Installment Method

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. A cash basis farmer who is not required to maintain an inventory can use the installment method to report gain from the sale of property used or produced in farming.

If you finance the buyer's purchase of your property, instead of having the buyer get a loan or mortgage from a third party, you probably have an installment sale. It is not an installment sale if the buyer borrows the money from a third party and then pays you the total selling price.

If a sale qualifies as an installment sale, the gain must be reported under the installment method unless:

1. You elect out of using the installment method, or
2. You use an accrual method of accounting.

See Electing out, later, for information on recognizing the entire gain in the year of sale.

If you use an accrual method of accounting, you generally cannot use the installment method to report gain on any property sold or disposed of after December 16, 1999. However, this rule does not apply to the sale of property used or produced in farming. See Publication 538 for more information.

Sale at a loss. If your sale results in a loss, you cannot use the installment method. If the loss is on an installment sale of business assets, you can deduct it only in the tax year of sale. You cannot deduct a loss on the sale of property owned for personal use.

Form 6252. Each year, including the year of sale, report your income from an installment sale on Form 6252. Attach this form to your tax return.

Disposition of installment obligation. If you sell or discount an 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 this takes place during the year of sale, report your entire gain on your return for that year. If it takes place in a later year, you may have a disposition of an installment obligation.

Cancellation. If 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 fair market value at the time you cancel it. Fair market value (FMV) is discussed later.

Transfer due to death. The 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 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 the 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 gain or loss on the disposition.

More information. For more information on the disposition of an installment obligation, see Publication 537.

Inventory. The sale of farm inventory items 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 are paid in later years. However, if you are a cash basis farmer and are not required to maintain an inventory, you may be able to use the installment method to report the sale of property you use or produce in your farming business. For a definition of farm inventory, see Farm Inventory in chapter 3.

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.

Electing out. If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you will not receive all the sale proceeds in that year. You then do not report any gain from the payments you receive in later years.

To make this election, report the sale on Schedule D (Form 1040) or Form 4797, whichever applies, and not on Form 6252.

When to elect out. Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Once made, the election generally cannot be revoked. However, if you timely file your return for the year the sale takes place you can still make the election by filing an amended return within six months of the due date of the 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.

More information. See Electing Out of the Installment Method in Publication 537 for more information.

You must continue to report the interest income on payments you receive in subsequent years.

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