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Free tax software Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. Free tax software General RulesFiguring Installment Sale Income Reporting Installment Sale Income Other RulesElecting Out of the Installment Method Payments Received or Considered Received Escrow Account Depreciation Recapture Income Sale to a Related Person Like-Kind Exchange Contingent Payment Sale Single Sale of Several Assets Sale of a Business Unstated Interest and Original Issue Discount (OID) Disposition of an Installment Obligation Repossession Interest on Deferred Tax Reporting an Installment SaleRelated person. Free tax software Several assets. Free tax software Special situations. Free tax software Schedule D (Form 1040). Free tax software Form 4797. Free tax software How To Get Tax Help What Is an Installment Sale? An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. Free tax software The rules for installment sales do not apply if you elect not to use the installment method (see Electing Out of the Installment Method under Other Rules, later) or the transaction is one for which the installment method may not apply. Free tax software The installment sales method cannot be used for the following. Free tax software Sale of inventory. Free tax software   The regular sale of inventory of personal property does not qualify as an installment sale even if you receive a payment after the year of sale. Free tax software See Sale of a Business under Other Rules, later. Free tax software Dealer sales. Free tax software   Sales of personal property by a person who regularly sells or otherwise disposes of the same type of personal property on the installment plan are not installment sales. Free tax software This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. Free tax software However, the rule does not apply to an installment sale of property used or produced in farming. Free tax software Special rule. Free tax software   Dealers of time-shares and residential lots can treat certain sales as installment sales and report them under the installment method if they elect to pay a special interest charge. Free tax software For more information, see section 453(l). Free tax software Stock or securities. Free tax software   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. Free tax software You must report the entire gain on the sale in the year in which the trade date falls. Free tax software Installment obligation. Free tax software   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. Free tax software General Rules 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. Free tax software See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. Free tax software Sale at a loss. Free tax software   If your sale results in a loss, you cannot use the installment method. Free tax software If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. Free tax software Unstated interest. Free tax software   If your sale calls for payments in a later year and the sales contract provides for little or no interest, you may have to figure unstated interest, even if you have a loss. Free tax software See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Free tax software Figuring Installment Sale Income You can use the following discussions or Form 6252 to help you determine gross profit, contract price, gross profit percentage, and installment sale income. Free tax software Each payment on an installment sale usually consists of the following three parts. Free tax software Interest income. Free tax software Return of your adjusted basis in the property. Free tax software Gain on the sale. Free tax software 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. Free tax software You do not include in income the part that is the return of your basis in the property. Free tax software Basis is the amount of your investment in the property for installment sale purposes. Free tax software Interest Income You must report interest as ordinary income. Free tax software Interest is generally not included in a down payment. Free tax software 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. Free tax software Interest provided in the agreement is called stated interest. Free tax software If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Free tax software See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Free tax software 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. Free tax software A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). Free tax software Figuring adjusted basis for installment sale purposes. Free tax software   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. Free tax software 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. Free tax software Worksheet A. Free tax software Figuring Adjusted Basis and Gross Profit Percentage 1. Free tax software Enter the selling price for the property   2. Free tax software Enter your adjusted basis for the property     3. Free tax software Enter your selling expenses     4. Free tax software Enter any depreciation recapture     5. Free tax software Add lines 2, 3, and 4. Free tax software  This is your adjusted basis for installment sale purposes   6. Free tax software Subtract line 5 from line 1. Free tax software If zero or less, enter -0-. Free tax software  This is your gross profit     If the amount entered on line 6 is zero, stop here. Free tax software You cannot use the installment method. Free tax software   7. Free tax software Enter the contract price for the property   8. Free tax software Divide line 6 by line 7. Free tax software This is your gross profit percentage   Selling price. Free tax software   The selling price is the total cost of the property to the buyer and includes any of the following. Free tax software Any money you are to receive. Free tax software The fair market value (FMV) of any property you are to receive (FMV is discussed in Property Used As a Payment under Other Rules, later). Free tax software 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). Free tax software Any of your selling expenses the buyer pays. Free tax software   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Free tax software Adjusted basis for installment sale purposes. Free tax software   Your adjusted basis is the total of the following three items. Free tax software Adjusted basis. Free tax software Selling expenses. Free tax software Depreciation recapture. Free tax software Adjusted basis. Free tax software   Basis is your investment in the property for installment sale purposes. Free tax software The way you figure basis depends on how you acquire the property. Free tax software The basis of property you buy is generally its cost. Free tax software The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Free tax software   While you own property, various events may change your original basis. Free tax software Some events, such as adding rooms or making permanent improvements, increase basis. Free tax software Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Free tax software The result is adjusted basis. Free tax software   For more information on how to figure basis and adjusted basis, see Publication 551. Free tax software For more information regarding your basis in property you inherited from someone who died in 2010 and whose executor filed Form 8939, Allocation of Increase In Basis for Property Acquired From a Decedent, see Publication 4895. Free tax software Selling expenses. Free tax software   Selling expenses relate to the sale of the property. Free tax software They include commissions, attorney fees, and any other expenses paid on the sale. Free tax software Selling expenses are added to the basis of the sold property. Free tax software Depreciation recapture. Free tax software   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Free tax software See Depreciation Recapture Income under Other Rules, later. Free tax software Gross profit. Free tax software   Gross profit is the total gain you report on the installment method. Free tax software   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Free tax software If the property you sold was your home, subtract from the gross profit any gain you can exclude. Free tax software See Sale of Your Home , later, under Reporting Installment Sale Income. Free tax software Contract price. Free tax software   Contract price equals: The selling price, minus The mortgages, debts, and other liabilities assumed or taken by the buyer, plus The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes. Free tax software Gross profit percentage. Free tax software   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Free tax software This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Free tax software   The gross profit percentage generally remains the same for each payment you receive. Free tax software However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. Free tax software Example. Free tax software You sell property at a contract price of $6,000 and your gross profit is $1,500. Free tax software Your gross profit percentage is 25% ($1,500 ÷ $6,000). Free tax software 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. Free tax software The remainder (balance) of each payment is the tax-free return of your adjusted basis. Free tax software Amount to report as installment sale income. Free tax software   Multiply the payments you receive each year (less interest) by the gross profit percentage. Free tax software The result is your installment sale income for the tax year. Free tax software In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Free tax software A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Free tax software For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. Free tax software Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. Free tax software You then must refigure the gross profit percentage for the remaining payments. Free tax software Refigure your gross profit using Worksheet B. Free tax software You will spread any remaining gain over future installments. Free tax software Worksheet B. Free tax software New Gross