a third party, including a government agency.
taxmap/pubs/p537-002.htm#en_us_publink1000221657This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of all the necessary facts.
taxmap/pubs/p537-002.htm#en_us_publink1000221658If the property the buyer gives you is a third-party note (or other obligation of a third party), you are considered to have received a payment equal to the note's FMV. Because the FMV of the note is itself a payment on your installment sale, any payments you later receive from the third party are not considered payments on the sale. The excess of the note's face value over its FMV is interest. Exclude this interest in determining the selling price of the property. However, see
Exception under
Property Used As a Payment, earlier.
You sold real estate in an installment sale. As part of the down payment, the buyer assigned to you a $50,000, 8% interest 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.
taxmap/pubs/p537-002.htm#en_us_publink1000221660A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. For more information on the amount you should treat as a payment, see
Exception under
Property Used As a Payment, earlier.
If you receive a government or corporate bond for a sale before October 22,
2004, and the bond has interest coupons attached or can be readily traded in an
established securities market, you are considered to have received payment equal
to the bond's FMV. However, see
Exception under
Property Used As a Payment, earlier.
The buyer's note (unless payable on demand) is not considered payment on the sale. However, its full face value is included when figuring the selling price and the contract price. Payments you receive on the note are used to figure your gain in the year received.
taxmap/pubs/p537-002.htm#en_us_publink1000221662If you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation. This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. It does not apply to the following dispositions.
- Sales of property used or produced in farming.
- Sales of personal-use property.
- Qualifying sales of time-shares and residential lots.
The net debt proceeds are the gross debt minus the direct expenses of getting the debt. The amount treated as a payment is considered received on the later of the following dates.
- The date the debt becomes secured.
- The date you receive the debt proceeds.
A debt is secured by an installment obligation to the extent that payment of principal or interest on the debt is directly secured (under the terms of the loan or any underlying arrangement) by any 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.
taxmap/pubs/p537-002.htm#en_us_publink1000221663The net debt proceeds treated as a payment on the pledged installment obligation cannot be more than the excess of item (1) over item (2), below.
- The total contract price on the installment sale.
- Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment.
The pledge rule accelerates the reporting of the installment obligation payments. Do not report payments received on the obligation after it has been pledged until the payments received exceed the amount reported under the pledge rule.
taxmap/pubs/p537-002.htm#en_us_publink1000221665The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances.
- The debt was outstanding on December 17, 1987.
- The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing
occurred.
A refinancing as a result of the creditor's calling of the debt is treated as a continuation of the original debt so long as a person other than the creditor or a person related to the creditor provides the refinancing.
This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Any excess is treated as a payment on the installment obligation.
taxmap/pubs/p537-002.htm#en_us_publink1000221666In some cases, the sales agreement or a later agreement may call for the buyer to establish an irrevocable escrow account from which the remaining installment payments (including interest) are to be made. These sales cannot be reported on the installment method. The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement.
taxmap/pubs/p537-002.htm#en_us_publink1000221667You sell property for $100,000. The sales agreement calls for a down payment of $10,000 and payment of $15,000 in each of the next 6 years to be made from an irrevocable escrow account containing the balance of the purchase price plus interest. You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. You report the entire gain in the year of
sale.
taxmap/pubs/p537-002.htm#en_us_publink1000221668If you make an installment sale and in a later year an irrevocable escrow account is established to pay the remaining installments plus interest, the amount placed in the escrow account represents payment of the balance of the installment obligation.
taxmap/pubs/p537-002.htm#en_us_publink1000221669If an escrow arrangement imposes a substantial restriction on your right to receive the sale proceeds, the sale can be reported on the installment method, provided it otherwise qualifies. For an escrow arrangement to impose a substantial restriction, it must serve a
bona fide
purpose of the buyer, that is, a real and definite restriction placed on the
seller or a specific economic benefit conferred on the buyer.
taxmap/pubs/p537-002.htm#en_us_publink1000221670If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. The recapture income is also included in Part I of Form 6252. However, the gain equal to the recapture income is reported in full in the year of the sale. Only the gain greater than the recapture income is reported on the installment method. For more information on depreciation recapture, see chapter 3 in Publication
544.
The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. Determining gross profit is discussed under
General Rules, earlier.
If you sell depreciable property to a related person and the sale is an installment sale, you may not be able to report the sale using the installment method. If you sell property to a related person and the related person disposes of the property before you receive all payments with respect to the sale, you may have to treat the amount realized by the related person as received by you when the related person disposes of the property. These rules are explained under
Sale of Depreciable Property and under
Sale and Later Disposition, later.
If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Instead, all payments to be received are considered received in the year of sale. However, see
Exception, below. Depreciable property for this rule is any property the purchaser can depreciate.
Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount.
In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income.
taxmap/pubs/p537-002.htm#en_us_publink1000221673You can use the installment method to report a sale of depreciable property to a related person if no significant tax deferral benefit will be derived from the sale. You must show to the satisfaction of the IRS that avoidance of federal income tax was not one of the principal purposes of the sale.
taxmap/pubs/p537-002.htm#en_us_publink1000221674Related persons include the following.
- A person and all controlled entities with respect to that
person.
- A taxpayer and any trust in which such taxpayer (or his spouse) is a beneficiary, unless that beneficiary's interest in the trust is a remote contingent
interest.
- Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of that
estate.
- Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits
interests.
For information about which entities are controlled entities, see section
1239(c).
taxmap/pubs/p537-002.htm#en_us_publink1000221675Generally, a special rule applies if you sell or exchange property to a related person on the installment method (first disposition) who then sells, exchanges, or gives away the property (second disposition) under the following circumstances.
- The related person makes the second disposition before making all payments on the first
disposition.
- The related person disposes of the property within 2 years of the first disposition. This rule does not apply if the property involved is marketable
securities.
Under this rule, you treat part or all of the amount the related person realizes (or the FMV if the disposed property is not sold or exchanged) from the second disposition as if you received it at the time of the second disposition.
Related persons include the following.
- Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal
descendants.
- A partnership or estate and a partner or beneficiary.
- A trust (other than a section 401(a) employees trust) and a
beneficiary.
- A trust and an owner of the trust.
- Two corporations that are members of the same controlled group as defined in section
267(f).
- The fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both
trusts.
- A tax-exempt educational or charitable organization and a person (if an individual, including members of the individual's family) who directly or indirectly controls such an
organization.
