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H&r block free military 3. H&r block free military   Lifetime Learning Credit Table of Contents Introduction Can You Claim the CreditWho Can Claim the Credit Who Cannot Claim the Credit What Expenses QualifyQualified Education Expenses No Double Benefit Allowed Expenses That Do Not Qualify Who Is an Eligible Student Who Can Claim a Dependent's Expenses Figuring the CreditEffect of the Amount of Your Income on the Amount of Your Credit Claiming the Credit Introduction For 2013, there are two tax credits available to help you offset the costs of higher education by reducing the amount of your income tax. H&r block free military They are the American opportunity credit and the lifetime learning credit. H&r block free military This chapter discusses the lifetime learning credit. H&r block free military The American opportunity credit is discussed in chapter 2, The American Opportunity Credit . H&r block free military This chapter explains: Who can claim the lifetime learning credit, What expenses qualify for the credit, Who is an eligible student, Who can claim a dependent's expenses, How to figure the credit, How to claim the credit, and When the credit must be repaid. H&r block free military What is the tax benefit of the lifetime learning credit. H&r block free military   For the tax year, you may be able to claim a lifetime learning credit of up to $2,000 for qualified education expenses paid for all eligible students. H&r block free military There is no limit on the number of years the lifetime learning credit can be claimed for each student. H&r block free military   A tax credit reduces the amount of income tax you may have to pay. H&r block free military Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself. H&r block free military The lifetime learning credit is a nonrefundable credit. H&r block free military This means that it can reduce your tax to zero, but if the credit is more than your tax the excess will not be refunded to you. H&r block free military   Your allowable lifetime learning credit may be limited by the amount of your income and the amount of your tax. H&r block free military Can you claim more than one education credit this year. H&r block free military   For each student, you can elect for any year only one of the credits. H&r block free military For example, if you elect to take the lifetime learning credit for a child on your 2013 tax return, you cannot, for that same child, also claim the American opportunity credit for 2013. H&r block free military   If you are eligible to claim the lifetime learning credit and you are also eligible to claim the American opportunity credit for the same student in the same year, you can choose to claim either credit, but not both. H&r block free military   If you pay qualified education expenses for more than one student in the same year, you can choose to take certain credits on a per-student, per-year basis. H&r block free military This means that, for example, you can claim the American opportunity credit for one student and the lifetime learning credit for another student in the same year. H&r block free military Differences between the American opportunity and lifetime learning credits. H&r block free military   There are several differences between these two credits. H&r block free military For example, you can claim the American opportunity credit for the same student for no more than 4 tax years, but any year in which the Hope Scholarship Credit was claimed counts toward the 4 years. H&r block free military However, there is no limit on the number of years for which you can claim a lifetime learning credit based on the same student's expenses. H&r block free military The differences between these credits are shown in Appendix B, Highlights of Education Tax Benefits for Tax Year 2013 near the end of this publication. H&r block free military Overview of the lifetime learning credit. H&r block free military   See Table 3-1, Overview of the Lifetime Learning Credit for the basics of the lifetime learning credit. H&r block free military The details are discussed in this chapter. H&r block free military Can You Claim the Credit The following rules will help you determine if you are eligible to claim the lifetime learning credit on your tax return. H&r block free military Who Can Claim the Credit Generally, you can claim the lifetime learning credit if all three of the following requirements are met. H&r block free military You pay qualified education expenses of higher education. H&r block free military You pay the education expenses for an eligible student. H&r block free military The eligible student is either yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. H&r block free military Table 3-1. H&r block free military Overview of the Lifetime Learning Credit Maximum credit Up to $2,000 credit per return Limit on modified adjusted gross income (MAGI) $127,000 if married filling jointly;  $63,000 if single, head of household, or qualifying widow(er) Refundable or nonrefundable Nonrefundable—credit limited to the amount of tax you must pay on your taxable income Number of years of postsecondary education Available for all years of postsecondary education and for courses to acquire or improve job skills Number of tax years credit available Available for an unlimited number of years Type of program required Student does not need to be pursuing a program leading to a degree or other recognized education credential Number of courses Available for one or more courses Felony drug conviction Felony drug convictions do not make the student ineligible Qualified expenses Tuition and fees required for enrollment or attendance (including amounts required to be paid to the institution for course-related books, supplies, and equipment) Payments for academic periods Payments made in 2013 for academic periods beginning in 2013 or beginning in the first 3 months of 2014 Note. H&r block free military Qualified education expenses paid by a dependent for whom you claim an exemption, or by a third party for that dependent, are considered paid by you. H&r block free military “Qualified education expenses” are defined later under Qualified Education Expenses . H&r block free military “Eligible students” are defined later under Who Is an Eligible Student . H&r block free military A dependent for whom you claim an exemption is defined later under Who Can Claim a Dependent's Expenses . H&r block free military You may find Figure 3-1, Can You Claim the Lifetime Learning Credit for 2013 , later, helpful in determining if you can claim a lifetime learning credit on your tax return. H&r block free military Who Cannot Claim the Credit You cannot claim the lifetime learning credit for 2013 if any of the following apply. H&r block free military Your filing status is married filing separately. H&r block free military You are listed as a dependent on another person's tax return (such as your parents'). H&r block free military See Who Can Claim a Dependent's Expenses , later. H&r block free military Your modified adjusted gross income (MAGI) is $63,000 or more ($127,000 or more in the case of a joint return). H&r block free military MAGI is explained later under Effect of the Amount of Your Income on the Amount of Your Credit . H&r block free military You (or your spouse) were a nonresident alien for any part of 2013 and the nonresident alien did not elect to be treated as a resident alien for tax purposes. H&r block free military More information on nonresident aliens can be found in Publication 519. H&r block free military You claim the American Opportunity Credit (see chapter 2) or a Tuition and Fees Deduction (see chapter 6) for the same student in 2013. H&r block free military What Expenses Qualify The lifetime learning credit is based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. H&r block free military Generally, the credit is allowed for qualified education expenses paid in 2013 for an academic period beginning in 2013 or in the first 3 months of 2014. H&r block free military For example, if you paid $1,500 in December 2013 for qualified tuition for the spring 2014 semester beginning in January 2014, you may be able to use that $1,500 in figuring your 2013 credit. H&r block free military Academic period. H&r block free military   An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. H&r block free military In the case of an educational institution that uses credit hours or clock hours and does not have academic terms, each payment period can be treated as an academic period. H&r block free military Paid with borrowed funds. H&r block free military   You can claim a lifetime learning credit for qualified education expenses paid with the proceeds of a loan. H&r block free military You use the expenses to figure the lifetime learning credit for the year in which the expenses are paid, not the year in which the loan is repaid. H&r block free military Treat loan disbursements sent directly to the educational institution as paid on the date the institution credits the student's account. H&r block free military Student withdraws from class(es). H&r block free military   You can claim a lifetime learning credit for qualified education expenses not refunded when a student withdraws. H&r block free military Qualified Education Expenses For purposes of the lifetime learning credit, qualified education expenses are tuition and certain related expenses required for enrollment in a course at an eligible educational institution. H&r block free military The course must be either part of a postsecondary degree program or taken by the student to acquire or improve job skills. H&r block free military Eligible educational institution. H&r block free military   An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U. H&r block free military S. H&r block free military Department of Education. H&r block free military It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. H&r block free military The educational institution should be able to tell you if it is an eligible educational institution. H&r block free military   Certain educational institutions located outside the United States also participate in the U. H&r block free military S. H&r block free military Department of Education's Federal Student Aid (FSA) programs. H&r block free military Related expenses. H&r block free military   Student-activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution for enrollment or attendance. H&r block free military Prepaid expenses. H&r block free military   Qualified education expenses paid in 2013 for an academic period that begins in the first three months of 2014 can be used in figuring an education credit for 2013 only. H&r block free military See Academic period , earlier. H&r block free military For example, you pay $2,000 in December 2013 for qualified tuition for the 2014 winter quarter that begins in January 2014, you can use that $2,000 in figuring an education credit for 2013 only (if you meet all the other