Profit Percentage — Selling Price Reduced 1. Free tax software Enter the reduced selling  price for the property   2. Free tax software Enter your adjusted  basis for the  property     3. Free tax software Enter your selling  expenses     4. Free tax software Enter any depreciation  recapture     5. Free tax software Add lines 2, 3, and 4. Free tax software   6. Free tax software Subtract line 5 from line 1. Free tax software  This is your adjusted  gross profit   7. Free tax software Enter any installment sale  income reported in  prior year(s)   8. Free tax software Subtract line 7 from line 6   9. Free tax software Future installments   10. Free tax software Divide line 8 by line 9. Free tax software  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. Free tax software Example. Free tax software In 2011, you sold land with a basis of $40,000 for $100,000. Free tax software Your gross profit was $60,000. Free tax software You received a $20,000 down payment and the buyer's note for $80,000. Free tax software The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. Free tax software Your gross profit percentage is 60%. Free tax software You reported a gain of $12,000 on each payment received in 2011 and 2012. Free tax software In 2013, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2013, 2014, and 2015 are reduced to $15,000 for each year. Free tax software The new gross profit percentage, 46. Free tax software 67%, is figured on Example—Worksheet B. Free tax software You will report a gain of $7,000 (46. Free tax software 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. Free tax software Example — Worksheet B. Free tax software New Gross Profit Percentage — Selling Price Reduced 1. Free tax software Enter the reduced selling  price for the property 85,000 2. Free tax software Enter your adjusted  basis for the  property 40,000   3. Free tax software Enter your selling  expenses -0-   4. Free tax software Enter any depreciation  recapture -0-   5. Free tax software Add lines 2, 3, and 4. Free tax software 40,000 6. Free tax software Subtract line 5 from line 1. Free tax software  This is your adjusted  gross profit 45,000 7. Free tax software Enter any installment sale  income reported in  prior year(s) 24,000 8. Free tax software Subtract line 7 from line 6 21,000 9. Free tax software Future installments 45,000 10. Free tax software Divide line 8 by line 9. Free tax software  This is your new gross profit percentage* 46. Free tax software 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Free tax software Reporting Installment Sale Income Generally, you will use Form 6252 to report installment sale income from casual sales of real or personal property during the tax year. Free tax software You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. Free tax software See Schedule D (Form 1040) and Form 4797 , later. Free tax software If the property was your main home, you may be able to exclude part or all of the gain. Free tax software See Sale of Your Home , later. Free tax software Form 6252 Use Form 6252 to report an installment sale in the year it takes place and to report payments received, or considered received because of related party resales, in later years. Free tax software Attach it to your tax return for each year. Free tax software Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. Free tax software Which parts to complete. Free tax software   Which part to complete depends on whether you are filing the form for the year of sale or a later year. Free tax software Year of sale. Free tax software   Complete lines 1 through 4, Part I, and Part II. Free tax software If you sold property to a related party during the year, also complete Part III. Free tax software Later years. Free tax software   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. Free tax software   If you sold a marketable security to a related party after May 14, 1980, and before January 1, 1987, complete Form 6252 for each year of the installment agreement, even if you did not receive a payment. Free tax software (After December 31, 1986, the installment method is not available for the sale of marketable securities. Free tax software ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Free tax software Complete Part III unless you received the final payment during the tax year. Free tax software   If you sold property other than a marketable security to a related party after May 14, 1980, complete Form 6252 for the year of sale and for 2 years after the year of sale, even if you did not receive a payment. Free tax software Complete lines 1 through 4 and Part II for any year during this 2-year period in which you receive a payment from the sale. Free tax software Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. Free tax software Schedule D (Form 1040) Enter the gain figured on Form 6252 (line 26) for personal-use property (capital assets) on Schedule D (Form 1040), as a short-term gain (line 4) or long-term gain (line 11). Free tax software If your gain from the installment sale qualifies for long-term capital gain treatment in the year of sale, it will continue to qualify in later tax years. Free tax software Your gain is long-term if you owned the property for more than 1 year when you sold it. Free tax software Form 4797 An installment sale of property used in your business or that earns rent or royalty income may result in a capital gain, an ordinary gain, or both. Free tax software All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. Free tax software For trade or business property held for more than 1 year, enter the amount from line 26 of Form 6252 on Form 4797, line 4. Free tax software If the property was held 1 year or less or you have an ordinary gain from the sale of a noncapital asset (even if the holding period is more than 1 year), enter this amount on Form 4797, line 10, and write “From Form 6252. Free tax software ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. Free tax software See Publication 523 for information about excluding the gain. Free tax software If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. Free tax software Seller-financed mortgage. Free tax software   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. Free tax software   When you report interest income received from a buyer who uses the property as a personal residence, write the buyer's name, address, and social security number (SSN) on line 1 of Schedule B (Form 1040A or 1040), Interest and Ordinary Dividends. Free tax software   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. Free tax software   If either person fails to include the other person's SSN, a $50 penalty will be assessed. Free tax software Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. Free tax software The following topics are discussed. Free tax software Electing out of the installment method. Free tax software Payments received or considered received. Free tax software Escrow account. Free tax software Depreciation recapture income. Free tax software Sale to a related person. Free tax software Like-kind exchange. Free tax software Contingent payment sale. Free tax software Single sale of several assets. Free tax software Sale of a business. Free tax software Unstated interest and original issue discount. Free tax software Disposition of an installment obligation. Free tax software Repossession. Free tax software Interest on deferred tax. Free tax software 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. Free tax software To figure the amount of gain to report, use the fair market value (FMV) of the buyer's installment obligation that represents the buyer's debt to you. Free tax software Notes, mortgages, and land contracts are examples of obligations that are included at FMV. Free tax software You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. Free tax software If you use the cash method of accounting, the FMV of the obligation will never be considered to be less than the FMV of the property sold (minus any other consideration received). Free tax software Example. Free tax software You sold a parcel of land for $50,000. Free tax software You received a $10,000 down payment and will receive the balance over the next 10 years at $4,000 a year, plus 8% interest. Free tax software The buyer gave you a note for $40,000. Free tax software The note had an FMV of $40,000. Free tax software You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. Free tax software The land cost $25,000, and you owned it for more than one year. Free tax software You decide to elect out of the installment method and report the entire gain in the year of sale. Free tax software Gain realized:     Selling price $50,000 Minus: Property's adj. Free tax software basis $25,000     Commission 3,000 28,000 Gain realized $22,000 Gain recognized in year of sale:   Cash $10,000 Market value of note 40,000 Total realized in year of sale $50,000 Minus: Property's adj. Free tax software basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. Free tax software You include the entire gain in income in the year of sale, so you do not include in income any principal payments you receive in later tax years. Free tax software The interest on the note is ordinary income and is reported as interest income each year. Free tax software How to elect out. Free tax software   To make this election, do not report your sale on Form 6252. Free tax software Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. Free tax software When to elect out. Free tax software   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Free tax software Automatic six-month extension. Free tax software   If you timely file your tax return without making the election, you still can make the election by filing an amended return within 6 months of the due date of your return (excluding extensions). Free tax software Write “Filed pursuant to section 301. Free tax software 9100-2” at the top of the amended return and file it where the original return was filed. Free tax software Revoking the election. Free tax software   Once made, the election can be revoked only with IRS approval. Free tax software A