- An individual and a corporation when the individual owns, directly or indirectly, more than 50% of the value of the outstanding stock of the
corporation.
- A fiduciary of a trust and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the
corporation.
- The grantor and fiduciary, and the fiduciary and beneficiary, of any
trust.
- Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each
corporation.
- An S corporation and a corporation that is not an S corporation if the same persons own more than 50% in value of the outstanding stock of each
corporation.
- A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the
partnership.
- An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary
bequest.
Example 1.(p7)
In 2011, Harvey Green sold farm land to his son Bob for $500,000, which was to be paid in five equal payments over 5 years, plus adequate stated interest on the balance due. His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). He received $100,000 in 2011 and included $50,000 in income for that year ($100,000 × 0.50). Bob made no improvements to the property and sold it to Alfalfa Inc., in 2012 for $600,000 after making the payment for that year. The amount realized from the second disposition is $600,000. Harvey figures his installment sale income for 2012 as follows:
| Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first
disposition | $500,000 |
| Subtract: Sum of payments from Bob in 2011 and 2012 | - 200,000 |
| Amount treated as received because of second disposition | $300,000 |
| Add: Payment from Bob in 2012 | + 100,000 |
| Total payments received and treated as received for 2012 | $400,000 |
| Multiply by gross profit % | × .50 |
| Installment sale income for 2012 | $200,000 |
Harvey will not include in his installment sale income any principal payments he receives on the installment obligation for 2013, 2014, and 2015 because he has already reported the total payments of $500,000 from the first disposition ($100,000 in 2011 and $400,000 in 2012).
taxmap/pubs/p537-002.htm#en_us_publink1000221679Example 2.(p7)
Assume the facts are the same as
Example 1
except that Bob sells the property for only $400,000. The gain for 2012 is figured as follows:
| Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first
disposition | $400,000 |
| Subtract: Sum of payments from Bob in 2011 and 2012 | − 200,000 |
| Amount treated as received because of second disposition | $200,000 |
| Add: Payment from Bob in 2012 | + 100,000 |
| Total payments received and treated as received for 2012 | $300,000 |
| Multiply by gross profit % | × .50 |
| Installment sale income for 2012 | $150,000 |
| | |
Harvey receives a $100,000 payment in 2013 and another in 2014. They are not taxed because he treated the $200,000 from the disposition in 2012 as a payment received and paid tax on the installment sale income. In 2015, he receives the final $100,000 payment. He figures the installment sale income he must recognize in 2015 as follows:
| Total payments from the first disposition received by the end of
2015 | $500,000 |
| Minus the sum of: | | |
| Payment from 2011 | $100,000 | |
| Payment from 2012 | 100,000 | |
| Amount treated as received in 2012 | 200,000 | |
| Total on which gain was previously recognized |
− 400,000 |
| Payment on which gain is recognized for 2015 |
$100,000
|
| Multiply by gross profit % | × .50 |
| Installment sale income for 2015 | $ 50,000 |
This rule does not apply to a second disposition, and any later transfer, if you can show to the satisfaction of the IRS that neither the first disposition (to the related person) nor the second disposition had as one of its principal purposes the avoidance of federal income tax. Generally, an involuntary second disposition will qualify under the nontax avoidance exception, such as when a creditor of the related person forecloses on the property or the related person declares bankruptcy.
The nontax avoidance exception also applies to a second disposition that is also an installment sale if the terms of payment under the installment resale are substantially equal to or longer than those for the first installment sale. However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale.
In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. A transfer after the death of the person making the first disposition or the related person's death, whichever is earlier, is not treated as a second disposition.
taxmap/pubs/p537-002.htm#en_us_publink1000221683If you trade business or investment property solely for the same kind of property to be held as business or investment property, you can postpone reporting the gain. These trades are known as like-kind exchanges. The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave
up.
You do not have to report any part of your gain if you receive only like-kind property. However, if you also receive money or other property (boot) in the exchange, you must report your gain to the extent of the money and the FMV of the other property received.
For more information on like-kind exchanges, see
Like-Kind Exchanges in chapter 1 of Publication
544.
If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine the installment sale income each year.
- 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.
In 2012, George Brown trades personal property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. He also receives an installment note for $800,000 in the trade. Under the terms of the note, he is to receive $100,000 (plus interest) in 2013 and the balance of $700,000 (plus interest) in
2014.
George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). The contract price is $800,000 ($1,000,000 − $200,000). The gross profit percentage is 75% ($600,000 ÷ $800,000). He reports no gain in 2012 because the like-kind property he receives is not treated as a payment for figuring gain. He reports $75,000 gain for 2013 (75% of $100,000 payment received) and $525,000 gain for 2014 (75% of $700,000 payment
received).
taxmap/pubs/p537-002.htm#en_us_publink1000221686A deferred exchange is one in which you transfer property you use in business or hold for investment and receive like-kind property later that you will use in business or hold for investment. Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. If certain rules are met, these funds will not be considered a payment until you have the right to receive the funds or, if earlier, the end of the exchange period. See Regulations section 1.1031(k)-1(j)(2) for these rules.
taxmap/pubs/p537-002.htm#en_us_publink1000221687A contingent payment sale is one in which the total selling price cannot be determined by the end of the tax year of sale. This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years.
If the selling price cannot be determined by the end of the tax year, you must use different rules to figure the contract price and the gross profit percentage than those you use for an installment sale with a fixed selling price.
For rules on using the installment method for a contingent payment sale, see Regulations section
15a.453-1(c).
taxmap/pubs/p537-002.htm#en_us_publink1000221688If you sell different types of assets in a single sale, you must identify each asset to determine whether you can use the installment method to report the sale of that asset. You also have to allocate part of the selling price to each asset. If you sell assets that constitute a trade or business, see
Sale of a Business, later.
Unless an allocation of the selling price has been agreed to by both parties in an arm's-length transaction, you must allocate the selling price to an asset based on its FMV. If the buyer assumes a debt, or takes the property subject to a debt, you must reduce the FMV of the property by the debt. This becomes the net FMV.
A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. It must be reported separately. The remaining assets sold at a gain are reported together.
taxmap/pubs/p537-002.htm#en_us_publink1000221689You sold three separate and unrelated parcels of real property (A, B, and C) under a single contract calling for a total selling price of $130,000. The total selling price consisted of a cash payment of $20,000, the buyer's assumption of a $30,000 mortgage on parcel B, and an installment obligation of $80,000 payable in eight annual installments, plus interest at 8% a
year.
