Installment Sales Introduction

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Question or Topic

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The Question: What is taxed if I do not receive all of the sales proceeds in the year the property is sold?

Objectives - Determine the tax treatment when the sales price is paid in multiple payments.

Property Sales - Installment Sales Organizer

1040 Installment Sale Organizer

Installment Sales for Dealers

	The Answer

What is an "Installment Sale"

An installment sale is a sale of property at a gain where at least one payment is to be received after the tax year in which the sale occurs. You are required to report the sale on the installment method unless you "elect out" in the year of the sale. If you elect out, you report all the gain as income in the year of the sale. Installment sale rules do not apply to losses. You cannot use the installment method to report gain from the sale of inventory or stocks and securities traded on an established securities market.

Under the installment method, you include in income each year only part of the gain you receive, or are considered to have received plus the interest. Use Form 6252, Installment Sale Income, to report installment income each year. You will need to file the IRS Form you ordinarily use for reporting your income tax, and you may need to attach Form 4797 and Schedule D.

In general, interest should be charged on an installment sale. If interest is not charged or the interest rate is too low, the law states that there is a minimum amount of interest you, as a seller, are considered to have received. This "imputed" or "unstated" interest is taxable. You must use the applicable federal rate (AFR) to figure the unstated interest on the sale. The rates are published monthly in the Internal Revenue Bulletin.

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 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 that method.

When reporting a sale of depreciable property, you must include any depreciation recapture income (up to the amount of the gain) in income for the year of sale. Report any remaining gain on the installment method.

Therefore, you will need to be certain the down payment and initial cash payments you receive before your tax year ends will provide you the cash you need for the closing, making any other payments regarding the sale, paying off any debt on the property and paying the tax which will be due on the sale -

Danger and Warning

including the tax which will be due on the amount of depreciation you have claimed since you owned the property !

Danger and Warning — tax will be due on the amount of depreciation you have claimed since you owned the property !

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, 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 you sell or discount the obligation during the year of sale, report your entire gain on your return for that year. If the transaction 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, not 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.

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.

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. 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.

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 do 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, 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 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.

	Solutions

Solutions are dependent upon facts & circumstances, law and the objectives. These elements vary from one time to another, from one circumstance to another and from person or entity to another.

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