revocation is retroactive. Free tax software You will not be allowed to revoke the election if either of the following applies. Free tax software One of the purposes is to avoid federal income tax. Free tax software The tax year in which any payment was received has closed. Free tax software 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. Free tax software In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Free tax software 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. Free tax software However, as discussed later, the buyer's assumption of your debt is treated as a recovery of your basis rather than as a payment in many cases. Free tax software 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. Free tax software Include these expenses in the selling and contract prices when figuring the gross profit percentage. Free tax software 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. Free tax software Mortgage not more than basis. Free tax software   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. Free tax software It is considered a recovery of your basis. Free tax software The contract price is the selling price minus the mortgage. Free tax software Example. Free tax software You sell property with an adjusted basis of $19,000. Free tax software You have selling expenses of $1,000. Free tax software 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). Free tax software The selling price is $25,000 ($15,000 + $10,000). Free tax software Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Free tax software The contract price is $10,000 ($25,000 − $15,000 mortgage). Free tax software Your gross profit percentage is 50% ($5,000 ÷ $10,000). Free tax software You report half of each $2,000 payment received as gain from the sale. Free tax software You also report all interest you receive as ordinary income. Free tax software Mortgage more than basis. Free tax software   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Free tax software The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Free tax software   To figure the contract price, subtract the mortgage from the selling price. Free tax software This is the total amount (other than interest) you will receive directly from the buyer. Free tax software Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Free tax software The contract price is then the same as your gross profit from the sale. Free tax software    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. Free tax software Example. Free tax software The selling price for your property is $9,000. Free tax software The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Free tax software Your adjusted basis in the property is $4,400. Free tax software You have selling expenses of $600, for a total installment sale basis of $5,000. Free tax software The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Free tax software This amount is included in the contract price and treated as a payment received in the year of sale. Free tax software 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%. Free tax software Report 100% of each payment (less interest) as gain from the sale. Free tax software 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. Free tax software Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. Free tax software You are considered to receive a payment equal to the outstanding canceled debt. Free tax software Example. Free tax software Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. Free tax software On April 4, 2013, she bought the land for $70,000. Free tax software At that time, $30,000 of her loan to you was outstanding. Free tax software She agreed to forgive this $30,000 debt and to pay you $20,000 (plus interest) on August 1, 2013, and $20,000 on August 1, 2014. Free tax software She did not assume an existing mortgage. Free tax software She canceled the $30,000 debt you owed her. Free tax software You are considered to have received a $30,000 payment at the time of the sale. Free tax software 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. Free tax software If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Free tax software Compare the debt to your installment sale basis in the property being sold. Free tax software If the debt is less than your installment sale basis, none of it is treated as a payment. Free tax software If it is more, only the difference is treated as a payment. Free tax software 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. Free tax software These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . Free tax software However, they apply only to the following types of debt the buyer assumes. Free tax software Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Free tax software Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Free tax software 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. Free tax software The value of the assumed debt is then considered a payment to you in the year of sale. Free tax software Property Used As a Payment If you receive property other than money from the buyer, it is still considered a payment in the year received. Free tax software However, see Like-Kind Exchange , later. Free tax software Generally, the amount of the payment is the property's FMV on the date you receive it. Free tax software Exception. Free tax software   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 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. Free tax software See Unstated Interest and Original Issue Discount (OID) , later. Free tax software Debt not payable on demand. Free tax software   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. Free tax software This is true even if the debt is guaranteed by a third party, including a government agency. Free tax software Fair market value (FMV). Free tax software   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. Free tax software Third-party note. Free tax software   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. Free tax software 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. Free tax software The excess of the note's face value over its FMV is interest. Free tax software Exclude this interest in determining the selling price of the property. Free tax software However, see Exception under Property Used As a Payment, earlier. Free tax software Example. Free tax software You sold real estate in an installment sale. Free tax software As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. Free tax software The FMV of the third-party note at the time of the sale was $30,000. Free tax software This amount, not $50,000, is a payment to you in the year of sale. Free tax software 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. Free tax software The remaining 40% is interest taxed as ordinary income. Free tax software Bond. Free tax software   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. Free tax software For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. Free tax software    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. Free tax software However, see Exception under Property Used As a Payment, earlier. Free tax software Buyer's note. Free tax software   The buyer's note (unless payable on demand) is not considered payment on the sale. Free tax software However, its full face value is included when figuring the selling price and the contract price. Free tax software Payments you receive on the note are used to figure your gain in the year received. Free tax software Installment Obligation Used as Security (Pledge Rule) If you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation. Free tax software This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. Free tax software It does not apply to the following dispositions. Free tax software Sales of property used or produced in farming. Free tax software Sales of personal-use property. Free tax software Qualifying sales of time-shares and residential lots. Free tax software The net debt proceeds are the gross debt minus the direct expenses of getting the debt. Free tax software The amount treated as a payment is considered received on the later of the following dates. Free tax software The date the debt becomes secured. Free tax software The date you receive the debt proceeds. Free tax software A debt is secured by an installment obligation to the extent that payment of principal or interest on the debt is directly secured (under the terms of the loan or any underlying arrangement) by any interest in the installment obligation. Free tax software For sales after December 16, 1999, payment on a debt is treated as directly secured by an interest in an installment obligation to the extent an arrangement allows you to satisfy all or part of the debt with the installment obligation. Free tax software Limit. Free tax software   The net debt proceeds treated as a payment on the pledged installment obligation cannot be more than the excess of item (1) over item (2), below. Free tax software The total contract price on the installment sale. Free tax software Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. Free tax software Installment payments. Free tax software   The pledge rule accelerates the reporting of the installment obligation payments. Free tax software Do not report payments received on the obligation after it has been pledged until the payments received exceed the amount reported under the pledge rule. Free tax software Exception. Free tax software   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. Free tax software The debt was outstanding on December 17, 1987. Free tax software The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. Free tax software   A refinancing as a result of the creditor's calling of the debt is treated as a continuation of the original debt so long as a person other than the creditor or a person related to the creditor provides the refinancing. Free tax software   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Free tax software Any excess is treated as a payment on the installment obligation. Free tax software Escrow Account In some cases, the sales agreement or a later agreement may call for the