Your installment sale basis for each parcel was $15,000. Your net gain was $85,000 ($130,000 − $45,000). You report the gain on the installment
method.
The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000,
respectively.
The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining
parcels.
Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. You should allocate the cash payment of $20,000 received in the year of sale and the note receivable on the basis of their proportionate net FMV. The allocation is figured as follows:
| | Parcels
A and B | Parcel C |
| FMV | $120,000 | $10,000 |
| Minus: Mortgage assumed | 30,000 | -0- |
| Net FMV | $ 90,000 | $10,000 |
| Proportionate net FMV: | | |
| Percentage of total | 90% | 10% |
| Payments in year of sale: | | |
| $20,000 × 90% | $18,000 | |
| $20,000 × 10% | | $2,000 |
| Excess of parcel B mortgage over installment sale basis | 15,000 | -0- |
Allocation of payments
received (or considered
received) in year of sale
| $ 33,000 | $ 2,000 |
You cannot report the sale of parcel C on the installment method because the sale results in a loss. You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. However, if parcel C was held for personal use, the loss is not
deductible.
You allocate the installment obligation of $80,000 to the properties sold based on their proportionate net FMVs (90% to parcels A and B, 10% to parcel
C).
taxmap/pubs/p537-002.htm#en_us_publink1000221691The installment sale of an entire business for one overall price under a single contract is not the sale of a single asset.
taxmap/pubs/p537-002.htm#en_us_publink1000221692To determine whether any of the gain on the sale of the business can be reported on the installment method, you must allocate the total selling price and the payments received in the year of sale between each of the following classes of
assets.
- Assets sold at a loss.
- Real and personal property eligible for the installment method.
- Real and personal property ineligible for the installment method,
including:
- Inventory,
- Dealer property, and
- Stocks and securities.
The sale of inventories of personal property cannot be reported on the installment method. All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years.
If inventory items are included in an installment sale, you may have an agreement stating which payments are for inventory and which are for the other assets being sold. If you do not, each payment must be allocated between the inventory and the other assets sold.
Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Use your basis in the inventory to figure the cost of goods sold. Deduct the part of the selling expenses allocated to inventory as an ordinary business expense.
taxmap/pubs/p537-002.htm#en_us_publink1000221694Except for assets exchanged under the like-kind exchange rules, both the buyer and seller of a business must use the residual method to allocate the sale price to each business asset sold. This method determines gain or loss from the transfer of each asset and the buyer's basis in the
assets.
The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b).
A group of assets constitutes a trade or business if goodwill or going concern value could, under any circumstances, attach to the assets or if the use of the assets would constitute an active trade or business under section 355.
The residual method provides for the consideration to be reduced first by cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). The consideration remaining after this reduction must be allocated among the various business assets in a certain order.
For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order.
- Certificates of deposit, U.S. Government securities, foreign currency, and actively traded personal property, including stock and
securities.
- Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. However, see Regulations section 1.338-6(b)(2)(iii) for exceptions that apply to debt instruments issued by persons related to a target corporation, contingent debt instruments, and debt instruments convertible into stock or other property.
- Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of
business.
- All other assets except section 197 intangibles.
- Section 197 intangibles except goodwill and going concern
value.
- Goodwill and going concern value (whether or not they qualify as section 197 intangibles).
If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. For example, if an asset is described in both (4) and (6), include it in (4).
taxmap/pubs/p537-002.htm#en_us_publink1000221695The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market value of any of the assets. This agreement is binding on both parties unless the IRS determines the amounts are not appropriate.
taxmap/pubs/p537-002.htm#en_us_publink1000221696Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets. Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred.
taxmap/pubs/p537-002.htm#en_us_publink1000221697A partner who sells a partnership interest at a gain may be able to report the sale on the installment method. The sale of a partnership interest is treated as the sale of a single capital asset. The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. (The term "unrealized receivables" includes depreciation recapture income, discussed earlier.)
The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. The gain allocated to the other assets can be reported under the installment method.
For more information on the treatment of unrealized receivables and inventory, see Publication
541.
On June 4, 2012, you sold the machine shop you had operated since 2004. You received a $100,000 down payment and the buyer's note for $120,000. The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2013. The total selling price is $220,000. Your selling expenses are
$11,000.
The selling expenses are divided among all the assets sold, including inventory.
Your selling expense for each asset is 5% of the asset's selling price ($11,000
selling expense ÷ $220,000 total selling price).
The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:
| | | Depre-
ciation | Adj. |
| Asset | FMV | Claimed | Basis |
| Inventory | $ 10,000 | -0- | $ 8,000 |
| Land | 42,000 | -0- | 15,000 |
| Building | 48,000 | $9,000 | 36,000 |
| Machine A | 71,000 | 27,200 | 63,800 |
| Machine B | 24,000 | 12,960 | 22,040 |
| Truck | 6,500 | 18,624 | 5,376 |
| | $201,500 | $67,784
| $150,216 |
| | | | |
Under the residual method, you allocate the selling price to each of the assets based on their FMV ($201,500). The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill.
The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis, and the gain for each asset are shown in the following chart.
| | Sale
Price | Sale
Exp. | Adj.
Basis | Gain |
| Inventory | $ 10,000 | $ 500 | $ 8,000 | $ 1,500 |
| Land | 42,000 | 2,100 | 15,000 | 24,900 |
| Building | 48,000 | 2,400 | 36,000 | 9,600 |
| Mch. A | 71,000 | 3,550 | 63,800 | 3,650 |
| Mch. B | 24,000 | 1,200 | 22,040 | 760 |
| Truck | 6,500 | 325 | 5,376 | 799 |
| Goodwill | 18,500 | 925 | -0- | 17,575 |
| | $220,000 | $11,000 | $150,216 | $58,784 |
The building was acquired in 2004, the year the business began, and it is section 1250 property. There is no depreciation recapture income because the building was depreciated using the straight line
method.
All gain on the truck, machine A, and machine B is depreciation recapture income since it is the lesser of the depreciation claimed or the gain on the sale. Figure depreciation recapture in Part III of Form
4797.
The total depreciation recapture income reported in Part II of Form 4797 is $5,209. This consists of $3,650 on machine A, $799 on the truck, and $760 on machine B (the gain on each item because it was less than the depreciation claimed). These gains are reported in full in the year of sale and are not included in the installment sale
computation.
Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. The selling prices of the truck and machines are also removed from the total selling price because gain on these items is reported in full in the year of
sale.
The selling price equals the contract price for the installment sale ($108,500). The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart.
| | Selling
Price | Install-
ment
Sale
Basis | Gross
Profit |
| Land | $ 42,000 | $17,100 | $24,900 |
| Building | 48,000 | 38,400 | 9,600 |
| Goodwill | 18,500 | 925 | 17,575 |
| Total | $108,500 | $56,425 | $52,075 |
| | | | |
The gross profit percentage (gross profit ÷ contract price) for the installment sale is 48% ($52,075 ÷ $108,500). The gross profit percentage for each asset is figured as follows:
| Percentage |
| Land— $24,900 ÷ $108,500 | 22.95 |
| Building— $9,600 ÷ $108,500 | 8.85 |
| Goodwill— $17,575 ÷ $108,500 | 16.20 |
| Total | 48.00 |
The sale includes assets sold on the installment method and assets for which the gain is reported in full in the year of sale, so payments must be allocated between the installment part of the sale and the part reported in the year of sale. The selling price for the installment sale is $108,500. This is 49.3% of the total selling price of $220,000 ($108,500 ÷ $220,000). The selling price of assets not reported on the installment method is $111,500. This is 50.7% ($111,500 ÷ $220,000) of the total selling
price.
Multiply principal payments by 49.3% to determine the part of the payment for the installment sale. The balance, 50.7%, is for the part reported in the year of the sale.
The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Only the part for the installment sale (49.3%) is used in the installment sale
computation.
The only payment received in 2012 is the down payment of $100,000. The part of the payment for the installment sale is $49,300 ($100,000 × 49.3%). This amount is used in the installment sale
computation.
taxmap/pubs/p537-002.htm#en_us_publink1000221703Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2012.
| Income |
| Land—22.95% of $49,300 | $11,314 |
| Building—8.85% of $49,300 | 4,363 |
| Goodwill—16.2% of $49,300 | 7,987 |
| Total installment income for 2012 | $23,664 |
You figure installment income for years after 2012 by applying the same gross profit percentages to 49.3% of the total payments you receive on the buyer's note during the
year.
taxmap/pubs/p537-002.htm#en_us_publink1000221706An installment sale contract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the principal payment. Interest provided in the contract is called stated
interest.
If an installment sale contract does not provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest. If section 483 applies to the contract, this interest is called unstated interest. If section 1274 applies to the contract, this interest is called original issue discount (OID).
An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later).
taxmap/pubs/p537-002.htm#en_us_publink1000221707Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. As a result, the buyer cannot deduct the unstated interest. The seller must report the unstated interest as income.
Personal-use property is any property in which substantially all of its use by the buyer is not in connection with a trade or business or an investment activity.
If the debt is subject to the section 483 rules and is also subject to the below-market loan rules, such as a gift loan, compensation-related loan, or corporation-shareholder loan, then both parties are subject to the below-market loan rules rather than the unstated interest
rules.
taxmap/pubs/p537-002.htm#en_us_publink1000221708If either section 1274 or section 483 applies to the installment sale contract, you must treat part of the installment sale price as interest, even though interest is not called for in the sales agreement. If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated
interest.
Include the unstated interest in income based on your regular method of accounting. Include OID in income over the term of the
contract.
The OID includible in income each year is based on the constant yield method described in section 1272. (In some cases, the OID on an installment sale contract also may include all or part of the stated interest, especially if the stated interest is not paid at least annually.)
If you do not use the installment method to report the sale, report the entire gain under your method of accounting in the year of sale. Reduce the selling price by any stated principal treated as interest to determine the gain.
Report unstated interest or OID on your tax return, in addition to stated
interest.
taxmap/pubs/p537-002.htm#en_us_publink1000221709Any part of the stated selling price of an installment sale contract treated by the buyer as interest reduces the buyer's basis in the property and increases the buyer's interest expense. These rules do not apply to personal-use property (for example, property not used in a trade or business).
taxmap/pubs/p537-002.htm#en_us_publink1000221710An installment sale contract generally provides for adequate stated interest if the contract's stated principal amount is at least equal to the sum of the present values of all principal and interest payments called for under the contract. The present value of a payment is determined based on the test rate of interest, defined next. (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value.) In general, an installment sale contract provides for adequate stated interest if the stated interest rate (based on an appropriate compounding period) is at least equal to the test rate of interest.
taxmap/pubs/p537-002.htm#en_us_publink1000221711The test rate of interest for a contract is the 3-month rate. The 3-month rate is the lower of the following applicable federal rates (AFRs).
- The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the first month in which there is a binding written contract that substantially provides the terms under which the sale or exchange is ultimately
completed.
- The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the month in which the sale or exchange
occurs.
The AFR depends on the month the binding contract for the sale or exchange of property is made or the month of the sale or exchange and the term of the instrument. For an installment obligation, the term of the instrument is its weighted average maturity, as defined in Regulations section 1.1273-1(e)(3). The AFR for each term is shown below.
- For a term of 3 years or less, the AFR is the federal short-term
rate.
- For a term of over 3 years, but not over 9 years, the AFR is the federal mid-term
rate.
- For a term of over 9 years, the AFR is the federal long-term rate.
 | The applicable federal rates are published monthly in the Internal Revenue Bulletin (IRB). You can get this information by contacting an IRS office. IRBs are also available on
IRS.gov. |
taxmap/pubs/p537-002.htm#en_us_publink1000221714For sales or exchanges of property (other than new section 38 property, which includes most tangible personal property subject to depreciation) involving seller financing of $5,339,300 or less, the test rate of interest cannot be more than 9%, compounded semiannually. For seller financing over $5,339,300 and for all sales or exchanges of new section 38 property, the test rate of interest is 100% of the AFR.
