Payments Received
Including Payments Considered Received
You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale. These payments include the
down payment and each later payment of principal on the buyer's debt to you.
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. See Mortgage less than
basis, later for an exception to this rule.
Buyer pays seller's expenses.
If the buyer pays any of the 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.
Buyer assumes mortgage.
If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply.
Mortgage less than basis.
If the buyer assumes a mortgage that is less than your installment sale basis, it is not considered a payment to you. It is actually a recovery of
your basis. The selling price minus the mortgage equals the contract price.
Example.
You 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.
Mortgage more than basis.
If the buyer assumes a mortgage that is more than your installment sale basis, you recover your entire basis. You are also relieved of the
obligation to repay the amount borrowed. 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 you will directly receive 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 will always be 100%.
Example.
The 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 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 is 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 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.
Buyer assumes other debts.
If 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. 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 debts.
- 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 business, such as a balance due for inventory.
If the buyer assumes any other type of debt, such as a personal loan, 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 considered a payment to you in the year of sale.
Payment of property.
If you receive property rather than money from the buyer, it is still considered a payment. However, see Trading property for like-kind
property, earlier. The amount of the payment is the property's FMV on the date you receive it.
Fair market value (FMV).
This is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, who both have
reasonable knowledge of all the necessary facts. If your installment sale fits this description, the value assigned to property in your agreement with
the buyer is good evidence of its FMV.
Third-party note.
If 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 note is itself a payment on your installment sale, any payments you later receive on the note are not considered
payments on your sale.
Example.
You sold real estate in an installment sale. As part of the down payment, the buyer assigned to you a $5,000, 8% third-party note. The FMV of the
third-party note at the time of your sale was $3,000. This amount, not $5,000, is a payment to you in the year of sale. Because the third-party note
had an FMV equal to 60% of its face value ($3,000 ÷ $5,000), 60% of each payment of principal you receive on this note is a nontaxable return
of capital. The remaining 40% is taxed as ordinary income.
Bond.
A bond or other evidence of debt you receive from the buyer that is payable on demand is treated as a payment in the year you receive it. If you
receive a government or corporate bond that has interest coupons attached or that can be readily traded in an established securities market, you are
considered to have received payment equal to the bond's FMV.
Buyer's note.
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.
Guarantee.
If a third party or government agency guarantees the buyer's payments to you, the guarantee itself is not considered payment.
Unstated interest.
An installment sale contract generally provides that each deferred payment on the sale will include interest or 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 each payment due more than 6 months after the date of sale
may be treated as interest. The amount treated as interest is referred to as unstated interest.
When the stated interest rate in the contract is lower than the applicable federal rate, unstated interest is the difference between interest
figured at the federal rate and interest figured at the rate specified in the sales contract.
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 the Internet at www.irs.gov.
Generally, the unstated interest rules do not apply to a debt given in consideration for a sale or exchange of personal-use property.
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.
Unstated interest reduces the stated selling price of the property and the buyer's basis in the property. It increases the seller's interest income
and the buyer's interest expense.
More information.
For more information, see Unstated Interest and Original Issue Discount in Publication 537.
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 chapter 10 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
generally taxable as ordinary income in the year of sale. See Depreciation recapture, later. This applies even if no payments are received
in that year.
Example
On January 3, 2002, 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 2002. Your selling expenses were $15,000.
Adjusted basis and depreciation.
The adjusted basis and depreciation claimed on each asset sold are as follows:
| |
Depreciation |
Adjusted |
| Asset |
Claimed |
Basis |
| Home* |
-0- |
$30,000 |
| Land |
-0- |
61,250 |
| Buildings |
$31,500 |
28,500 |
| Truck |
3,001 |
1,499 |
| Equipment |
15,811 |
9,189 |
| Tractor |
15,811 |
9,189 |
| Cattle** |
1,977 |
2,023 |
| Cattle*** |
19,167 |
833 |
| * Owned and used as main home for at least 2 of the 5 years prior to the sale |
| ** Held less than 2 years |
| ***Held 2 years or more |
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 2001 in anticipation of
selling the farm. The section 179 deduction was not claimed on any asset.
| |
Selling |
Selling |
Adjusted |
|
| |
Price |
Expense |
Basis |
Gain |
| Home* |
$50,000 |
$2,500 |
$30,000 |
$17,500 |
| Land |
125,000 |
6,250 |
61,250 |
57,500 |
| Buildings |
55,000 |
2,750 |
28,500 |
23,750 |
| Truck |
5,000 |
250 |
1,499 |
3,251 |
| Equip. |
17,000 |
850 |
9,189 |
6,961 |
| Tractor |
23,000 |
1,150 |
9,189 |
12,661 |
| Cattle** |
5,000 |
250 |
2,023 |
2,727 |
| Cattle*** |
20,000 |
1,000 |
833 |
18,167 |
| |
$300,000 |
$15,000 |
$142,483 |
$142,517 |
| * Owned and used as main home for at least 2 of the 5 years prior to the sale |
| ** Held less than 2 years |
| ***Held 2 years or more |
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 2 years or more 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.
| |
|
Installment |
|
| |
Selling |
Sale |
Gross |
| |
Price |
Basis |
Profit |
| Farm land |
$125,000 |
$67,500 |
$57,500 |
| Buildings |
55,000 |
31,250 |
23,750 |
| Truck |
5,000 |
4,750 |
250 |
| Cattle* |
5,000 |
4,250 |
750 |
| |
$190,000 |
$107,750 |
$82,250 |
| * Held less than 2 years |
|
Section 1231 gains.
The ordinary income part of the gain on the truck is reported in the year of sale, so 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:
| |
Percent |
| Farm land ($57,500 ÷ $140,000) |
41.0714 |
| Buildings ($23,750 ÷ $140,000) |
16.9643 |
| Truck ($250 ÷ $140,000) |
0.1786 |
| Cattle* ($750 ÷ $140,000) |
0.5357 |
| Total |
58.75 |
| * Held less than 2 years |
|
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 2002 is $75,000 ($50,000 down payment + $25,000
payment on July 1). The installment sale part of the total payments received in 2002 is $42,000 ($75,000 × .56). Figure the gain to report for
each asset by multiplying its gross profit percentage times $42,000.
| |
Income |
| Farm land - 41.0714% × $42,000 |
$17,250 |
| Buildings - 16.9643% × $42,000 |
7,125 |
| Truck - 0.1786% × $42,000 |
75 |
| Cattle* - 0.5357% × $42,000 |
225 |
| Total installment income for 2002 |
$24,675 |
| * Held less than 2 years |
|
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 2002.
You figure installment income for the years after 2002 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:
| |
Income |
| Farm land - 41.0714% × $28,000 |
$11,500 |
| Buildings - 16.9643% × $28,000 |
4,750 |
| Truck - 0.1786% × $28,000 |
50 |
| Cattle* - 0.5357% × $28,000 |
150 |
| Total installment income |
$16,450 |
| * Held less than 2 years |
|
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:
| Selling price |
$190,000 |
| Minus: Installment basis |
(107,750) |
| Gross profit |
$82,250 |
| Gain reported in 2002 (year of sale) |
$24,675 |
| Gain reported in 2003: |
|
| $28,000 × 58.75% |
16,450 |
| Gain reported in 2004: |
|
| $28,000 × 58.75% |
16,450 |
| Gain reported in 2005: |
|
| $28,000 × 58.75% |
16,450 |
| Gain reported in 2006: |
|
| $14,000 × 58.75% |
8,225 |
| Total gain reported |
$82,250 |
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