requirements). H&r block free military You cannot use any amount you paid in 2012 or 2014 to figure the qualified education expenses you use to figure your 2013 education credit(s). H&r block free military In the following examples, assume that each student is an eligible student at an eligible educational institution. H&r block free military Example 1. H&r block free military   Jackson is a sophomore in University V's degree program in dentistry. H&r block free military This year, in addition to tuition, he is required to pay a fee to the university for the rental of the dental equipment he will use in this program. H&r block free military Because the equipment rental fee must be paid to University V for enrollment and attendance, Jackson's equipment rental fee is a qualified expense. H&r block free military Example 2. H&r block free military   Donna and Charles, both first-year students at College W, are required to have certain books and other reading materials to use in their mandatory first-year classes. H&r block free military The college has no policy about how students should obtain these materials, but any student who purchases them from College W's bookstore will receive a bill directly from the college. H&r block free military Charles bought his books from a friend, so what he paid for them is not a qualified education expense. H&r block free military Donna bought hers at College W's bookstore. H&r block free military Although Donna paid College W directly for her first-year books and materials, her payment is not a qualified expense because the books and materials are not required to be purchased from College W for enrollment or attendance at the institution. H&r block free military Example 3. H&r block free military   When Marci enrolled at College X for her freshman year, she had to pay a separate student activity fee in addition to her tuition. H&r block free military This activity fee is required of all students, and is used solely to fund on-campus organizations and activities run by students, such as the student newspaper and student government. H&r block free military No portion of the fee covers personal expenses. H&r block free military Although labeled as a student activity fee, the fee is required for Marci's enrollment and attendance at College X. H&r block free military Therefore, it is a qualified expense. H&r block free military No Double Benefit Allowed You cannot do any of the following: Deduct higher education expenses on your income tax return (as, for example, a business expense) and also claim a lifetime learning credit based on those same expenses. H&r block free military Claim a lifetime learning credit in the same year that you are claiming a tuition and fees deduction for the same student. H&r block free military Claim a lifetime learning credit and an American opportunity credit based on the same qualified education expenses. H&r block free military Claim a lifetime learning credit based on the same expenses used to figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or qualified tuition program (QTP). H&r block free military See Coordination With American Opportunity and Lifetime Learning Credits in chapter 7, Coverdell Education Savings Account, and Coordination With American Opportunity and Lifetime Learning Credits in chapter 8, Qualified Tuition Program. H&r block free military Claim a credit based on qualified education expenses paid with tax-free educational assistance, such as a scholarship, grant, or assistance provided by an employer. H&r block free military See Adjustments to Qualified Education Expenses, next. H&r block free military This image is too large to be displayed in the current screen. H&r block free military Please click the link to view the image. H&r block free military Figure 3-1 Adjustments to Qualified Education Expenses For each student, reduce the qualified education expenses paid by or on behalf of that student under the following rules. H&r block free military The result is the amount of adjusted qualified education expenses for each student. H&r block free military Tax-free educational assistance. H&r block free military   For tax-free educational assistance received in 2013, reduce the qualified educational expenses for each academic period by the amount of tax-free educational assistance allocable to that academic period. H&r block free military See Academic period , earlier. H&r block free military   Some tax-free educational assistance received after 2013 may be treated as a refund of qualified education expenses paid in 2013. H&r block free military This tax-free educational assistance is any tax-free educational assistance received by you or anyone else after 2013 for qualified education expenses paid on behalf of a student in 2013 (or attributable to enrollment at an eligible educational institution during 2013). H&r block free military   If this tax-free educational assistance is received after 2013 but before you file your 2013 income tax return, see Refunds received after 2013 but before your income tax return is filed , later. H&r block free military If this tax-free educational assistance is received after 2013 and after you file your 2013 income tax return, see Refunds received after 2013 and after your income tax return is filed , later. H&r block free military   Tax-free educational assistance includes: The tax-free part of scholarships and fellowships (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), and Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. H&r block free military Generally, any scholarship or fellowship is treated as tax free. H&r block free military However, a scholarship or fellowship is not treated as tax free to the extent the student includes it in gross income (if the student is required to file a tax return for the year the scholarship or fellowship is received) and either of the following is true. H&r block free military The scholarship or fellowship (or any part of it) must be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. H&r block free military The scholarship or fellowship (or any part of it) may be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. H&r block free military You may be able to increase the combined value of an education credit and certain educational assistance if the student includes some or all of the educational assistance in income in the year it is received. H&r block free military For examples, see Coordination with Pell grants and other scholarships, later. H&r block free military Refunds. H&r block free military   A refund of qualified education expenses may reduce adjusted qualified education expenses for the tax year or require repayment (recapture) of a credit claimed in an earlier year. H&r block free military Some tax-free educational assistance received after 2013 may be treated as a refund. H&r block free military See Tax-free educational assistance , earlier. H&r block free military Refunds received in 2013. H&r block free military   For each student, figure the adjusted qualified education expenses for 2013 by adding all the qualified education expenses for 2013 and subtracting any refunds of those expenses received from the eligible educational institution during 2013. H&r block free military Refunds received after 2013 but before your income tax return is filed. H&r block free military   If anyone receives a refund after 2013 of qualified education expenses paid on behalf of a student in 2013 and the refund is paid before you file an income tax return for 2013, the amount of qualified education expenses for 2013 is reduced by the amount of the refund. H&r block free military Refunds received after 2013 and after your income tax return is filed. H&r block free military   If anyone receives a refund after 2013 of qualified education expenses paid on behalf of a student in 2013 and the refund is paid after you file an income tax return for 2013, you may need to repay some or all of the credit. H&r block free military See Credit recapture, next. H&r block free military Credit recapture. H&r block free military    If any tax-free educational assistance for the qualified education expenses paid in 2013 or any refund of your qualified education expenses paid in 2013 is received after you file your 2013 income tax return, you must recapture (repay) any excess credit. H&r block free military You do this by refiguring the amount of your adjusted qualified education expenses for 2013 by reducing the expenses by the amount of the refund or tax-free educational assistance. H&r block free military You then refigure your education credit(s) for 2013 and figure the amount by which your 2013 tax liability would have increased if you had claimed the refigured credit(s). H&r block free military Include that amount as an additional tax for the year the refund or tax-free assistance was received. H&r block free military Example. H&r block free military   You pay $9,300 in tuition and fees in December 2013, and your child began college in January 2014. H&r block free military You filed your 2013 tax return on February 14, 2014, and claimed a lifetime learning credit of $1,860. H&r block free military You claimed no other tax credits. H&r block free military After you filed your return, your child withdrew from two courses and you received a refund of $2,900. H&r block free military You must refigure your 2013 lifetime learning credit using $6,400 of qualified education expenses instead of $9,300. H&r block free military The refigured credit is $1,280 and your tax liability increased by $580. H&r block free military See instructions for your 2014 income tax return to determine where to include this tax. H&r block free military If you pay qualified education expenses in 2014 for an academic period that begins in the first 3 months of 2014 and you receive tax-free educational assistance, or a refund, as described above, you may choose to reduce your qualified education expenses for 2014 instead of reducing your expenses for 2013. H&r block free military Amounts that do not reduce qualified education expenses. H&r block free military   Do not reduce qualified education expenses by amounts paid with funds the student receives as: Payment for services, such as wages, A loan, A gift, An inheritance, or A withdrawal from the student's personal savings. H&r block free military   Do not reduce the qualified education expenses by any scholarship or fellowship reported as income on the student's tax return in the following situations. H&r block free military The use of the money is restricted, by the terms of the scholarship or fellowship, to costs of attendance (such as room and board) other than qualified education expenses, as defined in Qualified education expenses in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. H&r block free military The use of the money is not restricted. H&r block free military For examples, see Adjustments to Qualified Education Expenses in chapter 2, American Opportunity Credit. H&r block free military Coordination with Pell grants