For information on new section 38 property, see section 48(b) as in effect before the enactment of Public Law
101-508.
taxmap/pubs/p537-002.htm#en_us_publink1000221715In the case of certain land transfers between related persons (described later), the test rate is no more than 6 percent, compounded semiannually.
taxmap/pubs/p537-002.htm#en_us_publink1000221716If an installment sale contract does not provide for adequate stated interest, generally either section 1274 or section 483 will apply to the contract. These sections recharacterize part of the stated principal amount as interest. Whether either of these sections applies to a particular installment sale contract depends on several factors, including the total selling price and the type of property sold.
taxmap/pubs/p537-002.htm#en_us_publink1000221717For purposes of determining whether either section 1274 or section 483 applies to an installment sale contract, all sales or exchanges that are part of the same transaction (or related transactions) are treated as a single sale or exchange and all contracts arising from the same transaction (or a series of related transactions) are treated as a single contract. Also, the total consideration due under an installment sale contract is determined at the time of the sale or exchange. Any payment (other than a debt instrument) is taken into account at its FMV.
taxmap/pubs/p537-002.htm#en_us_publink1000221718Section 1274 applies to a debt instrument issued for the sale or exchange of property if any payment under the instrument is due more than 6 months after the date of the sale or exchange and the instrument does not provide for adequate stated interest. Section 1274, however, does not apply to an installment sale contract that is a cash method debt instrument (defined next) or that arises from the following transactions.
- A sale or exchange for which the total payments are $250,000 or less.
- The sale or exchange of an individual's main home.
- The sale or exchange of a farm for $1,000,000 or less by an individual, an estate, a testamentary trust, a small business corporation (defined in section 1244(c)(3)), or a domestic partnership that meets requirements similar to those of section 1244(c)(3).
- Certain land transfers between related persons (described
later).
This is any debt instrument given as payment for the sale or exchange of property (other than new section 38 property) with a stated principal of $3,813,800 or less if the following items apply.
- The lender (holder) does not use an accrual method of accounting and is not a dealer in the type of property sold or
exchanged.
- Both the borrower (issuer) and the lender jointly elect to account for interest under the cash method of
accounting.
- Section 1274 would apply except for the election in (2) above.
The section 483 rules (discussed next) apply to debt instruments issued in a land sale between related persons to the extent the sum of the following amounts does not exceed $500,000.
- The stated principal of the debt instrument issued in the sale or
exchange.
- The total stated principal of any other debt instruments for prior land sales between these individuals during the calendar
year.
The section 1274 rules, if otherwise applicable, apply to debt instruments issued in a sale of land to the extent the stated principal amount exceeds $500,000, or if any party to the sale is a nonresident alien.
Related persons include an individual and the members of the individual's family and their spouses. Members of an individual's family include the individual's spouse, brothers and sisters (whole or half), ancestors, and lineal descendants. Membership in the individual's family can be the result of a legal
adoption.
taxmap/pubs/p537-002.htm#en_us_publink1000221721Section 483 generally applies to an installment sale contract that does not provide for adequate stated interest and is not covered by section 1274. Section 483, however, generally does not apply to an installment sale contract that arises from the following transactions.
- A sale or exchange for which no payments are due more than one year after the date of the sale or exchange.
- A sale or exchange for $3,000 or less.
Sections 1274 and 483 do not apply under the following circumstances.
- An assumption of a debt instrument in connection with a sale or exchange or the acquisition of property subject to a debt instrument, unless the terms or conditions of the debt instrument are modified in a manner that would constitute a deemed exchange under Regulations section 1.1001-3.
- A debt instrument issued in connection with a sale or exchange of property if either the debt instrument or the property is publicly traded.
- A sale or exchange of all substantial rights to a patent, or an undivided interest in property that includes part or all substantial rights to a patent, if any amount is contingent on the productivity, use, or disposition of the property transferred. See chapter 2 of Publication
544 for more information.
- An annuity contract issued in connection with a sale or exchange of property if the contract is described in section 1275(a)(1)(B) and Regulations section 1.1275-1(j).
- A transfer of property subject to section 1041 (relating to transfers of property between spouses or incident to divorce).
- A demand loan that is a below-market loan described in section 7872(c)(1) (for example, gift loans and corporation-shareholder loans).
- A below-market loan described in section 7872(c)(1) issued in connection with the sale or exchange of personal-use property. This rule applies only to the holder.
For information on figuring unstated interest and OID and other special rules, see sections 1274 and 483 and the related regulations. In the case of an installment sale contract that provides for contingent payments, see Regulations sections 1.1275-4(c) and
1.483-4.
taxmap/pubs/p537-002.htm#en_us_publink1000221724A disposition generally includes a sale, exchange, cancellation, bequest, distribution, or transmission of an installment obligation. An installment obligation is the buyer's note, deed of trust, or other evidence that the buyer will make future payments to
you.
If you are using the installment method and you dispose of the installment obligation, generally you will have a gain or loss to report. It is considered gain or loss on the sale of the property for which you received the installment obligation. If the original installment sale produced ordinary income, the disposition of the obligation will result in ordinary income or loss. If the original sale resulted in a capital gain, the disposition of the obligation will result in a capital gain or loss. If the original installment sale resulted in a section 1231 capital gain (or loss), the disposition of the obligation will result in either a long-term capital gain or an ordinary
loss.
taxmap/pubs/p537-002.htm#en_us_publink1000221725Use the following rules to figure your gain or loss from the disposition of an installment obligation.
- If you sell or exchange the obligation, or you accept less than face value in satisfaction of the obligation, your gain or loss is the difference between your basis in the obligation and the amount you realize.
- If you dispose of the obligation in any other way, your gain or loss is the difference between your basis in the obligation and its FMV at the time of the disposition. This rule applies, for example, when you give the installment obligation to someone else or cancel the buyer's debt to you.
Figure your basis in an installment obligation by multiplying the unpaid balance on the obligation by your gross profit percentage. Subtract that amount from the unpaid balance. The result is your basis in the installment obligation.
taxmap/pubs/p537-002.htm#en_us_publink1000221727Several years ago, you sold property on the installment method. The buyer still owes you $10,000 of the sale price. This is the unpaid balance on the buyer's installment obligation to you. Your gross profit percentage is 60%, so $6,000 (60% × $10,000) is the profit owed you on the obligation. The rest of the unpaid balance, $4,000, is your basis in the
obligation.
taxmap/pubs/p537-002.htm#en_us_publink1000221728No gain or loss is recognized on the transfer of an installment obligation between a husband and wife or a former husband and wife if the transfer is incident to a divorce. A transfer is incident to a divorce if it occurs within one year after the date on which the marriage ends or is related to the end of the marriage. The same tax treatment of the transferred obligation applies to the transferee spouse or former spouse as would have applied to the transferor spouse or former spouse. The basis of the obligation to the transferee spouse (or former spouse) is the adjusted basis of the transferor spouse.
