Publication 225 |
2000 Tax Year |
Figuring Installment 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, 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 adjusted
basis in the property.
Interest income.
You must report interest on Schedule B (Form 1040) 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. See
Unstated interest, later.
Return of basis and gain on sale.
The rest of each payment is treated as if it were made up of two
parts. One part is a tax-free return of your adjusted basis. The other
part is your gain.
Figuring gain part of payment. To figure what part of
any payment is gain, multiply the payment (less interest) by the gross
profit percentage. Use the following worksheet to figure the gross
profit percentage.
1) |
Selling price |
|
2) |
Installment sale basis: |
| Adjusted basis of property |
|
| Selling expenses |
|
| Depreciation recapture |
|
|
3) |
Gross profit (line 1 - line 2) |
|
4) |
Contract price |
|
5) |
Gross profit percentage
(line 3 x line 4) |
|
Selling price.
The selling price is the total cost of the property to the buyer.
It includes any money and the fair market value of any property you
are to receive. It also includes any debt the buyer pays, assumes, or
takes, to which the property is subject. The debt could be a note,
mortgage, or any other liability, such as a lien, accrued interest, or
taxes you owe on the property. If the buyer pays any of your selling
expenses, that amount is also included in the selling price. The
selling price does not include interest, whether stated or unstated.
Installment sale basis.
Three items comprise installment sale basis.
- Adjusted basis
- Selling expenses
- Depreciation recapture
Adjusted basis.
Basis is a way of measuring your investment in the property. The
way you figure basis depends on how you first acquired the property.
The basis of property you bought is generally its cost. The basis of
property you inherited, received as a gift, built yourself, or
received in a tax-free exchange is figured differently. See chapter 7
for information on determining basis.
While you own personal-use 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.
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 you took depreciation deductions on the asset, you may need to
recapture part of the gain on the sale of the asset as ordinary
income. See Sale of depreciable property, later.
Gross profit.
Gross profit is the total gain you report on the installment
method.
To figure your gross profit, subtract your installment sale basis
from the selling price. If the property you sold was your home,
subtract from the gross profit any gain you can exclude. See
Publication 523
for information on excluding gain on the sale of your
home.
Contract price.
The contract price is the total of all principal payments you are
to receive on the installment sale. It includes payments you are
considered to receive, even though you are not paid anything directly.
See Payments Received, later.
If part of the selling price is paid in cash and you hold a
mortgage payable from the buyer to you for the remainder, then the
contract price equals the selling price. The selling price is the
total cost of the property to the buyer.
Gross profit percentage.
A certain percentage of each payment (after subtracting interest)
is reported as gain from the sale. It is called the "gross profit
percentage" and is figured by dividing your gross profit by the
contract price.
The gross profit percentage generally remains the same for each
payment you receive. However, see Selling price reduced,
later, for an example of changing the gross profit percentage.
Example.
You sell property at a contract price of $200,000 and your gross
profit is $50,000. Your gross profit percentage is 25% ($50,000
x $200,000). After subtracting interest, you report 25% of each
payment, including the down payment, as gain from the sale for the tax
year you receive the payment.
Amount to include in income.
Each year as you receive payments on the installment sale, multiply
the payments (after subtracting interest) by the gross profit
percentage to determine the amount you must include in income for the
tax year.
Sale of depreciable property.
You cannot use the installment method to report any depreciation
recapture income up to the gain on the sale. However, report any gain
greater than the recapture income on the installment method. The
recapture income reported in the year of sale is added to the
property's adjusted basis to determine your gross profit on the
installment sale.
You generally cannot report gain from the sale of depreciable
property to a related person on the installment method. See Sale
to a Related Person in Publication 537.
Figure your depreciation recapture income (including the section
179 deduction and the section 179A deduction recapture) in Part III of
Form 4797. Report the depreciation recapture income in Part II of Form
4797 as ordinary income in the year of sale.
If you sell depreciable business property, prepare Form 4797 first
in order to figure the amount to enter on line 12 of Part I, Form
6252.
For more information on the section 179 deduction, see Section
179 Deduction in chapter 8.
For more information on the section
179A deductions, see chapter 12 in Publication 535.
For more
information on depreciation recapture, see Depreciation Recapture
in chapter 11.
Selling price reduced.
If the selling price is reduced at a later date, the gross profit
on the sale will also change. You must then refigure your gross profit
percentage for the remaining payments. Refigure your gross profit
using the reduced sale price and then subtract the gain already
reported. Spread the remaining gain over the future installments.
Example.
In 1998, you sold land with a basis of $40,000 for $100,000. Your
gross profit was $60,000. You received a $20,000 down payment and the
buyer's note for $80,000. The note provides for four annual payments
of $20,000 each, plus 12% interest, beginning in 1999. Your gross
profit percentage is 60%. You reported a gain of $12,000 on each
payment received in 1998 and 1999. In 2000, you and the buyer agreed
to reduce the purchase price to $85,000 and the payments for 2000,
2001, and 2002 are reduced to $15,000 for each year.
The new gross profit percentage, 46.67%, is figured as follows.
1) |
Reduced selling price |
$85,000 |
2) |
Minus: Basis |
40,000 |
3) |
Adjusted gross profit |
$45,000 |
4) |
Minus: Gain reported in 1998 & 1999 |
24,000 |
5) |
Gain to be reported |
$21,000 |
6) |
Selling price to be received: |
| Reduced selling price |
$85,000 |
| Minus: Payments received in 1998 and
1999 |
40,000 |
$45,000 |
7) |
New gross profit percentage
(line 5 x line 6) |
46.67% |
You will report a gain of $7,000 (46.67% of $15,000) on each of the
$15,000 installments due in 2000, 2001, and 2002.
Sale to a related person.
Special rules apply to an
installment sale between related persons. For purposes of these rules,
spouses, children, grandchildren, brothers, sisters, and parents are
all considered related persons. A partnership or corporation in which
you have an interest, or an estate or trust with which you have a
connection, can also be considered a related person.
For information on these rules, see Sale to a Related Person
in Publication 537.
Trading property for like-kind property.
If you trade business or investment property solely for the same
kind of property, you can postpone reporting the gain. See
Like-Kind Exchanges in chapter 10
for a discussion of
like-kind property.
If the trade includes an installment obligation, the following
rules apply.
- 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.
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