and other scholarships. H&r block free military   In some cases, you may be able to reduce your tax liability by including scholarships in income. H&r block free military If you are claiming an education credit for a claimed dependent who received a scholarship, you may be able to reduce your tax liability if the student includes the scholarship in income. H&r block free military The scholarship must be one that may (by its terms) be applied to expenses (such as room and board) other than qualified education expenses. H&r block free military Example 1—No scholarship. H&r block free military Judy Green, who is unmarried, is taking courses at a public community college to be recertified to teach in public schools. H&r block free military Her AGI and her MAGI, for purposes of the credit, are $27,000. H&r block free military Judy takes the standard deduction of $5,950 and personal exemption of $3,800, reducing her AGI to taxable income of $17,250 and her tax before credits is $2,156. H&r block free military She claims no credits other than the lifetime learning credit. H&r block free military In July 2013 she paid $700 for the summer 2013 semester; in August 2013 she paid $1,900 for the fall 2013 semester; and in December 2013 she paid another $1,900 for the spring semester beginning in January 2014. H&r block free military Judy and the college meet all requirements for the lifetime learning tax credit. H&r block free military She can use all of the $4,500 tuition she paid in 2013 when figuring her 2013 lifetime learning credit. H&r block free military She claims a $900 lifetime learning credit and her tax after credits is $1,256. H&r block free military Example 2—Scholarship excluded from income. H&r block free military The facts are the same as in Example 1—No scholarship, except that Judy was awarded a $1,500 scholarship. H&r block free military Under the terms of her scholarship, it may be used to pay any educational expenses, including room and board. H&r block free military If Judy excludes the scholarship from income, she will be deemed (for purposes of computing her education credit) as having used the scholarship to pay for tuition, required fees, and course materials. H&r block free military Only $3,000 of the $4,500 tuition she paid in 2013 could be used when figuring her 2013 lifetime learning credit. H&r block free military Her lifetime learning credit would be reduced to $600 and her tax after credits would be $1,556. H&r block free military Example 3—Scholarship included in income. H&r block free military The facts are the same as in Example 2—Scholarship excluded from income. H&r block free military If, unlike Example 2, Judy includes the $1,500 scholarship in income, she will be deemed to have used the entire scholarship to pay for room and board. H&r block free military Judy's AGI will increase to $28,500, her taxable income would be $18,750, and her tax before credits would be $2,381. H&r block free military She would be able to use the $4,500 of adjusted qualified education expenses to figure her credit. H&r block free military Judy could claim a $900 lifetime learning credit and her tax after credits would be $1,481. H&r block free military Expenses That Do Not Qualify Qualified education expenses do not include amounts paid for: Insurance, Medical expenses (including student health fees), Room and board, Transportation, or Similar personal, living, or family expenses. H&r block free military This is true even if the amount must be paid to the institution as a condition of enrollment or attendance. H&r block free military Sports, games, hobbies, and noncredit courses. H&r block free military   Qualified education expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. H&r block free military However, if the course of instruction or other education is part of the student's degree program or is taken by the student to acquire or improve job skills, these expenses can qualify. H&r block free military Comprehensive or bundled fees. H&r block free military   Some eligible educational institutions combine all of their fees for an academic period into one amount. H&r block free military If you do not receive or do not have access to an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed above, contact the institution. H&r block free military The institution is required to make this allocation and provide you with the amount you paid (or were billed) for qualified education expenses on Form 1098-T. H&r block free military See Figuring the Credit , later, for more information about Form 1098-T. H&r block free military Who Is an Eligible Student For purposes of the lifetime learning credit, an eligible student is a student who is enrolled in one or more courses at an eligible educational institution (as defined under Qualified Education Expenses , earlier). H&r block free military Who Can Claim a Dependent's Expenses If there are qualified education expenses for your dependent during a tax year, either you or your dependent, but not both of you, can claim a lifetime learning credit for your dependent's expenses for that year. H&r block free military For you to claim a lifetime learning credit for your dependent's expenses, you must also claim an exemption for your dependent. H&r block free military You do this by listing your dependent's name and other required information on Form 1040 (or Form 1040A), line 6c. H&r block free military IF you. H&r block free military . H&r block free military . H&r block free military THEN only. H&r block free military . H&r block free military . H&r block free military claim an exemption on your tax return for a dependent who is an eligible student you can claim the lifetime learning credit based on that dependent's expenses. H&r block free military The dependent cannot claim the credit. H&r block free military do not claim an exemption on your tax return for a dependent who is an eligible student (even if entitled to the exemption) the dependent can claim the lifetime learning credit. H&r block free military You cannot claim the credit based on this dependent's expenses. H&r block free military Expenses paid by dependent. H&r block free military   If you claim an exemption on your tax return for an eligible student who is your dependent, treat any expenses paid (or deemed paid) by your dependent as if you had paid them. H&r block free military Include these expenses when figuring the amount of your lifetime learning credit. H&r block free military    Qualified education expenses paid directly to an eligible educational institution for your dependent under a court-approved divorce decree are treated as paid by your dependent. H&r block free military Expenses paid by you. H&r block free military   If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring the amount of the lifetime learning credit. H&r block free military If neither you nor anyone else claims an exemption for the dependent, only the dependent can include any expenses you paid when figuring the lifetime learning credit. H&r block free military Expenses paid by others. H&r block free military   Someone other than you, your spouse, or your dependent (such as a relative or former spouse) may make a payment directly to an eligible educational institution to pay for an eligible student's qualified education expenses. H&r block free military In this case, the student is treated as receiving the payment from the other person and, in turn, paying the institution. H&r block free military If you claim an exemption on your tax return for the student, you are considered to have paid the expenses. H&r block free military Example. H&r block free military In 2013, Ms. H&r block free military Allen makes a payment directly to an eligible educational institution for her grandson Todd's qualified education expenses. H&r block free military For purposes of claiming a lifetime learning credit, Todd is treated as receiving the money from his grandmother and, in turn, paying his qualified education expenses himself. H&r block free military Unless an exemption for Todd is claimed on someone else's 2013 tax return, only Todd can use the payment to claim a lifetime learning credit. H&r block free military If anyone, such as Todd's parents, claims an exemption for Todd on his or her 2013 tax return, whoever claims the exemption may be able to use the expenses to claim a lifetime learning credit. H&r block free military If anyone else claims an exemption for Todd, Todd cannot claim a lifetime learning credit. H&r block free military Tuition reduction. H&r block free military   When an eligible educational institution provides a reduction in tuition to an employee of the institution (or spouse or dependent child of an employee), the amount of the reduction may or may not be taxable. H&r block free military If it is taxable, the employee is treated as receiving a payment of that amount and, in turn, paying it to the educational institution on behalf of the student. H&r block free military For more information on tuition reductions, see Qualified Tuition Reduction in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions. H&r block free military Figuring the Credit The amount of the lifetime learning credit is 20% of the first $10,000 of qualified education expenses you paid for all eligible students. H&r block free military The maximum amount of lifetime learning credit you can claim for 2013 is $2,000 (20% × $10,000). H&r block free military However, that amount may be reduced based on your MAGI. H&r block free military See Effect of the Amount of Your Income on the Amount of Your Credit , later. H&r block free military Example. H&r block free military Bruce and Toni Harper are married and file a joint tax return. H&r block free military For 2013, their MAGI is $75,000. H&r block free military Toni is attending a local college (an eligible educational institution) to earn credits toward a degree in nursing. H&r block free military She already has a bachelor's degree in history and wants to become a nurse. H&r block free military In August 2013, Toni paid $5,000 of qualified education expenses for her fall 2013 semester. H&r block free military Bruce and Toni can claim a $1,000 (20% × $5,000) lifetime learning credit on their 2013 joint tax return. H&r block free military Form 1098-T. H&r block free military   To help you figure your lifetime learning credit, the student should receive Form 1098-T. H&r block free military Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2014. H&r block free military An institution may choose to report either payments received (box 1), or amounts billed (box 2), for qualified education expenses. H&r block free military However, the amounts in boxes 1 and 2 of Form 1098-T might be different from what you paid. H&r block free military When figuring the credit, use only the amounts you paid or are deemed to have paid in 2013 for qualified education expenses. H&r block free military   In addition, Form 1098-T should give other information for that institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements or refunds, and whether the student was enrolled at least half-time or was a graduate student. H&r block free military    The eligible educational institution may ask for a completed Form W-9S, or similar statement to obtain the student's name, address, and taxpayer identification number. H&r block free military Effect of the Amount of Your Income on the Amount of Your Credit The amount of your lifetime learning credit is phased out (gradually reduced) if your MAGI is between $53,000 and $63,000 ($107,000 and $127,000 if you file a joint return). H&r block free military You cannot claim a lifetime learning credit if your MAGI is $63,000 or more ($127,000 or more if you file a joint return). H&r block free military Modified adjusted gross income (MAGI). H&r block free military   For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return. H&r block free military MAGI when using Form 1040A. H&r block free military   If you file Form 1040A, your MAGI is the AGI on line 22 of that form. H&r block free military MAGI when using Form 1040. H&r block free military   If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any: Foreign earned income exclusion, Foreign housing exclusion, Foreign housing deduction, Exclusion of income by bona fide residents of American Samoa, and Exclusion of income by bona fide residents of Puerto Rico. H&r block free military You can use Worksheet 3-1 to figure your MAGI. H&r block free military Worksheet 3-1. H&r block free military MAGI for the Lifetime Learning Credit 1. H&r block free military Enter your adjusted gross income  (Form 1040, line 38)   1. H&r block free military   2. H&r block free military Enter your foreign earned income exclusion and/or housing exclusion (Form 2555, line 45, or Form 2555-EZ, line 18)   2. H&r block free military       3. H&r block free military Enter your foreign housing deduction (Form 2555, line 50)   3. H&r block free military       4. H&r block free military Enter the amount of income from Puerto Rico you are excluding   4. H&r block free military       5. H&r block free military Enter the amount of income from American Samoa you are excluding (Form 4563, line 15)   5. H&r block free military       6. H&r block free military Add the amounts on lines 2, 3, 4, and 5   6. H&r block free military   7. H&r block free military Add the amounts on lines 1 and 6. H&r block free military  This is your modified adjusted  gross income. H&r block free military Enter this amount  on Form 8863, line 14   7. H&r block free military   Phaseout. H&r block free military   If your MAGI is within the range of incomes where the credit must be reduced, you will figure your reduced credit using lines 10-18 of Form 8863. H&r block free military The same method is shown in the following example. H&r block free military Example. H&r block free military You are filing a joint return with a MAGI of $112,000. H&r block free military In 2013, you paid $6,600 of qualified education expenses. H&r block free military You figure the tentative lifetime learning credit (20% of the first $10,000 of qualified education expenses you paid for all eligible students). H&r block free military The result is a $1,320 (20% x $6,600) tentative credit. H&r block free military Because your MAGI is within the range of incomes where the credit must be reduced, you must multiply your tentative credit ($1,320) by a fraction. H&r block free military The numerator of the fraction is $127,000 (the upper limit for those filing a joint return) minus your MAGI. H&r block free military The denominator is $20,000, the range of incomes for the phaseout ($107,000 to $127,000). H&r block free military The result is the amount of your phased out (reduced) lifetime learning credit ($990). H&r block free military   $1,320 × $127,000 − $112,000  $20,000 = $990   Claiming the Credit You claim the lifetime learning credit by completing Form 8863 and submitting it with your Form 1040 or 1040A. H&r block free military Enter the credit on Form 1040, line 49, or Form 1040A, line 31. H&r block free military Note. H&r block free military In Appendix A, Illustrated Example of Education Credits at the end of this publication, there is an example illustrating the use of Form 8863 when both the American opportunity credit and the lifetime learning credit are claimed on the same tax return. 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H&r block free military Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. H&r block free military 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. H&r block free military Several assets. H&r block free military Special situations. H&r block free military Schedule D (Form 1040). H&r block free military Form 4797. H&r block free military 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. H&r block free military 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. H&r block free military The installment sales method cannot be used for the following. H&r block free military Sale of inventory. H&r block free military   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. H&r block free military See Sale of a Business under Other Rules, later. H&r block free military Dealer sales. H&r block free military   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. H&r block free military This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. H&r block free military However, the rule does not apply to an installment sale of property used or produced in farming. H&r block free military Special rule. H&r block free military   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. H&r block free military For more information, see section 453(l). H&r block free military Stock or securities. H&r block free military   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. H&r block free military You must report the entire gain on the sale in the year in which the trade date falls. H&r block free military Installment obligation. H&r block free military   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. H&r block free military 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. H&r block free military See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. H&r block free military Sale at a loss. H&r block free military   If your sale results in a loss, you cannot use the installment method. H&r block free military If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. H&r block free military Unstated interest. H&r block free military   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. H&r block free military See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. H&r block free military 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. H&r block free military Each payment on an installment sale usually consists of the following three parts. H&r block free military Interest income. H&r block free military Return of your adjusted basis in the property. H&r block free military Gain on the sale. H&r block free military 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. H&r block free military You do not include in income the part that is the return of your basis in the property. H&r block free military Basis is the amount of your investment in the property for installment sale purposes. H&r block free military Interest Income You must report interest as ordinary income. H&r block free military Interest is generally not included in a down payment. H&r block free military 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. H&r block free military Interest provided in the agreement is called stated interest. H&r block free military If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. H&r block free military See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. H&r block free military 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. H&r block free military A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). H&r block free military Figuring adjusted basis for installment sale purposes. H&r block free military   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. H&r block free military 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. H&r block free military Worksheet A. H&r block free military Figuring Adjusted Basis and Gross Profit Percentage 1. H&r block free military Enter the selling price for the property   2. H&r block free military Enter your adjusted basis for the property     3. H&r block free military Enter your selling expenses     4. H&r block free military Enter any depreciation recapture     5. H&r block free military Add lines 2, 3, and 4. H&r block free military  This is your adjusted basis for installment sale purposes   6. H&r block free military Subtract line 5 from line 1. H&r block free military If zero or less, enter -0-. H&r block free military  This is your gross profit     If the amount entered on line 6 is zero, stop here. H&r block free military You cannot use the installment method. H&r block free military   7. H&r block free military Enter the contract price for the property   8. H&r block free military Divide line 6 by line 7. H&r block free military This is your gross profit percentage   Selling price. H&r block free military   The selling price is the total cost of the property to the buyer and includes any of the following. H&r block free military Any money you are to receive. H&r block free military 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). H&r block free military 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). H&r block free military Any of your selling expenses the buyer pays. H&r block free military   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. H&r block free military Adjusted basis for installment sale purposes. H&r block free military   Your adjusted basis is the total of the following three items. H&r block free military Adjusted basis. H&r block free military Selling expenses. H&r block free military Depreciation recapture. H&r block free military Adjusted basis. H&r block free military   Basis is your investment in the property for installment sale purposes. H&r block free military The way you figure basis depends on how you acquire the property. H&r block free military The basis of property you buy is generally its cost. H&r block free military The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. H&r block free military   While you own property, various events may change your original basis. H&r block free military Some events, such as adding rooms or making permanent improvements, increase basis. H&r block free military Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. H&r block free military The result is adjusted basis. H&r block free military   For more information on how to figure basis and adjusted basis, see Publication 551. H&r block free military 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. H&r block free military Selling expenses. H&r block free military   Selling expenses relate to the sale of the property. H&r block free military They include commissions, attorney fees, and any other expenses