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taxmap/pubs/p225-043.htm#TXMP19fb7192 Figuring Installment Sale Income(p60)

Installment Sale

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, you must include in income both the interest part and 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 installment sale purposes.

taxmap/pubs/p225-043.htm#TXMP489b27b8 Interest income.(p60)

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.

taxmap/pubs/p225-043.htm#TXMP71f54fd7 Adjusted basis and installment sale income (gain on sale).(p60)

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).

taxmap/pubs/p225-043.htm#TXMP149fbc76 Figuring adjusted basis for installment sale purposes.(p60)

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.

taxmap/pubs/p225-043.htm#w15067v0101

Worksheet A. Figuring Adjusted Basis and Gross Profit Percentage 1. Enter the selling price for the property              2. Enter your adjusted basis for the property                3. Enter your selling expenses                4. Enter any depreciation recapture                5. Add lines 2, 3, and 4. This is your adjusted basis for installment sale purposes              6. Subtract line 5 from line 1. If zero or less, enter -0-. This is your gross profit                If the amount entered on line 6 is zero, Stop here. You cannot use the installment method.   7. Enter the contract price for the property              8. Divide line 6 by line 7. This is your gross profit percentage

taxmap/pubs/p225-043.htm#TXMP0b039506 Selling price.(p60)

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 at Property used as a payment under Payments Received or Considered Received),
• 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.

Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount.

taxmap/pubs/p225-043.htm#TXMP5a21c161 Adjusted basis for installment sale purposes.(p60)

Your adjusted basis is the total of the following three items.

• Adjusted basis.
• Selling expenses.
• Depreciation recapture.

taxmap/pubs/p225-043.htm#TXMP18bc4b81 Adjusted basis.(p60)

Basis is the amount of your investment in the property for installment sale 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.

taxmap/pubs/p225-043.htm#TXMP181304ad Selling expenses.(p61)

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.

taxmap/pubs/p225-043.htm#TXMP35ae99c6 Depreciation recapture.(p61)

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.

taxmap/pubs/p225-043.htm#TXMP5b4c60dc Gross profit.(p61)

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.

taxmap/pubs/p225-043.htm#TXMP5e993eb2 Contract price.(p61)

Contract price equals:

1. The selling price, minus
2. The mortgages, debts, and other liabilities assumed or taken by the buyer, plus
3. The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes.

taxmap/pubs/p225-043.htm#TXMP3da0b9c8 Gross profit percentage.(p61)

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.

taxmap/pubs/p225-043.htm#TXMP3f024022
Example.(p61)

You sell property at a contract price of $6,000 and your gross profit is $1,500. Your gross profit percentage is 25% ($1,500 ÷ $6,000). 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.

taxmap/pubs/p225-043.htm#TXMP2b5abb2d (p61)

taxmap/pubs/p225-043.htm#TXMP60f6b1a4 Amount to report as installment sale income.(p61)

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.

taxmap/pubs/p225-043.htm#TXMP0f8b0f11 Sale of depreciable property.(p61)

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.

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.

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 depreciation recapture, see Depreciation Recapture in chapter 9.

taxmap/pubs/p225-043.htm#TXMP1c0d153b Selling price reduced.(p61)

If the selling price is reduced at a later date, the gross profit on the sale also will change. You then must 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.

taxmap/pubs/p225-043.htm#w15067v0102

Worksheet B. New Gross Profit Percentage — Selling Price Reduced 1. Enter the reduced selling price for the property              2. Enter your adjusted basis for the property                3. Enter your selling expenses                4. Enter any depreciation recapture                5. Add lines 2, 3, and 4.              6. Subtract line 5 from line 1. This is your adjusted gross profit              7. Enter any installment sale income reported in prior year(s)              8. Subtract line 7 from line 6              9. Future installments                10. Divide line 8 by line 9. This is your new gross profit percentage*.              * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income.

taxmap/pubs/p225-043.htm#TXMP465c0ea5
Example.(p61)

In 2005, 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 2006. Your gross profit percentage is 60%. You reported a gain of $12,000 on each payment received in 2005 and 2006.

In 2007, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2007, 2008, and 2009 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 2007, 2008, and 2009.

taxmap/pubs/p225-043.htm#w15067v0103

Example — Worksheet B. New Gross Profit Percentage — Selling Price Reduced 1. Enter the reduced selling price for the property 85,000 2. Enter your adjusted basis for the property 40,000   3. Enter your selling expenses -0-   4. Enter any depreciation recapture -0-   5. Add lines 2, 3, and 4. 40,000 6. Subtract line 5 from line 1. This is your adjusted gross profit 45,000 7. Enter any installment sale income reported in prior year(s) 24,000 8. Subtract line 7 from line 6 21,000 9. Future installments   45,000 10. Divide line 8 by line 9. This is your new gross profit percentage*. 46.67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income.

taxmap/pubs/p225-043.htm#TXMP2905bb93 Sale to a related person.(p61)

If you sell depreciable 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. For information on these rules, see the instructions for Form 6252 and Sale to a Related Person in Publication 537.

taxmap/pubs/p225-043.htm#TXMP7e8032e0 Trading property for like-kind property.(p61)

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 to determine installment sale income each year.

• 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.

Previous Page:  Publication 225 - Farmer's Tax Guide - Installment Method Next Page:  Publication 225 - Farmer's Tax Guide - Payments Received or Considered Received Use   to find additional occurrences of topic items.