The nonrecognition rule does not apply if the spouse or former spouse receiving the obligation is a nonresident alien.
taxmap/pubs/p537-002.htm#en_us_publink1000221729A gift of an installment obligation is a disposition. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you make the gift.
taxmap/pubs/p537-002.htm#en_us_publink1000221730If an installment obligation is canceled or otherwise becomes unenforceable, it is treated as a disposition other than a sale or exchange. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you cancel it. If the parties are related, the FMV of the obligation is considered to be no less than its full face value.
taxmap/pubs/p537-002.htm#en_us_publink1000221731If you accept part payment on the balance of the buyer's installment debt to you and forgive the rest of the debt, you treat the settlement as a disposition of the installment obligation. Your gain or loss is the difference between your basis in the obligation and the amount you realize on the settlement.
taxmap/pubs/p537-002.htm#en_us_publink1000221732The following transactions generally are not dispositions.
taxmap/pubs/p537-002.htm#en_us_publink1000221733If you reduce the selling price but do not cancel the rest of the buyer's debt to you, it is not considered a disposition of the installment obligation. You must refigure the gross profit percentage and apply it to payments you receive after the reduction. See
Selling Price Reduced under
General Rules, earlier.
If the buyer of your property sells it to someone else and you agree to let the new buyer assume the original buyer's installment obligation, you have not disposed of the installment obligation. It is not a disposition even if the new buyer pays you a higher rate of interest than the original buyer.
taxmap/pubs/p537-002.htm#en_us_publink1000221735The transfer of an installment obligation (other than to a buyer) as a result of the death of the seller is not a disposition. Any unreported gain from the installment obligation is not treated as gross income to the decedent. No income is reported on the decedent's return due to the transfer. Whoever receives the installment obligation as a result of the seller's death is taxed on the installment payments the same as the seller would have been had the seller lived to receive the payments.
However, if an installment obligation is canceled, becomes unenforceable, or is transferred to the buyer because of the death of the holder of the obligation, it is a disposition. The estate must figure its gain or loss on the disposition. If the holder and the buyer were related, the FMV of the installment obligation is considered to be no less than its full face value.
taxmap/pubs/p537-002.htm#en_us_publink1000221736If you repossess your property after making an installment sale, you must figure the following amounts.
- Your gain (or loss) on the repossession.
- Your basis in the repossessed property.
The rules for figuring these amounts depend on the kind of property you repossess. The rules for repossessions of personal property differ from those for real property. Special rules may apply if you repossess property that was your main home before the sale. See Regulations section 1.1038-2 for further
information.
The repossession rules apply whether or not title to the property was ever transferred to the buyer. It does not matter how you repossess the property, whether you foreclose or the buyer voluntarily surrenders the property to you. However, it is not a repossession if the buyer puts the property up for sale and you repurchase it.
For the repossession rules to apply, the repossession must at least partially discharge (satisfy) the buyer's installment obligation to you. The discharged obligation must be secured by the property you repossess. This requirement is met if the property is auctioned off after you foreclose and you apply the installment obligation to your bid price at the auction.
taxmap/pubs/p537-002.htm#en_us_publink1000221737You report gain or loss from a repossession on the same form you used to report the original sale. If you reported the sale on Form 4797, use it to report the gain or loss on the
repossession.
taxmap/pubs/p537-002.htm#en_us_publink1000221738If you repossess personal property, you may have a gain or a loss on the repossession. In some cases, you also may have a bad
debt.
To figure your gain or loss, subtract the total of your basis in the installment obligation and any repossession expenses you have from the FMV of the property. If you receive anything from the buyer besides the repossessed property, add its value to the property's FMV before making this calculation.
How you figure your basis in the installment obligation depends on whether or not you reported the original sale on the installment method. The method you used to report the original sale also affects the character of your gain or loss on the
repossession.
taxmap/pubs/p537-002.htm#en_us_publink1000221739The following paragraphs explain how to figure your basis in the installment obligation and the character of any gain or loss if you did not use the installment method to report the gain on the original
sale.
taxmap/pubs/p537-002.htm#en_us_publink1000221740Your basis is figured on the obligation's full face value or its FMV at the time of the original sale, whichever you used to figure your gain or loss in the year of sale. From this amount, subtract all payments of principal you have received on the obligation. The result is your basis in the installment obligation. If only part of the obligation is discharged by the repossession, figure your basis in only that part.
taxmap/pubs/p537-002.htm#en_us_publink1000221741Add any repossession costs to your basis in the obligation. If the FMV of the property you repossess is more than this total, you have a gain. This is gain on the installment obligation, so it is all ordinary income. If the FMV of the repossessed property is less than the total of your basis plus repossession costs, you have a loss. You included the full gain in income in the year of sale, so the loss is a bad debt. How you deduct the bad debt depends on whether you sold business or nonbusiness property in the original sale. See chapter 4 of Publication
550
for information on nonbusiness bad debts and chapter 10 of Publication 535,
Business Expenses, for information on business bad debts.
The following paragraphs explain how to figure your basis in the installment obligation and the character of any gain or loss if you used the installment method to report the gain on the original
sale.
taxmap/pubs/p537-002.htm#en_us_publink1000221743Multiply the unpaid balance of your installment obligation by your gross profit percentage. Subtract that amount from the unpaid balance. The result is your basis in the installment obligation.
taxmap/pubs/p537-002.htm#en_us_publink1000221744If the FMV of the repossessed property is more than the total of your basis in the obligation plus any repossession costs, you have a gain. If the FMV is less, you have a loss. Your gain or loss on the repossession is of the same character (capital or ordinary) as your gain on the original sale.
 | Use Worksheet C to determine the taxable gain or loss on a repossession of personal property reported on the installment method.
|
taxmap/pubs/p537-002.htm#en_us_publink1000292524Example —
Worksheet C. Figuring Gain or Loss on Repossession of Personal
Property Note.