paid on the sale. H&r block free military Selling expenses are added to the basis of the sold property. H&r block free military Depreciation recapture. H&r block free military   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. H&r block free military See Depreciation Recapture Income under Other Rules, later. H&r block free military Gross profit. H&r block free military   Gross profit is the total gain you report on the installment method. H&r block free military   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. H&r block free military If the property you sold was your home, subtract from the gross profit any gain you can exclude. H&r block free military See Sale of Your Home , later, under Reporting Installment Sale Income. H&r block free military Contract price. H&r block free military   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. H&r block free military Gross profit percentage. H&r block free military   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. H&r block free military This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. H&r block free military   The gross profit percentage generally remains the same for each payment you receive. H&r block free military However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. H&r block free military Example. H&r block free military You sell property at a contract price of $6,000 and your gross profit is $1,500. H&r block free military Your gross profit percentage is 25% ($1,500 ÷ $6,000). H&r block free military 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. H&r block free military The remainder (balance) of each payment is the tax-free return of your adjusted basis. H&r block free military Amount to report as installment sale income. H&r block free military   Multiply the payments you receive each year (less interest) by the gross profit percentage. H&r block free military The result is your installment sale income for the tax year. H&r block free military In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. H&r block free military A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. H&r block free military For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. H&r block free military Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. H&r block free military You then must refigure the gross profit percentage for the remaining payments. H&r block free military Refigure your gross profit using Worksheet B. H&r block free military You will spread any remaining gain over future installments. H&r block free military Worksheet B. H&r block free military New Gross Profit Percentage — Selling Price Reduced 1. H&r block free military Enter the reduced selling  price for the property   2. H&r block free military Enter your adjusted  basis for the  property     3. H&r block free military Enter your selling  expenses     4. H&r block free military Enter any depreciation  recapture     5. H&r block free military Add lines 2, 3, and 4. H&r block free military   6. H&r block free military Subtract line 5 from line 1. H&r block free military  This is your adjusted  gross profit   7. H&r block free military Enter any installment sale  income reported in  prior year(s)   8. H&r block free military Subtract line 7 from line 6   9. H&r block free military Future installments   10. H&r block free military Divide line 8 by line 9. H&r block free military  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. H&r block free military Example. H&r block free military In 2011, you sold land with a basis of $40,000 for $100,000. H&r block free military Your gross profit was $60,000. H&r block free military You received a $20,000 down payment and the buyer's note for $80,000. H&r block free military The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. H&r block free military Your gross profit percentage is 60%. H&r block free military You reported a gain of $12,000 on each payment received in 2011 and 2012. H&r block free military 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. H&r block free military The new gross profit percentage, 46. H&r block free military 67%, is figured on Example—Worksheet B. H&r block free military You will report a gain of $7,000 (46. H&r block free military 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. H&r block free military Example — Worksheet B. H&r block free military New Gross Profit Percentage — Selling Price Reduced 1. H&r block free military Enter the reduced selling  price for the property 85,000 2. H&r block free military Enter your adjusted  basis for the  property 40,000   3. H&r block free military Enter your selling  expenses -0-   4. H&r block free military Enter any depreciation  recapture -0-   5. H&r block free military Add lines 2, 3, and 4. H&r block free military 40,000 6. H&r block free military Subtract line 5 from line 1. H&r block free military  This is your adjusted  gross profit 45,000 7. H&r block free military Enter any installment sale  income reported in  prior year(s) 24,000 8. H&r block free military Subtract line 7 from line 6 21,000 9. H&r block free military Future installments 45,000 10. H&r block free military Divide line 8 by line 9. H&r block free military  This is your new gross profit percentage* 46. H&r block free military 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. H&r block free military 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. H&r block free military You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. H&r block free military See Schedule D (Form 1040) and Form 4797 , later. H&r block free military If the property was your main home, you may be able to exclude part or all of the gain. H&r block free military See Sale of Your Home , later. H&r block free military 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. H&r block free military Attach it to your tax return for each year. H&r block free military Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. H&r block free military Which parts to complete. H&r block free military   Which part to complete depends on whether you are filing the form for the year of sale or a later year. H&r block free military Year of sale. H&r block free military   Complete lines 1 through 4, Part I, and Part II. H&r block free military If you sold property to a related party during the year, also complete Part III. H&r block free military Later years. H&r block free military   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. H&r block free military   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. H&r block free military (After December 31, 1986, the installment method is not available for the sale of marketable securities. H&r block free military ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. H&r block free military Complete Part III unless you received the final payment during the tax year. H&r block free military   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. H&r block free military 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. H&r block free military Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. H&r block free military 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). H&r block free military 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. H&r block free military Your gain is long-term if you owned the property for more than 1 year when you sold it. H&r block free military 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. H&r block free military All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. H&r block free military 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. H&r block free military 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. H&r block free military ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. H&r block free military See Publication 523 for information about excluding the gain. H&r block free military If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. H&r block free military Seller-financed mortgage. H&r block free military   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. H&r block free military   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. H&r block free military   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. H&r block free military   If either person fails to include the other person's SSN, a $50 penalty will be assessed. H&r block free military Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. H&r block free military The following topics are discussed. H&r block free military Electing out of the installment method. H&r block free military Payments received or considered received. H&r block free military Escrow account. H&r block free military Depreciation recapture income. H&r block free military Sale to a related person. H&r block free military Like-kind exchange. H&r block free military Contingent payment sale. H&r block free military Single sale of several assets. H&r block free military Sale of a business. H&r block free military Unstated interest and original issue discount. H&r block free military Disposition of an installment obligation. H&r block free military Repossession. H&r block free military Interest on deferred tax. H&r block free military 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. H&r block free military 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. H&r block free military Notes, mortgages, and land contracts are examples of obligations that are included at FMV. H&r block free military You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. H&r block free military 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). H&r block free military Example. H&r block free military You sold a parcel of land for $50,000. H&r block free military 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. H&r block free military The buyer gave you a note for $40,000. H&r block free military The note had an FMV of $40,000. H&r block free military You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. H&r block free military The land cost $25,000, and you owned it for more than one year. H&r block free military You decide to elect out of the installment method and report the entire gain in the year of sale. H&r block free military Gain realized:     Selling price $50,000 Minus: Property's adj. H&r block free military 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. H&r block free military basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. H&r block free military 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. H&r block free military The interest on the note is ordinary income and is reported as interest income each year. H&r block free military How to elect out. H&r block free military   To make this election, do not report your sale on Form 6252. H&r block free military Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. H&r block free military When to elect out. H&r block free military   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. H&r block free military Automatic six-month extension. H&r block free military   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). H&r