| Pub. 225, Farmer's Tax Guide |
2004 Tax Year |
Chapter 10 - Installment Sales
This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.
What's New
Bond or other debt received as payment. For sales on or after October 22, 2004, any bond or other evidence of debt you receive from the buyer that has interest coupons
attached or that
can be readily traded on an established securities market is treated as a payment in the year you receive it. For more information,
see
Bond under Property used as a payment, later.
Introduction
An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. If you realize
a gain on an
installment sale you may be able to report part of your gain when you receive each payment. This method of reporting gain
is called the installment
method. You cannot use the installment method to report a loss. You can choose to report all of your gain in the year of sale.
Installment obligation.
The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land contract,
mortgage, or other evidence of
the buyer's debt to you.
Topics - This chapter discusses:
-
The installment method
-
Figuring installment sale income
-
Payments received or considered received
-
Installment sale of a farm
Useful Items - You may want to see:
See chapter 16 for information about getting publications and forms.
An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. A 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 you elect out of
using the installment
method. See Electing out of the installment method, later, for information on recognizing the entire gain in the year of sale.
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.
Form 6252.
Use Form 6252 to report an installment sale in the year it takes place and to report payments received in later years.
Attach it to your tax return
for each year.
Disposition of installment obligation.
If you are using the installment method and you dispose of the 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 the original installment
sale produced
ordinary income, the disposition of the obligation will result in ordinary income or loss. If the original sale resulted in
a capital gain, the
disposition of the obligation will result in a capital gain or loss.
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 (FMV) at the time you cancel
it. If the parties are
related, the FMV of the obligation is considered to be no less than its full face value.
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 installment 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. If the holder and buyer were related,
the FMV of the
installment obligation is considered to be no less than its full face value.
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 receive payment in later years.
However, if you 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 examples of farm inventory, see Farm Inventory in chapter 2.
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 of the installment method.
If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though
you do not receive all the
sale proceeds in that year.
To make this election, do not report your sale on Form 6252. Instead, report it on Schedule D (Form 1040) or Form
4797, whichever applies.
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 can
be revoked only with IRS approval. However, if you timely file your tax return for the year the sale takes place you can still
make the election by
filing an amended return within 6 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.
Figuring Installment Sale Income
Each payment on an installment sale usually consists of the following three parts.
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.
See Unstated
interest, later.
Adjusted basis and installment sale income (Gain on sale).
After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if
it were made up of two parts.
-
A tax-free return of your adjusted basis in the property, and
-
Your gain (referred to as “installment sale income” on Form 6252).
Figuring adjusted basis for installment sale purposes.
You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. When you have
completed the worksheet, you
will also have determined the gross profit percentage necessary to figure your installment sale income (gain) for this year.
Worksheet A. Figuring Adjusted Basis and Gross Profit Percentage
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1.
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Enter the selling price for the property
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1.
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2.
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Enter your adjusted basis for the property
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2.
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3.
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Enter your selling expenses
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3.
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4.
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Enter any depreciation recapture
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4.
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5.
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Add lines 2, 3, and 4.
This is your adjusted basis
for installment sale purposes |
5.
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6.
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Subtract line 5 from line 1. If zero or less, enter -0-.
This is your gross profit |
6.
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| |
If the amount entered on line 6 is zero, Stop here. You cannot use the installment
method.
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7.
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Enter the contract price for the property
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7.
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8.
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Divide line 6 by line 7. This is your gross profit percentage |
8.
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Selling price.
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.
The selling price does not include interest, whether stated or unstated.
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.
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. See Depreciation
Recapture Income, in Publication 537.
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. However, see the example under
Selling price reduced,
later, for a situation where the gross profit percentage changes.
Example.
You sell property at a contract price of $2,000 and your gross profit is $500. Your gross profit percentage is 25% ($500 ÷
$2,000). 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.
Amount to report as installment sale income.
Multiply the payments you receive each year (less interest) by the gross profit percentage. The result is your installment
sales income for the tax
year. In certain circumstances, you may be treated as having received a payment, even though you received nothing directly.
A receipt of property or
the assumption of a mortgage on the property sold may be treated as a payment. For a detailed discussion, see Payments Received or Considered
Received, later.
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 included in your installment sale 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. See the
Form 6252 instructions for details.
For more information on the section 179 deduction, see Section 179 Deduction in chapter 7. 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 9.
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
the gross profit percentage
for the remaining payments. Refigure your gross profit using Worksheet B, New Gross Profit Percentage — Selling Price Reduced. You
will spread any remaining gain over future installments.
Worksheet B. New Gross Profit Percentage — Selling Price Reduced
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1.
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Enter the reduced selling
price for the property
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1.
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2.
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Enter your adjusted
basis for the
property
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2.
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3.
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Enter your selling
expenses
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3.
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4.
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Enter any depreciation
recapture
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4.
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5.
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Add lines 2, 3, and 4.
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5.
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6.
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Subtract line 5 from line 1.
This is your adjusted
gross profit |
6.
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7.
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Enter any installment sale
income reported in
prior year(s)
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7.
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8.
