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taxmap/pubs/p225-044.htm#TXMP05fff125 Payments Received or Considered Received(p62)

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. However, as discussed later, the buyer's assumption of your debt is treated as a recovery of basis, rather than as a payment, in many cases.

taxmap/pubs/p225-044.htm#TXMP6200b778 Buyer pays seller's expenses.(p62)

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.

taxmap/pubs/p225-044.htm#TXMP4ab45d48 Buyer assumes mortgage.(p62)

If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply.

taxmap/pubs/p225-044.htm#TXMP4ca1f6ab Mortgage less than basis.(p62)

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 considered a recovery of your basis. The contract price is the selling price minus the mortgage.

taxmap/pubs/p225-044.htm#TXMP23ebde38
Example.(p62)

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.

taxmap/pubs/p225-044.htm#TXMP0c2b825d Mortgage more than basis.(p62)

If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. 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 always will be 100%.

taxmap/pubs/p225-044.htm#TXMP211afbcb
Example.(p62)

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:

Selling price		$9,000
Minus: Mortgage		(6,000)
Amount actually received		$3,000
Add difference:
Mortgage	$6,000
Minus: Installment sale basis	n5,000	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 (less interest) 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.

taxmap/pubs/p225-044.htm#TXMP565a6660 Buyer assumes other debts.(p62)

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 or your legal fees relating to the sale, 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.

taxmap/pubs/p225-044.htm#TXMP02950e21 Property used as a payment.(p62)

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.

taxmap/pubs/p225-044.htm#TXMP450fa2aa Exception.(p62)

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.

taxmap/pubs/p225-044.htm#TXMP35a4a771 Debt not payable on demand.(p62)

Any evidence of debt you receive from the buyer that is not payable on demand is not considered a payment. This is true even if the debt is guaranteed by a third party, including a government agency.

taxmap/pubs/p225-044.htm#TXMP76a557a0 Fair market value (FMV).(p62)

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 both having a reasonable knowledge of all the necessary facts.

taxmap/pubs/p225-044.htm#TXMP17b1253e Third-party note.(p62)

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 FMV of 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. The excess of the note's face value over its FMV is interest. Exclude this interest in determining the selling price of the property. However, see Exception under Property used as a payment, earlier.

taxmap/pubs/p225-044.htm#TXMP2f1e467f
Example.(p62)

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 interest taxed as ordinary income.

taxmap/pubs/p225-044.htm#TXMP71b230bb Bond.(p62)

A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. For more information on the amount you should treat as a payment, see Exception, under Property used as a payment, earlier.

If you receive a government or corporate bond for a sale before October 22, 2004, and the bond has interest coupons attached or 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.

taxmap/pubs/p225-044.htm#TXMP34571e55 Buyer's note.(p62)

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.

taxmap/pubs/p225-044.htm#TXMP10963bdc Unstated interest.(p63)

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 Internal Revenue Code section 483 applies to the contract, this interest is called unstated interest.

If Internal Revenue Code section 1274 applies to the contract, this interest is called original issue discount (OID).

In general, an installment sale contract provides for adequate stated interest if the stated interest rate (based on an appropriate compounding period) is at least equal to the applicable federal rate (AFR).

The AFRs 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 IRS website at www.irs.gov.

Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Therefore, the buyer cannot deduct the unstated interest. The seller must report the unstated interest as income. 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.

If the debt is subject to the IRC section 483 rules and is also subject to the below-market loan rules, such as a gift loan, compensation-related loan or corporation-shareholder loan, then both parties are subject to the below-market loan rules rather than the unstated interest rules.

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.

taxmap/pubs/p225-044.htm#TXMP7e6ffd62 More information.(p63)

For more information, see Unstated Interest and Original Issue Discount (OID) in Publication 537.

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