Installment Sale of a Farm

The installment sale of a farm for one overall price under a single contract is not the sale of a single asset. It generally includes the sale of real property and personal property reportable on the installment method. It may also include the sale of farm inventory, which cannot be reported on the installment method. See Inventory, earlier. The selling price must be allocated to determine the amount received for each class of asset.

The tax treatment of the gain or loss on the sale of each class of assets is determined by its classification as a capital asset or as property used in the business, and by the length of time held. (See chapters 10 and 11 for a discussion of capital assets.) Separate computations must be made to figure the gain or loss for each class of asset sold. See Sale of a Farm in chapter 10.

If you report the sale of property on the installment method, any depreciation recapture under section 1245 or 1250 of the Internal Revenue Code is taxable as ordinary income in the year of sale. This applies even if no payments are received in that year.

Example

On January 3, 2001, you sold your farm, including the equipment and livestock (cattle used for breeding). You received $50,000 down and the buyer's note for $200,000. In addition, the buyer assumed an outstanding $50,000 mortgage on the farm land. The total selling price was $300,000. The note payments of $25,000 each, plus adequate interest, are due every July 1 and January 1, beginning in July 2001. Your selling expenses were $15,000.

Adjusted basis and depreciation. The adjusted basis and depreciation claimed on each asset sold are as follows:

Gain on each asset. The following schedule shows the assets included in the sale, each asset's selling price based on its respective value, the selling expense allocated to each asset, the adjusted basis of each asset, and the gain on each asset. The selling expense for each asset is 5% of the selling price ($15,000 selling expense × $300,000 selling price). The livestock and produce held for sale were sold before the end of 2000 in anticipation of selling the farm. The section 179 deduction was not claimed on any asset.

Depreciation recapture. The buildings are section 1250 property. There is no depreciation recapture income for them because they were depreciated using the straight line method. See chapter 11 for more information on depreciation recapture.

Special rules may apply when you sell section 1250 assets depreciated under the straight line method. See the Unrecaptured Section 1250 Gain Worksheet in the instructions for Schedule D (Form 1040).

The truck used for hauling is section 1245 property. The entire depreciation of $3,001 is recapture income because it is less than the gain on the truck. The remaining gain of $250 is reported on the installment method.

The equipment and tractor are section 1245 property. The entire gain on each ($6,961 and $12,661, respectively) is depreciation recapture income.

The cattle used for breeding and held for less than 2 years are section 1245 property. The entire depreciation of $1,977 is recapture income because it is less than the gain. The remaining gain of $750 is reported on the installment method.

The cattle used for breeding and held for more than 2 years are also section 1245 property. Since the gain of $18,167 is less than the depreciation claimed ($19,167), the total gain is depreciation recapture income.

The total depreciation recapture income figured in Part III of Form 4797 is $42,767. (This is the sum of: $3,001 + $6,961 + $12,661 + $1,977 + $18,167.) Depreciation recapture income is reported as ordinary income in the year of sale even if no payments were received.

The part of the gain reported as depreciation recapture income on the truck and the cattle held less than 2 years ($3,001 and $1,977) is added to the adjusted basis of each property when making the installment sale computations.

Assets not reported on the installment method. In the year of sale, the gain on the cattle held 2 years or more, the equipment, and the tractor is reported in full. Because the entire gain on the home can be excluded from income, the installment method does not apply to the sale of the home. See Sale of your home in chapter 10. The selling price of these assets ($110,000) is subtracted from the total selling price ($300,000). The selling price for the assets included in the installment sale is $190,000.

Installment sale basis and gross profit. The following table shows each asset reported on the installment method, its selling price, installment sale basis, and gross profit.

Section 1231 gains. Since the ordinary income part of the gain on the truck is reported in the year of sale, the remaining gain ($250) and the gain on the land and buildings are reported as section 1231 gains. The cattle held for less than 2 years do not qualify for section 1231 treatment. The $750 gain on their sale is reported as ordinary gain in Part II of Form 4797 as payments are received. See Section 1231 Gains and Losses in chapter 11.

Contract price and gross profit percentage. The contract price is $140,000 for the part of the sale reported on the installment method. This is the selling price ($300,000) minus the mortgage assumed ($50,000) minus the selling price of the assets with gains fully reported in the year of sale or excluded from income ($110,000).

Gross profit percentage for the sale is 58.75% ($82,250 gross profit × $140,000 contract price). The gross profit percentage for each asset is figured as follows:

Figuring the gain to report on the installment method. Only 56% of each payment is reported on the installment method [$140,000 contract price × $250,000 to be received on the sale ($300,000 selling price - $50,000 mortgage assumed)]. The total amount received on the installment sale in 2001 is $75,000 ($50,000 down payment + $25,000 payment on July 1). The installment sale part of the total payments received in 2001 is $42,000 ($75,000 × .56). Figure the gain to report for each asset by multiplying its gross profit percentage times $42,000.

Reporting the sale. Report the installment sale on Form 6252. Then report the amounts from Form 6252 on Form 4797 and Schedule D (Form 1040). Attach a separate page to Form 6252 that shows the computations in the example.

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.

Section 1231 gains. The gains on the land, buildings, and truck are section 1231 gain. They may be reported as either capital or ordinary gain depending on the net balance when combined with other section 1231 losses. A net 1231 gain is capital gain and a net 1231 loss is an ordinary loss.

Depreciation recapture and gain on cattle. In the year of sale, you must report the total depreciation recapture income on Form 4797. The $225 gain on the cattle held less than 2 years is ordinary income reported in Part II of Form 4797. See Table 11-1 in chapter 11.

Installment income for years after 2001. You figure installment income for the years after 2001 by applying the same gross profit percentages to the payments you receive each year. If you receive $50,000 during the year, $28,000 is considered received on the installment sale (56% × $50,000). You realize income as follows:

In this example, no gain is ever recognized from the sale of your home. You will report the gain on cattle held less than 2 years as ordinary gain in Part II of Form 4797. You will combine your section 1231 gains with section 1231 losses in each of the later years to determine whether to report them as ordinary or capital gains. The interest received with each payment will be included in full as ordinary income.

Summary. The installment income (rounded to the nearest dollar) from the sale of the farm is reported as follows:

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