Use this worksheet only if you used the installment method to report the gain on the original
sale.
| 1. | Enter the fair market value of the repossessed property | 1,400 | | 2. | Enter the unpaid balance of the installment obligation | 800 | | | 3. | Enter your gross profit percentage for the installment
sale | 40% | | | 4. | Multiply line 2 by line 3. This is your unrealized profit | 320 | | | 5. | Subtract line 4 from line 2. This is the basis of the
obligation | 480 | | 6. | Enter your costs of repossessing the property | 75 | | 7. | Add lines 5 and 6 | 555 | | 8. | Subtract line 7 from line 1. This is your gain or loss on the
repossession | 845 |
|
taxmap/pubs/p537-002.htm#en_us_publink1000221748You sold your piano for $1,500 in December 2011 for $300 down and $100 a month (plus interest). The payments began in January 2012. Your gross profit percentage is 40%. You reported the sale on the installment method on your 2011 income tax return. After the fourth monthly payment, the buyer defaulted on the contract (which has an unpaid balance of $800) and you are forced to repossess the piano. The FMV of the piano on the date of repossession is $1,400. The legal costs of foreclosure and the expense of moving the piano back to your home total $75. You figure your gain on the repossession as follows:
taxmap/pubs/p537-002.htm#en_us_publink1000221751Your basis in repossessed personal property is its FMV at the time of the repossession.
taxmap/pubs/p537-002.htm#en_us_publink1000221752The FMV of repossessed property is a question of fact to be established in each case. If you bid for the property at a lawful public auction or judicial sale, its FMV is presumed to be the price it sells for, unless there is clear and convincing evidence to the contrary.
taxmap/pubs/p537-002.htm#en_us_publink1000221753The rules for the repossession of real property allow you to keep essentially the same adjusted basis in the repossessed property you had before the original sale. You can recover this entire adjusted basis when you resell the property. This, in effect, cancels out the tax treatment that applied to you on the original sale and puts you in the same tax position you were in before that sale.
taxmap/pubs/p537-002.htm#en_us_publink1000292519 | Worksheet C. Figuring Gain or Loss on Repossession of Personal
Property Note.
Use this worksheet only if you used the installment method to report the gain on the original
sale.
| 1. | Enter the fair market value of the repossessed property | | | 2. | Enter the unpaid balance of the installment obligation | | | | 3. | Enter your gross profit percentage for the installment
sale | | | | 4. | Multiply line 2 by line 3. This is your unrealized profit | | | | 5. | Subtract line 4 from line 2. This is the basis of the
obligation | | | 6. | Enter your costs of repossessing the property | | | 7. | Add lines 5 and 6 | | | 8. | Subtract line 7 from line 1. This is your gain or loss on the
repossession | |
|
As a result, the total payments you have received from the buyer on the original sale must be considered income to you. You report, as gain on the repossession, any part of the payments you have not yet included in income. These payments are amounts you previously treated as a return of your adjusted basis and excluded from income. However, the total gain you report is limited. See
Limit on taxable gain, later.
The rules concerning basis and gain on repossessed real property are mandatory. You must use them to figure your basis in the repossessed real property and your gain on the repossession. They apply whether or not you reported the sale on the installment method. However, they apply only if all of the following conditions are met.
- The repossession must be to protect your security rights in the
property.
- The installment obligation satisfied by the repossession must have been received in the original
sale.
- You cannot pay any additional consideration to the buyer to get your property back unless either of the situations listed below
applies.
- The requisition and payment of the additional consideration were provided for in the original contract of
sale.
- The buyer has defaulted, or default is imminent.
Additional consideration includes money and other property you pay or transfer to the buyer. For example, additional consideration is paid if you reacquire the property subject to a debt that arose after the original sale.
If any one of these three conditions is not met, use the rules discussed under
Personal Property, earlier, as if the property you repossess were personal rather than real property. Do not use the rules for real property.
Your gain on repossession is the difference between the following amounts.
- The total payments received, or considered received, on the
sale.
- The total gain already reported as income.
See the earlier discussions under
Payments Received or Considered Received for items considered payment on the sale.
Taxable gain is limited to your gross profit on the original sale minus the sum of the following
amounts.
- The gain on the sale you reported as income before the repossession.
- Your repossession costs.
This method of figuring taxable gain, in essence, treats all payments received
on the sale as income but limits your total taxable gain to the gross profit you
originally expected on the sale.
The limit on taxable gain does not apply if the selling price is indefinite and cannot be determined at the time of repossession. For example, a selling price stated as a percentage of the profits to be realized from the buyer's development of the property is an indefinite selling price.
taxmap/pubs/p537-002.htm#en_us_publink1000221759The taxable gain on repossession is ordinary income or capital gain, the same as the gain on the original sale. However, if you did not report the sale on the installment method, the gain is ordinary income.
taxmap/pubs/p537-002.htm#en_us_publink1000221760Your repossession costs include money or property you pay to reacquire the real property. This includes amounts paid to the buyer of the property, as well as amounts paid to others for such items as those listed below.
- Court costs and legal fees.
- Publishing, acquiring, filing, or recording of title.
- Lien clearance.
Repossession costs do not include the FMV of the buyer's obligations to you that are secured by the real property or the costs of reacquiring those obligations.
| Use Worksheet D to determine the taxable gain on a repossession of real property reported on the installment method.
|
taxmap/pubs/p537-002.htm#en_us_publink1000221764You sold a tract of land in January 2010 for $25,000. You accepted a $5,000 down payment, plus a $20,000 mortgage secured by the property and payable at the rate of $4,000 annually plus interest (9.5%). The payments began on January 1, 2011. Your adjusted basis in the property was $19,000 and you reported the transaction as an installment sale. Your selling expenses were $1,000. You figured your gross profit as follows:
| Selling price | $25,000 |
| Minus: | | | |
| Adjusted basis | $19,000 | |
| Selling expenses | 1,000 | 20,000 |
| Gross profit | $ 5,000 |
| | | | |
For this sale, the contract price equals the selling price. The gross profit percentage is 20% ($5,000 gross profit ÷ $25,000 contract price).
In 2010, you included $1,000 in income (20% × $5,000 down payment). In 2011, you reported a profit of $800 (20% × $4,000 annual installment). In 2012, the buyer defaulted and you repossessed the property. You paid $500 in legal fees to get the property back. Your taxable gain on the repossession is figured as follows:
taxmap/pubs/p537-002.htm#en_us_publink1000221766Example —
Worksheet D. Taxable Gain on Repossession of Real Property
Note.
Use this worksheet to determine taxable gain on the repossession of real property if you used the installment method to report the gain on the original
sale.
| 1. | Enter the total of all payments received or treated as received before
repossession | 9,000 | | 2. | Enter the total gain already reported as income | 1,800 | | 3. | Subtract line 2 from line 1. This is your gain on the
repossession | 7,200 | | 4. | Enter your gross profit on the original sale | 5,000 | | 5. | Enter your costs of repossessing the property | 500 | | 6. | Add line 2 and line 5 | 2,300 | | 7. | Subtract line 6 from line 4 | 2,700 | | 8. | Enter the lesser of line 3 or
line 7. This is your taxable gain on the repossession
| 2,700 |
|
Your basis in the repossessed property is determined as of the date of repossession. It is the sum of the following amounts.
