Installment sale
From Wikicpa
An installment sale is a sales arrangement whereby the selling price is collected in periodical installments. A down payment is usually required and the uncollected balance is subject (usually) to interest.
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Conditions of sale
Due to an increased in risk by the furture collections, the seller sometimes will include the following items in the purchsae contract.
- Retention of title by the seller
- Immediate transfer of title subject to a mortage for any uncollected installments
- Title held by an independent third party until the final payment is made
General Tax Tips
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
- You are not a qualified accrual method taxpayer
Source: IRS Publication 537
Tax Treatment
Figuring Installment Sale Income
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 the interest part in income, as well as 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 tax purposes. Interest Income
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.
Example
The selling price is the total cost of the property to the buyer. It includes:
- Any money you are to receive,
- The fair market value (FMV) of any property you are to receive (FMV is discussed later under Property Used As a Payment.),
- 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), and
- 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.
Adjusted basis for installment sale purposes. Your adjusted basis is the total of the following three items.
- Adjusted basis.
- Selling expenses.
- Depreciation recapture.
Adjusted basis. Basis is the amount of your investment in the property for tax 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.
Selling expenses. Selling expenses are any expenses that 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.
Depreciation recapture. If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income.
Gross profit. 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.
Contract price. Contract price equals the selling price plus mortgages, debts, and other liabilities assumed or taken by the buyer that are in excess of your adjusted basis for installment sale purposes.
Gross profit percentage. 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.
Example.
You sell property at a contract price of $6,000 and your gross profit is $1,500. Your gross profit percentage is 25% ($1,500 รท $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.