block free military Write “Filed pursuant to section 301. H&r block free military 9100-2” at the top of the amended return and file it where the original return was filed. H&r block free military Revoking the election. H&r block free military   Once made, the election can be revoked only with IRS approval. H&r block free military A revocation is retroactive. H&r block free military You will not be allowed to revoke the election if either of the following applies. H&r block free military One of the purposes is to avoid federal income tax. H&r block free military The tax year in which any payment was received has closed. H&r block free military 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. H&r block free military In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. H&r block free military 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. H&r block free military 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. H&r block free military 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. H&r block free military Include these expenses in the selling and contract prices when figuring the gross profit percentage. H&r block free military 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. H&r block free military Mortgage not more than basis. H&r block free military   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. H&r block free military It is considered a recovery of your basis. H&r block free military The contract price is the selling price minus the mortgage. H&r block free military Example. H&r block free military You sell property with an adjusted basis of $19,000. H&r block free military You have selling expenses of $1,000. H&r block free military 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). H&r block free military The selling price is $25,000 ($15,000 + $10,000). H&r block free military Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). H&r block free military The contract price is $10,000 ($25,000 − $15,000 mortgage). H&r block free military Your gross profit percentage is 50% ($5,000 ÷ $10,000). H&r block free military You report half of each $2,000 payment received as gain from the sale. H&r block free military You also report all interest you receive as ordinary income. H&r block free military Mortgage more than basis. H&r block free military   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. H&r block free military The part of the mortgage greater than your basis is treated as a payment received in the year of sale. H&r block free military   To figure the contract price, subtract the mortgage from the selling price. H&r block free military This is the total amount (other than interest) you will receive directly from the buyer. H&r block free military Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). H&r block free military The contract price is then the same as your gross profit from the sale. H&r block free military    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. H&r block free military Example. H&r block free military The selling price for your property is $9,000. H&r block free military The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. H&r block free military Your adjusted basis in the property is $4,400. H&r block free military You have selling expenses of $600, for a total installment sale basis of $5,000. H&r block free military The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). H&r block free military This amount is included in the contract price and treated as a payment received in the year of sale. H&r block free military 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%. H&r block free military Report 100% of each payment (less interest) as gain from the sale. H&r block free military 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. H&r block free military Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. H&r block free military You are considered to receive a payment equal to the outstanding canceled debt. H&r block free military Example. H&r block free military Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. H&r block free military On April 4, 2013, she bought the land for $70,000. H&r block free military At that time, $30,000 of her loan to you was outstanding. H&r block free military 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. H&r block free military She did not assume an existing mortgage. H&r block free military She canceled the $30,000 debt you owed her. H&r block free military You are considered to have received a $30,000 payment at the time of the sale. H&r block free military 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. H&r block free military If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. H&r block free military Compare the debt to your installment sale basis in the property being sold. H&r block free military If the debt is less than your installment sale basis, none of it is treated as a payment. H&r block free military If it is more, only the difference is treated as a payment. H&r block free military 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. H&r block free military These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . H&r block free military However, they apply only to the following types of debt the buyer assumes. H&r block free military Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. H&r block free military Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. H&r block free military 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. H&r block free military The value of the assumed debt is then considered a payment to you in the year of sale. H&r block free military 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. H&r block free military However, see Like-Kind Exchange , later. H&r block free military Generally, the amount of the payment is the property's FMV on the date you receive it. H&r block free military Exception. H&r block free military   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. H&r block free military See Unstated Interest and Original Issue Discount (OID) , later. H&r block free military Debt not payable on demand. H&r block free military   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. H&r block free military This is true even if the debt is guaranteed by a third party, including a government agency. H&r block free military Fair market value (FMV). H&r block free military   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. H&r block free military Third-party note. H&r block free military   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. H&r block free military 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. H&r block free military The excess of the note's face value over its FMV is interest. H&r block free military Exclude this interest in determining the selling price of the property. H&r block free military However, see Exception under Property Used As a Payment, earlier. H&r block free military Example. H&r block free military You sold real estate in an installment sale. H&r block free military As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. H&r block free military The FMV of the third-party note at the time of the sale was $30,000. H&r block free military This amount, not $50,000, is a payment to you in the year of sale. H&r block free military 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. H&r block free military The remaining 40% is interest taxed as ordinary income. H&r block free military Bond. H&r block free military   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. H&r block free military For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. H&r block free military    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. H&r block free military However, see Exception under Property Used As a Payment, earlier. H&r block free military Buyer's note. H&r block free military   The buyer's note (unless payable on demand) is not considered payment on the sale. H&r block free military However, its full face value is included when figuring the selling price and the contract price. H&r block free military Payments you receive on the note are used to figure your gain in the year received. H&r block free military 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. H&r block free military This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. H&r block free military It does not apply to the following dispositions. H&r block free military Sales of property used or produced in farming. H&r block free military Sales of personal-use property. H&r block free military Qualifying sales of time-shares and residential lots. H&r block free military The net debt proceeds are the gross debt minus the direct expenses of getting the debt. H&r block free military The amount treated as a payment is considered received on the later of the following dates. H&r block free military The date the debt becomes secured. H&r block free military The date you receive the debt proceeds. H&r block free military 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. H&r block free military 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. H&r block free military Limit. H&r block free military   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. H&r block free military The total contract price on the installment sale. H&r block free military Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. H&r block free military Installment payments. H&r block free military   The pledge rule accelerates the reporting of the installment obligation payments. H&r block free military 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. H&r block free military Exception. H&r block free military   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. H&r block free military The debt was outstanding on December 17, 1987. H&r block free military The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. H&r block free military   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. H&r block free military   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. H&r block free military Any excess is treated as a payment on the installment obligation. H&r block free military 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. H&r block free military These sales cannot be reported on the installment method. H&r block free military The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. H&r block free military When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. H&r block free military Example. H&r block free military You sell property for $100,000. H&r block free military 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. H&r block free military You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. H&r block free military You report the entire gain in the year of sale. H&r block free military Escrow established in a later year. H&r block free military   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. H&r block free military Substantial restriction. H&r block free military   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. H&r