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Subtract line 7 from line 6
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8.
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9.
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Divide line 8 by line 6.
This is your new
gross profit percentage
*.
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9.
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* Apply this percentage to all future payments to determine how much of each of those payments is installment sale
income.
|
Example.
In 2002, 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 2003. Your gross
profit percentage is
60%. You reported a gain of $12,000 on each payment received in 2002 and 2003.
In 2004, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2004, 2005, and 2006 are reduced
to $15,000 for each
year.
The new gross profit percentage, 46.67%, is figured in Worksheet B.
You will report a gain of $7,000 (46.67% of $15,000) on each of the $15,000 installments due in 2004, 2005, and 2006.
Example — Worksheet B. New Gross Profit Percentage — Selling Price Reduced
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1.
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Enter the reduced selling
price for the property
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1.
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85,000
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|
2.
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Enter your adjusted
basis for the
property
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2.
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40,000
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3.
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Enter your selling
expenses
|
3.
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–0–
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4.
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Enter any depreciation
recapture
|
4.
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–0–
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5.
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Add lines 2, 3, and 4.
|
5.
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40,000
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|
6.
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Subtract line 5 from line 1.
This is your adjusted
gross profit |
6.
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45,000
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|
7.
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Enter any installment sale
income reported in
prior year(s)
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7.
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24,000
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|
8.
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Subtract line 7 from line 6
|
8.
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21,000
|
|
9.
|
Divide line 8 by line 6.
This is your new
gross profit percentage
*.
|
9.
|
46.67%
|
|
* Apply this percentage to all future payments to determine how much of each of those payments is installment sale
income.
|
Sale to a related person.
If you sell property to a related person and the sale is an installment sale, you may not be able to report the sale
using the installment method.
If you sell property to a related person and the related person disposes of the property before you receive all payments with
respect to the sale, you
may have to treat the amount realized by the related person as received by you when the related person disposes of the property.
The definition of
related persons depends on whether you sold depreciable property or the related person disposed of the property.
For information on these rules, see the instructions for Form 6252 and 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 to be held as business or investment
property, you can postpone
reporting the gain. See Like-Kind Exchanges in chapter 8 for a discussion of like-kind property.
If, in addition to like-kind property, you receive an installment obligation in the exchange, 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.
Payments Received or Considered Received
You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale.
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 your 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 not more than your installment sale basis in the property, 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 in the property, 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 receive
directly 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 adjusted 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 treated as a payment received in the year of sale. The contract price is $4,000:
Your gross profit on the sale is also $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 being sold. 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 debt the buyer assumes.
-
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 your business, such as a balance due for inventory you purchased.
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 then considered a payment to you in the year of sale.
Property used as a payment.
If you receive property rather than money from the buyer, it is still considered a payment in the year received. However,
see Trading property
for like-kind property, earlier. Generally, the amount of the payment is the property's FMV on the date you receive it.
Exception.
If the property the buyer gives you is payable on demand or readily tradable, the amount you should consider as payment
in the year received is:
-
The FMV of the property on the date you receive it if you use the cash receipts and disbursements method of accounting,
-
The face amount of the obligation on the date you receive it if you use the accrual method of accounting, or
-
The stated redemption price at maturity less any original issue discount (OID) or, if there is no OID, the stated redemption
price at
maturity appropriately discounted to reflect total unstated interest. See Unstated interest, later.
Fair market value (FMV).
This is the price at which property would change hands between a willing buyer and a willing seller, neither being
under any compulsion to buy or
sell and who both have a reasonable knowledge of all the necessary facts.
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 from
the third party are not
considered payments on the sale. However, see Exception under Property used as a payment, earlier.
Example.
You sold real estate in an installment sale. As part of the down payment, the buyer assigned to you a $50,000, 8% third-party
note. The FMV of the
third-party note at the time of the sale was $30,000. This amount, not $50,000, is a payment to you in the year of sale. The
third-party note had an
FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable
return of
capital. The remaining 40% is 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. However, see Exception under Property used as a payment, earlier.
For sales on or after October 22, 2004, any bond or other evidence of debt you receive from the buyer that has interest coupons
attached or that
can be readily traded on an established securities market is treated as a payment in the year you receive it. For information
on the amount you should
treat as a payment, see Exception under Property used as a payment , earlier.
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.
Any evidence of debt you receive from the buyer that is not payable on demand is not considered a payment, even if
it is guaranteed by a third
party, including a government agency.
Unstated interest.
An installment sale contract may provide that each deferred payment on the sale will include interest or that 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 the stated principal amount
of the contract may be
recharacterized as interest. If section 483 applies to the contract, this interest is called 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 (OID) 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 8 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 8.
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.
On January 3, 2004, 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 2004. 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 2003
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
|
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** Held less than 2 years
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***Held 2 years or more
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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 9 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 8.
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.
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 9.
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 2004 is $75,000 ($50,000
down payment + $25,000
payment on July 1). The installment sale part of the total payments received in 2004 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 9–1 in chapter 9.
Installment income for years after 2004.
You figure installment income for the years after 2004 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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