buyer to establish an irrevocable escrow account from which the remaining installment payments (including interest) are to be made. Free tax software These sales cannot be reported on the installment method. Free tax software The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. Free tax software When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. Free tax software Example. Free tax software You sell property for $100,000. Free tax software The sales agreement calls for a down payment of $10,000 and payment of $15,000 in each of the next 6 years to be made from an irrevocable escrow account containing the balance of the purchase price plus interest. Free tax software You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. Free tax software You report the entire gain in the year of sale. Free tax software Escrow established in a later year. Free tax software   If you make an installment sale and in a later year an irrevocable escrow account is established to pay the remaining installments plus interest, the amount placed in the escrow account represents payment of the balance of the installment obligation. Free tax software Substantial restriction. Free tax software   If an escrow arrangement imposes a substantial restriction on your right to receive the sale proceeds, the sale can be reported on the installment method, provided it otherwise qualifies. Free tax software For an escrow arrangement to impose a substantial restriction, it must serve a bona fide purpose of the buyer, that is, a real and definite restriction placed on the seller or a specific economic benefit conferred on the buyer. Free tax software Depreciation Recapture Income If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Free tax software Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Free tax software Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. Free tax software The recapture income is also included in Part I of Form 6252. Free tax software However, the gain equal to the recapture income is reported in full in the year of the sale. Free tax software Only the gain greater than the recapture income is reported on the installment method. Free tax software For more information on depreciation recapture, see chapter 3 in Publication 544. Free tax software The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. Free tax software Determining gross profit is discussed under General Rules , earlier. Free tax software Sale to a Related Person 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. Free tax software 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. Free tax software These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. Free tax software Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Free tax software Instead, all payments to be received are considered received in the year of sale. Free tax software However, see Exception , below. Free tax software Depreciable property for this rule is any property the purchaser can depreciate. Free tax software Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. Free tax software In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. Free tax software The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. Free tax software Exception. Free tax software   You can use the installment method to report a sale of depreciable property to a related person if no significant tax deferral benefit will be derived from the sale. Free tax software You must show to the satisfaction of the IRS that avoidance of federal income tax was not one of the principal purposes of the sale. Free tax software Related person. Free tax software   Related persons include the following. Free tax software A person and all controlled entities with respect to that person. Free tax software A taxpayer and any trust in which such taxpayer (or his spouse) is a beneficiary, unless that beneficiary's interest in the trust is a remote contingent interest. Free tax software Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of that estate. Free tax software Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. Free tax software   For information about which entities are controlled entities, see section 1239(c). Free tax software Sale and Later Disposition Generally, a special rule applies if you sell or exchange property to a related person on the installment method (first disposition) who then sells, exchanges, or gives away the property (second disposition) under the following circumstances. Free tax software The related person makes the second disposition before making all payments on the first disposition. Free tax software The related person disposes of the property within 2 years of the first disposition. Free tax software This rule does not apply if the property involved is marketable securities. Free tax software Under this rule, you treat part or all of the amount the related person realizes (or the FMV if the disposed property is not sold or exchanged) from the second disposition as if you received it at the time of the second disposition. Free tax software See Exception , later. Free tax software Related person. Free tax software   Related persons include the following. Free tax software Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. Free tax software A partnership or estate and a partner or beneficiary. Free tax software A trust (other than a section 401(a) employees trust) and a beneficiary. Free tax software A trust and an owner of the trust. Free tax software Two corporations that are members of the same controlled group as defined in section 267(f). Free tax software The fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts. Free tax software A tax-exempt educational or charitable organization and a person (if an individual, including members of the individual's family) who directly or indirectly controls such an organization. Free tax software An individual and a corporation when the individual owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation. Free tax software A fiduciary of a trust and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation. Free tax software The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Free tax software Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. Free tax software An S corporation and a corporation that is not an S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation. Free tax software A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership. Free tax software An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. Free tax software Example 1. Free tax software In 2012, Harvey Green sold farm land to his son Bob for $500,000, which was to be paid in five equal payments over 5 years, plus adequate stated interest on the balance due. Free tax software His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. Free tax software His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). Free tax software He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. Free tax software 50). Free tax software Bob made no improvements to the property and sold it to Alfalfa Inc. Free tax software , in 2013 for $600,000 after making the payment for that year. Free tax software The amount realized from the second disposition is $600,000. Free tax software Harvey figures his installment sale income for 2013 as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $500,000 Subtract: Sum of payments from Bob in 2012 and 2013 - 200,000 Amount treated as received because of second disposition $300,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $400,000 Multiply by gross profit % × . Free tax software 50 Installment sale income for 2013 $200,000 Harvey will not include in his installment sale income any principal payments he receives on the installment obligation for 2014, 2015, and 2016 because he has already reported the total payments of $500,000 from the first disposition ($100,000 in 2012 and $400,000 in 2013). Free tax software Example 2. Free tax software Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. Free tax software The gain for 2013 is figured as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $400,000 Subtract: Sum of payments from Bob in 2012 and 2013 − 200,000 Amount treated as received because of second disposition $200,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $300,000 Multiply by gross profit % × . Free tax software 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. Free tax software They are not taxed because he treated the $200,000 from the disposition in 2013 as a payment received and paid tax on the installment sale income. Free tax software In 2016, he receives the final $100,000 payment. Free tax software He figures the installment sale income he must recognize in 2016 as follows: Total payments from the first disposition received by the end of 2016 $500,000 Minus the sum of:     Payment from 2012 $100,000   Payment from 2013 100,000   Amount treated as received in 2013 200,000   Total on which gain was previously recognized  − 400,000 Payment on which gain is recognized for 2016  $100,000 Multiply by gross profit % × . Free tax software 50 Installment sale income for 2016 $ 50,000 Exception. Free tax software   This rule does not apply to a second disposition, and any later transfer, if you can show to the satisfaction of the IRS that neither the first disposition (to the related person) nor the second disposition had as one of its principal purposes the avoidance of federal income tax. Free tax software Generally, an involuntary second disposition will qualify under the nontax avoidance exception, such as when a creditor of the related person forecloses on the property or the related person declares bankruptcy. Free tax software   The nontax avoidance exception also applies to a second disposition that is also an installment sale if the terms of payment under the installment resale are substantially equal to or longer than those for the first installment sale. Free tax software However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. Free tax software   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. Free tax software An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. Free tax