block free military 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. H&r block free military 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. H&r block free military Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. H&r block free military Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. H&r block free military The recapture income is also included in Part I of Form 6252. H&r block free military However, the gain equal to the recapture income is reported in full in the year of the sale. H&r block free military Only the gain greater than the recapture income is reported on the installment method. H&r block free military For more information on depreciation recapture, see chapter 3 in Publication 544. H&r block free military 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. H&r block free military Determining gross profit is discussed under General Rules , earlier. H&r block free military 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. H&r block free military 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. H&r block free military These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. H&r block free military Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. H&r block free military Instead, all payments to be received are considered received in the year of sale. H&r block free military However, see Exception , below. H&r block free military Depreciable property for this rule is any property the purchaser can depreciate. H&r block free military Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. H&r block free military In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. H&r block free military The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. H&r block free military Exception. H&r block free military   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. H&r block free military 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. H&r block free military Related person. H&r block free military   Related persons include the following. H&r block free military A person and all controlled entities with respect to that person. H&r block free military 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. H&r block free military 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. H&r block free military Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. H&r block free military   For information about which entities are controlled entities, see section 1239(c). H&r block free military 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. H&r block free military The related person makes the second disposition before making all payments on the first disposition. H&r block free military The related person disposes of the property within 2 years of the first disposition. H&r block free military This rule does not apply if the property involved is marketable securities. H&r block free military 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. H&r block free military See Exception , later. H&r block free military Related person. H&r block free military   Related persons include the following. H&r block free military Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. H&r block free military A partnership or estate and a partner or beneficiary. H&r block free military A trust (other than a section 401(a) employees trust) and a beneficiary. H&r block free military A trust and an owner of the trust. H&r block free military Two corporations that are members of the same controlled group as defined in section 267(f). H&r block free military 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. H&r block free military 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. H&r block free military 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. H&r block free military 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. H&r block free military The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. H&r block free military Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. H&r block free military 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. H&r block free military 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. H&r block free military An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. H&r block free military Example 1. H&r block free military 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. H&r block free military His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. H&r block free military His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). H&r block free military He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. H&r block free military 50). H&r block free military Bob made no improvements to the property and sold it to Alfalfa Inc. H&r block free military , in 2013 for $600,000 after making the payment for that year. H&r block free military The amount realized from the second disposition is $600,000. H&r block free military 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 % × . H&r block free military 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). H&r block free military Example 2. H&r block free military Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. H&r block free military 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 % × . H&r block free military 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. H&r block free military 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. H&r block free military In 2016, he receives the final $100,000 payment. H&r block free military 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 % × . H&r block free military 50 Installment sale income for 2016 $ 50,000 Exception. H&r block free military   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. H&r block free military 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. H&r block free military   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. H&r block free military However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. H&r block free military   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. H&r block free military An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. H&r block free military 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. H&r block free military 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. H&r block free military These trades are known as like-kind exchanges. H&r block free military The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. H&r block free military You do not have to report any part of your gain if you receive only like-kind property. H&r block free military 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. H&r block free military For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. H&r block free military Installment payments. H&r block free military   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. H&r block free military The contract price is reduced by the FMV of the like-kind property received in the trade. H&r block free military The gross profit is reduced by any gain on the trade that can be postponed. H&r block free military Like-kind property received in the trade is not considered payment on the installment obligation. H&r block free military Example. H&r block free military 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. H&r block free military He also receives an installment note for $800,000 in the trade. H&r block free military 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. H&r block free military George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). H&r block free military His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). H&r block free military The contract price is $800,000 ($1,000,000 − $200,000). H&r block free military The gross profit percentage is 75% ($600,000 ÷ $800,000). H&r block free military He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. H&r block free military 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). H&r block free military Deferred exchanges. H&r block free military   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. H&r block free military Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. H&r block free military 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. H&r block free military See Regulations section 1. H&r block free military 1031(k)-1(j)(2) for these rules. H&r block free military 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. H&r block free military This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. H&r block free military 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. H&r block free military For rules on using the installment method for a contingent payment sale, see Regulations section 15a. H&r block free military 453-1(c). H&r block free military 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. H&r block free military You also have to allocate part of the selling price to each asset. H&r block free military If you sell assets that constitute a trade or business, see Sale of a Business , later. H&r block free military 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. H&r block free military 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. H&r block free military This becomes the net FMV. H&r block free military A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. H&r block free military However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. H&r block free military It must be reported separately. H&r block free military The remaining assets sold at a gain are reported together. H&r block free military Example. H&r block free military 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. H&r block free military 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. H&r block free military Your installment sale basis for each parcel was $15,000. H&r block free military Your net gain was $85,000 ($130,000 − $45,000). H&r block free military You report the gain on the installment method. H&r block free military The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. H&r block free military The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. H&r block free military The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. H&r block free military You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. H&r block free military Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. H&r block free military 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. H&r block free military 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. H&r block free military You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. H&r block free military However, if parcel C was held for personal use, the loss is not deductible. H&r block free military 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). H&r block free military 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. H&r block free military 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. H&r block free military Assets sold at a loss. H&r block free military Real and personal property eligible for the installment method. H&r block free military Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. H&r block free military Inventory. H&r block free military   The sale of inventories of personal property cannot be reported on the installment method. H&r block free military All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. H&r block free military   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. H&r block free military If you do not, each payment must be allocated between the inventory and the other assets sold. H&r block free military   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. H&r block free military Use your basis in the inventory to figure the cost of goods sold. H&r block free military Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. H&r block free military Residual method. H&r block free military   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. H&r block free military This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. H&r block free military   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. H&r block free military 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). H&r block free military   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. H&r block free military   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). H&r block free military The consideration remaining after this reduction must be allocated among the various business assets in a certain order. H&r block free military   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. H&r block free military Certificates of deposit, U. H&r block free military S. H&r block free military Government securities, foreign currency, and actively traded personal property, including stock and securities. H&r block free military Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. H&r block free military However, see Regulations section 1. H&r block free military 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. H&r block free military 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. H&r block free military All other assets except section 197 intangibles. H&r block free military Section 197 intangibles except goodwill and going concern value. H&r block free military Goodwill and going concern value (whether or not they qualify as section 197 intangibles). H&r block free military   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. H&r block free military For example, if an asset is described in both (4) and (6), include it in (4). H&r block free military Agreement. H&r block free military   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. H&r block free military This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. H&r block free military Reporting requirement. H&r block free military   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. H&r block free military Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. H&r block free military The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. H&r block free military 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. H&r block free military The sale of a partnership interest is treated as the sale of a single capital asset. H&r block free military The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. H&r block free military (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. H&r block free military ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. H&r block free military The gain allocated to the other assets can be reported under the installment method. H&r block free military For more information on the treatment of unrealized receivables and inventory, see Publication 541. H&r block free military Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. H&r block free military You received a $100,000 down payment and the buyer's note for $120,000. H&r block free military The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. H&r block free military The total selling price is $220,000. H&r block free military Your selling expenses are $11,000. H&r block free military The selling expenses are divided among all the assets sold, including inventory. H&r block free military Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). H&r block free military The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. H&r block free military 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). H&r block free military The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. H&r block free military 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. H&r block free military   Sale  Price Sale   Exp. H&r block free military Adj. H&r block free military   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. H&r block free military A 71,000 3,550 63,800 3,650 Mch. H&r block free military 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. H&r block free military There is no depreciation recapture income because the building was depreciated using the straight line method. H&r block free military 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. H&r block free military Figure depreciation recapture in Part III of Form 4797. H&r block free military The total depreciation recapture income reported in Part II of Form 4797 is $5,209. H&r block free military 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). H&r block free military These gains are reported in full in the year of sale and are not included in the installment sale computation. H&r block free military Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. H&r block free military 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. H&r block free military The selling price equals the contract price for the installment sale ($108,500). H&r block free military The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. H&r block free military   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). H&r block free military The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. H&r block free military 95 Building— $9,600 ÷ $108,500 8. H&r block free military 85 Goodwill— $17,575 ÷ $108,500 16. H&r block free military 20 Total 48. H&r block free military 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. H&r block free military The selling price for the installment sale is $108,500. H&r block free military This is 49. H&r block free military 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). H&r block free military The selling price of assets not reported on the installment method is $111,500. H&r block free military This is 50. H&r block free military 7% ($111,500 ÷ $220,000) of the total selling price. H&r block free military Multiply principal payments by 49. H&r block free military 3% to determine the part of the payment for the installment sale. H&r block free military The balance, 50. H&r block free military 7%, is for the part reported in the year of the sale. H&r block free military The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. H&r block free military When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. H&r block free military Only the part for the installment sale (49. H&r block free military 3%) is used in the installment sale computation. H&r block free military The only payment received in 2013 is the down payment of $100,000. H&r block free military The part of the payment for the installment sale is $49,300 ($100,000 × 49. H&r block free military 3%). H&r block free military This amount is used in the installment sale computation. H&r block free military Installment income for 2013. H&r block free military   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. H&r block free military Income Land—22. H&r block free military 95% of $49,300 $11,314 Building—8. H&r block free military 85% of $49,300 4,363 Goodwill—16. H&r block free military 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. H&r block free military   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. H&r block free military 3% of the total payments you receive on the buyer's note during the year. H&r block free military 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. H&r block free military Interest provided in the contract is called stated interest. H&r block free military 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. H&r block free military If section 483 applies to the contract, this interest is called unstated interest. H&r block free military If section 1274 applies to the contract, this interest is called original issue discount (OID). H&r block free military An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). H&r block free military Treatment of unstated interest and OID. H&r block free military   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. H&r block free military As a result, the buyer cannot deduct the unstated interest. H&r block free military The seller must report the unstated interest as income. H&r block free military   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. H&r block free military   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. H&r block free military Rules for the seller. H&r block free military   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. H&r block free military If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. H&r block free military   Include the unstated interest in income based on your regular method of accounting. H&r block free military Include OID in income over the term of the contract. H&r block free military   The OID includible in income each year is based on the constant yield method described in section 1272. H&r block free military (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. H&r block free military )   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. H&r block free military Reduce the selling price by any stated principal treated as interest to determine the gain. H&r block free military   Report unstated interest or OID on your tax return, in addition to stated interest. H&r block free military Rules for the buyer. H&r block free military   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. H&r block free military These rules do not apply to personal-use property (for example, property not used in a trade or business). H&r block free military Adequate stated interest. H&r block free military   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. H&r block free military The present value of a payment is determined based on the test rate of interest, defined next. H&r block free military (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. H&r block free military ) 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. H&r block free military Test rate of interest. H&r block free military   The test rate of interest for a contract is the 3-month rate. H&r block free military The 3-month rate is the lower of the following applicable federal rates (AFRs). H&r block free military 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. H&r block free military 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. H&r block free military Applicable federal rate (AFR). H&r block free military   The AFR depends on the month the binding