- Your adjusted basis in the installment obligation.
- Your repossession costs.
- Your taxable gain on the repossession.
To figure your adjusted basis in the installment obligation at the time of repossession, multiply the unpaid balance by the gross profit percentage. Subtract that amount from the unpaid balance.
| Worksheet D. Taxable Gain on Repossession of Real Property Note.
Use this worksheet to determine taxable gain on the repossession of real property if you used the installment method to report the gain on the original
sale.
| 1. | Enter the total of all payments received or treated as received before
repossession | | | 2. | Enter the total gain already reported as income | | | 3. | Subtract line 2 from line 1. This is your gain on the
repossession | | | 4. | Enter your gross profit on the original sale | | | 5. | Enter your costs of repossessing the property | | | 6. | Add line 2 and line 5 | | | 7. | Subtract line 6 from line 4 | | | 8. | Enter the lesser of line 3 or
line 7. This is your taxable gain on the repossession
| |
|
| Use Worksheet E to determine the basis of real property repossessed. |
taxmap/pubs/p537-002.htm#en_us_publink1000292525Example —
Worksheet E. Basis of Repossessed Real Property | 1. | Enter the unpaid balance on the installment obligation | 16,000 | | 2. | Enter your gross profit percentage for the installment
sale | 20% | | 3. | Multiply line 1 by line 2. This is your unrealized profit | 3,200 | | 4. | Subtract line 3 from line 1. This is your adjusted basis in the installment obligation on the date of the
repossession | 12,800 | | 5. | Enter your taxable gain on the repossession | 2,700 | | 6. | Enter your costs of repossessing the property | 500 | | 7. | Add lines 4, 5, and 6. This is your basis in the repossessed real
property | 16,000 |
|
taxmap/pubs/p537-002.htm#en_us_publink1000221770 | Worksheet E. Basis of Repossessed Real Property | 1. | Enter the unpaid balance on the installment obligation | | | 2. | Enter your gross profit percentage for the installment
sale | | | 3. | Multiply line 1 by line 2. This is your unrealized profit | | | 4. | Subtract line 3 from line 1. This is your adjusted basis in the installment obligation on the date of the
repossession | | | 5. | Enter your taxable gain on the repossession | | | 6. | Enter your costs of repossessing the property | | | 7. | Add lines 4, 5, and 6. This is your basis in the repossessed real
property | |
|
taxmap/pubs/p537-002.htm#en_us_publink1000221772Assume the same facts as in the previous example. The unpaid balance of the installment obligation (the $20,000 note) is $16,000 at the time of repossession because the buyer made a $4,000 payment. The gross profit percentage on the original sale was 20%. Therefore, $3,200 (20% × $16,000 still due on the note) is unrealized profit. You figure your basis in the repossessed property as follows:
taxmap/pubs/p537-002.htm#en_us_publink1000221775If you resell the repossessed property, the resale may result in a capital gain or loss. To figure whether the gain or loss is long-term or short-term, your holding period includes the period you owned the property before the original sale plus the period after the repossession. It does not include the period the buyer owned the property.
If the buyer made improvements to the reacquired property, the holding period for these improvements begins on the day after the date of
repossession.
taxmap/pubs/p537-002.htm#en_us_publink1000221776If you repossess real property under these rules, you cannot take a bad debt deduction for any part of the buyer's installment obligation. This is true even if the obligation is not fully satisfied by the repossession.
If you took a bad debt deduction before the tax year of repossession, you are considered to have recovered the bad debt when you repossess the property. You must report the bad debt deduction taken in the earlier year as income in the year of repossession. However, if any part of the earlier deduction did not reduce your tax, you do not have to report that part as income. Your adjusted basis in the installment obligation is increased by the amount you report as income from recovering the bad debt.
taxmap/pubs/p537-002.htm#en_us_publink1000221777Generally, you must pay interest on the deferred tax related to any obligation that arises during a tax year from the disposition of property under the installment method if both of the following
apply.
- The property had a sales price over $150,000. In determining the sales price, treat all sales that are part of the same transaction as a single
sale.
- The total balance of all nondealer installment obligations arising during, and outstanding at the close of, the tax year is more than $5
million.
You must pay interest in subsequent years if installment obligations that originally required interest to be paid are still outstanding at the close of a tax
year.
taxmap/pubs/p537-002.htm#en_us_publink1000221779 This interest rule does not apply to dispositions of:
- Farm property,
- Personal use property by an individual,
- Personal property before 1989, or
- Real property before 1988.
First, find the underpayment rate in effect for the month with or within which your tax year ends. The underpayment rate is published quarterly in the Internal Revenue Bulletin, available at IRS.gov. Then multiply that rate by the deferred tax. The deferred tax is equal to the balance of the unrecognized gain at the end of the tax year multiplied by your maximum tax rate (ordinary or capital gain, as appropriate) in effect for the tax year.
For information on interest on dealer sales of timeshares and residential lots under the installment method, see section
453(l).
taxmap/pubs/p537-002.htm#en_us_publink1000221781Enter the interest as additional tax on your tax return. Individuals include it in the amount to be entered on the other taxes line (Form 1040, line 60, or Form 1040NR, U.S. Nonresident Alien Income Tax Return, line 59). In the space next to the line, indicate the amount with a code that identifies it. Generally, you will use "453A(c)" as the code. However, use "453(l)(3)" for interest on sales of timeshares or residential
lots.
U.S. corporations include the interest on the other taxes line on Form 1120, Schedule J, line 9f. Attach a statement showing the computation of each item included in the total on line 9f. Indicate the amount of interest from certain nondealer installment obligations with "Section 453A(c)." Indicate the amount of interest on sales of timeshares and residential lots with "Section
453(l)(3)."
Foreign corporations using Form 1120-F include the interest on the other taxes line (Form 1120-F, Schedule J, line 8). Check the "Other" box and attach a statement showing the computation of each item included in the total on line 8. Indicate the amount of interest from certain nondealer installment obligations with "Section 453A(c)." Indicate the amount of interest on sales of timeshares and residential lots with "Section
453(l)(3)."
Corporations can deduct the interest in the year it is paid or accrued. For individuals and other taxpayers, this interest is not deductible.
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