software A transfer after the death of the person making the first disposition or the related person's death, whichever is earlier, is not treated as a second disposition. Free tax software Like-Kind Exchange 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. Free tax software These trades are known as like-kind exchanges. Free tax software The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. Free tax software You do not have to report any part of your gain if you receive only like-kind property. Free tax software However, if you also receive money or other property (boot) in the exchange, you must report your gain to the extent of the money and the FMV of the other property received. Free tax software For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. Free tax software Installment payments. Free tax software   If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine the installment sale income each year. Free tax software The contract price is reduced by the FMV of the like-kind property received in the trade. Free tax software The gross profit is reduced by any gain on the trade that can be postponed. Free tax software Like-kind property received in the trade is not considered payment on the installment obligation. Free tax software Example. Free tax software In 2013, George Brown trades personal property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. Free tax software He also receives an installment note for $800,000 in the trade. Free tax software Under the terms of the note, he is to receive $100,000 (plus interest) in 2014 and the balance of $700,000 (plus interest) in 2015. Free tax software George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Free tax software His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). Free tax software The contract price is $800,000 ($1,000,000 − $200,000). Free tax software The gross profit percentage is 75% ($600,000 ÷ $800,000). Free tax software He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. Free tax software He reports $75,000 gain for 2014 (75% of $100,000 payment received) and $525,000 gain for 2015 (75% of $700,000 payment received). Free tax software Deferred exchanges. Free tax software   A deferred exchange is one in which you transfer property you use in business or hold for investment and receive like-kind property later that you will use in business or hold for investment. Free tax software Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. Free tax software If certain rules are met, these funds will not be considered a payment until you have the right to receive the funds or, if earlier, the end of the exchange period. Free tax software See Regulations section 1. Free tax software 1031(k)-1(j)(2) for these rules. Free tax software Contingent Payment Sale A contingent payment sale is one in which the total selling price cannot be determined by the end of the tax year of sale. Free tax software This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. Free tax software If the selling price cannot be determined by the end of the tax year, you must use different rules to figure the contract price and the gross profit percentage than those you use for an installment sale with a fixed selling price. Free tax software For rules on using the installment method for a contingent payment sale, see Regulations section 15a. Free tax software 453-1(c). Free tax software Single Sale of Several Assets If you sell different types of assets in a single sale, you must identify each asset to determine whether you can use the installment method to report the sale of that asset. Free tax software You also have to allocate part of the selling price to each asset. Free tax software If you sell assets that constitute a trade or business, see Sale of a Business , later. Free tax software Unless an allocation of the selling price has been agreed to by both parties in an arm's-length transaction, you must allocate the selling price to an asset based on its FMV. Free tax software If the buyer assumes a debt, or takes the property subject to a debt, you must reduce the FMV of the property by the debt. Free tax software This becomes the net FMV. Free tax software A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. Free tax software However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. Free tax software It must be reported separately. Free tax software The remaining assets sold at a gain are reported together. Free tax software Example. Free tax software You sold three separate and unrelated parcels of real property (A, B, and C) under a single contract calling for a total selling price of $130,000. Free tax software The total selling price consisted of a cash payment of $20,000, the buyer's assumption of a $30,000 mortgage on parcel B, and an installment obligation of $80,000 payable in eight annual installments, plus interest at 8% a year. Free tax software Your installment sale basis for each parcel was $15,000. Free tax software Your net gain was $85,000 ($130,000 − $45,000). Free tax software You report the gain on the installment method. Free tax software The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. Free tax software The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. Free tax software The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. Free tax software You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Free tax software Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. Free tax software You should allocate the cash payment of $20,000 received in the year of sale and the note receivable on the basis of their proportionate net FMV. Free tax software The allocation is figured as follows:   Parcels   A and B Parcel C FMV $120,000 $10,000 Minus: Mortgage assumed 30,000 -0- Net FMV $ 90,000 $10,000 Proportionate net FMV:     Percentage of total 90% 10% Payments in year of sale:     $20,000 × 90% $18,000   $20,000 × 10%   $2,000 Excess of parcel B mortgage over installment sale basis 15,000 -0- Allocation of payments  received (or considered  received) in year of sale $ 33,000 $ 2,000 You cannot report the sale of parcel C on the installment method because the sale results in a loss. Free tax software You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. Free tax software However, if parcel C was held for personal use, the loss is not deductible. Free tax software You allocate the installment obligation of $80,000 to the properties sold based on their proportionate net FMVs (90% to parcels A and B, 10% to parcel C). Free tax software Sale of a Business The installment sale of an entire business for one overall price under a single contract is not the sale of a single asset. Free tax software Allocation of Selling Price To determine whether any of the gain on the sale of the business can be reported on the installment method, you must allocate the total selling price and the payments received in the year of sale between each of the following classes of assets. Free tax software Assets sold at a loss. Free tax software Real and personal property eligible for the installment method. Free tax software Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. Free tax software Inventory. Free tax software   The sale of inventories of personal property cannot be reported on the installment method. Free tax software All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Free tax software   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. Free tax software If you do not, each payment must be allocated between the inventory and the other assets sold. Free tax software   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Free tax software Use your basis in the inventory to figure the cost of goods sold. Free tax software Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. Free tax software Residual method. Free tax software   Except for assets exchanged under the like-kind exchange rules, both the buyer and seller of a business must use the residual method to allocate the sale price to each business asset sold. Free tax software This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. Free tax software   The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. Free tax software This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b). Free tax software   A group of assets constitutes a trade or business if goodwill or going concern value could, under any circumstances, attach to the assets or if the use of the assets would constitute an active trade or business under section 355. Free tax software   The residual method provides for the consideration to be reduced first by cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). Free tax software The consideration remaining after this reduction must be allocated among the various business assets in a certain order. Free tax software   For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order. Free tax software Certificates of deposit, U. Free tax software S. Free tax software Government securities, foreign currency, and actively traded personal property, including stock and securities. Free tax software Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. Free tax software However, see Regulations section 1. Free tax software 338-6(b)(2)(iii) for exceptions that apply to debt instruments issued by persons related to a target corporation, contingent debt instruments, and debt instruments convertible into stock or other property. Free tax software Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of business. Free tax software All other assets except section 197 intangibles. Free tax software Section 197 intangibles except goodwill and going concern value. Free tax software Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Free tax software   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. Free tax software For example, if an asset is described in both (4) and (6), include it in (4). Free tax software Agreement. Free tax software   The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market value of any of the assets. Free tax software This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Free tax software Reporting requirement. Free tax software   Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets. Free tax software Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. Free tax software The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Free tax software Sale of Partnership Interest A partner who sells a partnership interest at a gain may be able to report the sale on the installment method. Free tax software The sale of a partnership interest is treated as the sale of a single capital asset. Free tax software The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. Free tax software (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. Free tax software ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. Free tax software The gain allocated to the other assets can be reported under the installment method. Free tax software For more information on the treatment of unrealized receivables and inventory, see Publication 541. Free tax software Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. Free tax software You received a $100,000 down payment and the buyer's note for $120,000. Free tax software The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. Free tax software The total selling price is $220,000. Free tax software Your selling expenses are $11,000. Free tax software The selling expenses are divided among all the assets sold, including inventory. Free tax software Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). Free tax software The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. Free tax software Asset FMV Claimed Basis Inventory $ 10,000 -0- $ 8,000 Land 42,000 -0- 15,000 Building 48,000 $9,000 36,000 Machine A 71,000 27,200 63,800 Machine B 24,000 12,960 22,040 Truck 6,500 18,624 5,376   $201,500 $67,784 $150,216         Under the residual method, you allocate the selling price to each of the assets based on their FMV ($201,500). Free tax software The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. Free tax software The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis, and the gain for each asset are shown in the following chart. Free tax software   Sale  Price Sale   Exp. Free tax software Adj. Free tax software   Basis Gain Inventory $ 10,000 $ 500 $ 8,000 $ 1,500 Land 42,000 2,100 15,000 24,900 Building 48,000 2,400 36,000 9,600 Mch. Free tax software A 71,000 3,550 63,800 3,650 Mch. Free tax software B 24,000 1,200 22,040 760 Truck 6,500 325 5,376 799 Goodwill 18,500 925 -0- 17,575   $220,000 $11,000 $150,216 $58,784 The building was acquired in 2005, the year the business began, and it is section 1250 property. Free tax software There is no depreciation recapture income because the building was depreciated using the straight line method. Free tax software All gain on the truck, machine A, and machine B is depreciation recapture income since it is the lesser of the depreciation claimed or the gain on the sale. Free tax software Figure depreciation recapture in Part III of Form 4797. Free tax software The total depreciation recapture income reported in Part II of Form 4797 is $5,209. Free tax software This consists of $3,650 on machine A, $799 on the truck, and $760 on machine B (the gain on each item because it was less than the depreciation claimed). Free tax software These gains are reported in full in the year of sale and are not included in the installment sale computation. Free tax software Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. Free tax software The selling prices of the truck and machines are also removed from the total selling price because gain on these items is reported in full in the year of sale. Free tax software The selling price equals the contract price for the installment sale ($108,500). Free tax software The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. Free tax software   Selling  Price Install- ment  Sale  Basis Gross  Profit Land $ 42,000 $17,100 $24,900 Building 48,000 38,400 9,600 Goodwill 18,500 925 17,575 Total $108,500 $56,425 $52,075         The gross profit percentage (gross profit ÷ contract price) for the installment sale is 48% ($52,075 ÷ $108,500). Free tax software The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. Free tax software 95 Building— $9,600 ÷ $108,500 8. Free tax software 85 Goodwill— $17,575 ÷ $108,500 16. Free tax software 20 Total 48. Free tax software 00 The sale includes assets sold on the installment method and assets for which the gain is reported in full in the year of sale, so payments must be allocated between the installment part of the sale and the part reported in the year of sale. Free tax software The selling price for the installment sale is $108,500. Free tax software This is 49. Free tax software 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). Free tax software The selling price of assets not reported on the installment method is $111,500. Free tax software This is 50. Free tax software 7% ($111,500 ÷ $220,000) of the total selling price. Free tax software Multiply principal payments by 49. Free tax software 3% to determine the part of the payment for the installment sale. Free tax software The balance, 50. Free tax software 7%, is for the part reported in the year of the sale. Free tax software The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. Free tax software When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Free tax software Only the part for the installment sale (49. Free tax software 3%) is used in the installment sale computation. Free tax software The only payment received in 2013 is the down payment of $100,000. Free tax software The part of the payment for the installment sale is $49,300 ($100,000 × 49. Free tax software 3%). Free tax software This amount is used in the installment sale computation. Free tax software Installment income for 2013. Free tax software   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. Free tax software Income Land—22. Free tax software 95% of $49,300 $11,314 Building—8. Free tax software 85% of $49,300 4,363 Goodwill—16. Free tax software 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. Free tax software   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. Free tax software 3% of the total payments you receive on the buyer's note during the year. Free tax software Unstated Interest and Original Issue Discount (OID) 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. Free tax software Interest provided in the contract is called stated interest. Free tax software 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. Free tax software If section 483 applies to the contract, this interest is called unstated interest. Free tax software If section 1274 applies to the contract, this interest is called original issue discount (OID). Free tax software An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). Free tax software Treatment of unstated interest and OID. Free tax software   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Free tax software As a result, the buyer cannot deduct the unstated interest. Free tax software The seller must report the unstated interest as income. Free tax software   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. Free tax software   If the debt is subject to the 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. Free tax software Rules for the seller. Free tax software   If either section 1274 or section 483 applies to the installment sale contract, you must treat part of the installment sale price as interest, even though interest is not called for in the sales agreement. Free tax software If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. Free tax software   Include the unstated interest in income based on your regular method of accounting. Free tax software Include OID in income over the term of the contract. Free tax software   The OID includible in income each year is based on the constant yield method described in section 1272. Free tax software (In some cases, the OID on an installment sale contract also may include all or part of the stated interest, especially if the stated interest is not paid at least annually. Free tax software )   If you do not use the installment method to report the sale, report the entire gain under your method of accounting in the year of sale. Free tax software Reduce the selling price by any stated principal treated as interest to determine the gain. Free tax software   Report unstated interest or OID on your tax return, in addition to stated interest. Free tax software Rules for the buyer. Free tax software   Any part of the stated selling price of an installment sale contract treated by the buyer as interest reduces the buyer's basis in the property and increases the buyer's interest expense. Free tax software These rules do not apply to personal-use property (for example, property not used in a trade or business). Free tax software Adequate stated interest. Free tax software   An installment sale contract generally provides for adequate stated interest if the contract's stated principal amount is at least equal to the sum of the present values of all principal and interest payments called for under the contract. Free tax software The present value of a payment is determined based on the test rate of interest, defined next. Free tax software (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. Free tax software ) 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 test rate of interest. Free tax software Test rate of interest. Free tax software   The test rate of interest for a contract is the 3-month rate. Free tax software The 3-month rate is the lower of the following applicable federal rates (AFRs). Free tax software The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the first month in which there is a binding written contract that substantially provides the terms under which the sale or exchange is ultimately completed. Free tax software The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the month in which the sale or exchange occurs. Free tax software Applicable federal rate (AFR). Free tax software   The AFR depends on the month the binding
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Tax Relief for Victims of Hurricane Sandy in New York

Updated 2/4/13 The IRS announced additional tax relief, further extending certain tax deadlines until April 1 for Nassau, Queens, Richmond and Suffolk counties. 

Updated 11/13/12 to add Orange, Putnam, Sullivan and Ulster counties.

NY-2012-47, Nov. 7, 2012

NEW YORK — Victims of Hurricane Sandy that began on Oct. 27, 2012 in parts of New York may qualify for tax relief from the Internal Revenue Service.

The President has declared Bronx, Kings, Nassau, New York, Orange, Putnam, Queens, Richmond, Rockland, Sullivan, Suffolk, Ulster and Westchester counties a federal disaster area. Individuals who reside or have a business in these counties may qualify for tax relief.

The declaration permits the IRS to postpone certain deadlines for taxpayers who reside or have a business in the disaster area. For instance, certain deadlines falling on or after Oct. 27, and on or before Feb. 1, have been postponed to Feb. 1, 2013.  

In addition, the IRS is waiving the failure-to-deposit penalties for employment and excise tax deposits due on or after Oct. 27, and on or before Nov. 26, as long as the deposits are made by Nov. 26, 2012.

If an affected taxpayer receives a penalty notice from the IRS, the taxpayer should call the telephone number on the notice to have the IRS abate any interest and any late filing or late payment penalties that would otherwise apply. Penalties or interest will be abated only for taxpayers who have an original or extended filing, payment or deposit due date, including an extended filing or payment due date, that falls within the postponement period.

The IRS automatically identifies taxpayers located in the covered disaster area and applies automatic filing and payment relief. But affected taxpayers who reside or have a business located outside the covered disaster area need to call the IRS disaster hotline at 866-562-5227 to request this tax relief.

For a full description of the relief being provided by the IRS to the victims of Hurricane Sandy, visit IRS.gov.

Covered Disaster Area

The counties above constitute a covered disaster area for purposes of Treas. Reg. § 301.7508A-1(d)(2) and are entitled to the relief detailed below.

Affected Taxpayers

Taxpayers considered to be affected taxpayers eligible for the postponement of time to file returns, pay taxes and perform other time-sensitive acts are those taxpayers listed in Treas. Reg. § 301.7508A-1(d)(1), and include individuals who live, and businesses whose principal place of business is located, in the covered disaster area. Taxpayers not in the covered disaster area, but whose records necessary to meet a deadline listed in Treas. Reg. § 301.7508A-1(c) are in the covered disaster area, are also entitled to relief. In addition, all relief workers affiliated with a recognized government or philanthropic organization assisting in the relief activities in the covered disaster area and any individual visiting the covered disaster area who was killed or injured as a result of the disaster are entitled to relief.

Grant of Relief

Under section 7508A, the IRS gives affected taxpayers until Feb. 1 to file most tax returns (including individual, corporate, and estate and trust income tax returns; partnership returns, S corporation returns, and trust returns; estate, gift, and generation-skipping transfer tax returns; and employment and certain excise tax returns), or to make tax payments, including estimated tax payments, that have either an original or extended due date occurring on or after Oct. 27 and on or before Feb. 1.

The IRS also gives affected taxpayers until Feb. 1 to perform other time-sensitive actions described in Treas. Reg. § 301.7508A-1(c)(1) and Rev. Proc. 2007-56, 2007-34 I.R.B. 388 (Aug. 20, 2007), that are due to be performed on or after Oct. 27 and on or before Feb. 1.

This relief also includes the filing of Form 5500 series returns, in the manner described in section 8 of Rev. Proc. 2007-56. The relief described in section 17 of Rev. Proc. 2007-56, pertaining to like-kind exchanges of property, also applies to certain taxpayers who are not otherwise affected taxpayers and may include acts required to be performed before or after the period above.

The postponement of time to file and pay does not apply to information returns in the W-2, 1098, 1099 series, or to Forms 1042-S or 8027. Penalties for failure to timely file information returns can be waived under existing procedures for reasonable cause. Likewise, the postponement does not apply to employment and excise tax deposits. The IRS, however, will abate penalties for failure to make timely employment and excise tax deposits due on or after Oct. 27 and on or before Nov. 26 provided the taxpayer makes these deposits by Nov. 26.

Casualty Losses

Affected taxpayers in a federally declared disaster area have the option of claiming disaster-related casualty losses on their federal income tax return for either this year or last year. Claiming the loss on an original or amended return for last year will get the taxpayer an earlier refund, but waiting to claim the loss on this year’s return could result in a greater tax saving, depending on other income factors.

Individuals may deduct personal property losses that are not covered by insurance or other reimbursements. For details, see Form 4684 and its instructions.

Affected taxpayers claiming the disaster loss on last year’s return should put the Disaster Designation “New York/Hurricane Sandy” at the top of the form so that the IRS can expedite the processing of the refund.

Other Relief

The IRS will waive the usual fees and expedite requests for copies of previously filed tax returns for affected taxpayers. Taxpayers should put the assigned Disaster Designation in red ink at the top of Form 4506, Request for Copy of Tax Return, or Form 4506-T, Request for Transcript of Tax Return, as appropriate, and submit it to the IRS.

Affected taxpayers who are contacted by the IRS on a collection or examination matter should explain how the disaster impacts them so that the IRS can provide appropriate consideration to their case.

Taxpayers may download forms and publications from the official IRS website, irs.gov, or order them by calling 800-TAX-FORM (800-829-3676). The IRS toll-free number for general tax questions is 800-829-1040.

Related Information

Disaster Assistance and Emergency Relief for Individuals and Businesses

Recent IRS Disaster Relief Announcements

 

Page Last Reviewed or Updated: 28-Oct-2013

The Free Tax Software

Free tax software Index A Abandonment of home, Abandonment. Free tax software Absence, temporary, Temporary absence. Free tax software Abstract fees, Settlement fees or closing costs. Free tax software Address, change of, Reminders Adjusted basis, Adjusted Basis, Adjusted Basis Definition of, Determining Basis Worksheet 1 to figure, Determining Basis, Worksheet 1. Free tax software Adjusted Basis of Home Sold—Illustrated Example 1 for Peter and Betty Clark, Worksheet 1. Free tax software Adjusted Basis of Home Sold—Illustrated Example 3 for Emily White, Worksheet 1 Instructions. Free tax software Adjusted Basis of Home Sold Adoption Adjusted basis of home for credit claimed, Decreases to Basis Advertising fees, Selling expenses. Free tax software Amount realized, Amount Realized Appraisal fees, Settlement fees or closing costs. Free tax software Architect's fees, Construction. 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Free tax software F Federal mortgage subsidies Recapture of, Recapturing (Paying Back) a Federal Mortgage Subsidy Figuring gain or loss, Figuring Gain or Loss, More information. Free tax software Fire insurance premiums, Settlement fees or closing costs. Free tax software Foreclosure, Foreclosure or repossession. Free tax software Foreign Service, Foreign Service member. Free tax software Ownership and use tests, Members of the uniformed services or Foreign Service, employees of the intelligence community, or employees or volunteers of the Peace Corps. Free tax software Form 1040 Reporting sale of home, Reporting the Sale Seller-financed mortgages, Seller-financed mortgage. Free tax software Form 1040, Schedule A Real estate taxes, Real estate taxes. Free tax software Form 1040, Schedule D Reporting sale of home, Reporting the Sale Form 1099-S Proceeds from real estate transactions, Date of sale. Free tax software , Form 1099-S. Free tax software , Form 1099-S. 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Free tax software Charges related to occupancy of house before closing, Settlement fees or closing costs. Free tax software Energy conservation subsidy, Decreases to Basis Meter and connection charges for construction, Construction. Free tax software V Vacant land Sale of, Vacant land. Free tax software W Worksheets, Worksheets. Free tax software Adjusted basis (Worksheet 1), Determining Basis, Worksheet 1. Free tax software Adjusted Basis of Home Sold—Illustrated Example 1 for Peter and Betty Clark, Worksheet 1. Free tax software Adjusted Basis of Home Sold—Illustrated Example 3 for Emily White, Worksheet 1 Instructions. Free tax software Adjusted Basis of Home Sold Gain (or loss), exclusion, and taxable gain (Worksheet 2), Worksheet 2. Free tax software Taxable Gain on Sale of Home—Completed Example 1 for Amy, Worksheet 1. Free tax software Adjusted Basis of Home Sold—Illustrated Example 1 for Peter and Betty Clark, Worksheet 2. 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