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Taxes military Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. Taxes 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. Taxes military Several assets. Taxes military Special situations. Taxes military Schedule D (Form 1040). Taxes military Form 4797. Taxes 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. Taxes 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. Taxes military The installment sales method cannot be used for the following. Taxes military Sale of inventory. Taxes 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. Taxes military See Sale of a Business under Other Rules, later. Taxes military Dealer sales. Taxes 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. Taxes military This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. Taxes military However, the rule does not apply to an installment sale of property used or produced in farming. Taxes military Special rule. Taxes 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. Taxes military For more information, see section 453(l). Taxes military Stock or securities. Taxes military   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. Taxes military You must report the entire gain on the sale in the year in which the trade date falls. Taxes military Installment obligation. Taxes 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. Taxes 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. Taxes military See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. Taxes military Sale at a loss. Taxes military   If your sale results in a loss, you cannot use the installment method. Taxes 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. Taxes military Unstated interest. Taxes 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. Taxes military See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Taxes 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. Taxes military Each payment on an installment sale usually consists of the following three parts. Taxes military Interest income. Taxes military Return of your adjusted basis in the property. Taxes military Gain on the sale. Taxes 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. Taxes military You do not include in income the part that is the return of your basis in the property. Taxes military Basis is the amount of your investment in the property for installment sale purposes. Taxes military Interest Income You must report interest as ordinary income. Taxes military Interest is generally not included in a down payment. Taxes 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. Taxes military Interest provided in the agreement is called stated interest. Taxes military If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Taxes military See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Taxes 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. Taxes military A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). Taxes military Figuring adjusted basis for installment sale purposes. Taxes military   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. Taxes 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. Taxes military Worksheet A. Taxes military Figuring Adjusted Basis and Gross Profit Percentage 1. Taxes military Enter the selling price for the property   2. Taxes military Enter your adjusted basis for the property     3. Taxes military Enter your selling expenses     4. Taxes military Enter any depreciation recapture     5. Taxes military Add lines 2, 3, and 4. Taxes military  This is your adjusted basis for installment sale purposes   6. Taxes military Subtract line 5 from line 1. Taxes military If zero or less, enter -0-. Taxes military  This is your gross profit     If the amount entered on line 6 is zero, stop here. Taxes military You cannot use the installment method. Taxes military   7. Taxes military Enter the contract price for the property   8. Taxes military Divide line 6 by line 7. Taxes military This is your gross profit percentage   Selling price. Taxes military   The selling price is the total cost of the property to the buyer and includes any of the following. Taxes military Any money you are to receive. Taxes 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). Taxes 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). Taxes military Any of your selling expenses the buyer pays. Taxes military   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Taxes military Adjusted basis for installment sale purposes. Taxes military   Your adjusted basis is the total of the following three items. Taxes military Adjusted basis. Taxes military Selling expenses. Taxes military Depreciation recapture. Taxes military Adjusted basis. Taxes military   Basis is your investment in the property for installment sale purposes. Taxes military The way you figure basis depends on how you acquire the property. Taxes military The basis of property you buy is generally its cost. Taxes military The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Taxes military   While you own property, various events may change your original basis. Taxes military Some events, such as adding rooms or making permanent improvements, increase basis. Taxes military Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Taxes military The result is adjusted basis. Taxes military   For more information on how to figure basis and adjusted basis, see Publication 551. Taxes 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. Taxes military Selling expenses. Taxes military   Selling expenses relate to the sale of the property. Taxes military They include commissions, attorney fees, and any other expenses paid on the sale. Taxes military Selling expenses are added to the basis of the sold property. Taxes military Depreciation recapture. Taxes military   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Taxes military See Depreciation Recapture Income under Other Rules, later. Taxes military Gross profit. Taxes military   Gross profit is the total gain you report on the installment method. Taxes military   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Taxes military If the property you sold was your home, subtract from the gross profit any gain you can exclude. Taxes military See Sale of Your Home , later, under Reporting Installment Sale Income. Taxes military Contract price. Taxes 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. Taxes military Gross profit percentage. Taxes military   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Taxes military This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Taxes military   The gross profit percentage generally remains the same for each payment you receive. Taxes military However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. Taxes military Example. Taxes military You sell property at a contract price of $6,000 and your gross profit is $1,500. Taxes military Your gross profit percentage is 25% ($1,500 ÷ $6,000). Taxes 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. Taxes military The remainder (balance) of each payment is the tax-free return of your adjusted basis. Taxes military Amount to report as installment sale income. Taxes military   Multiply the payments you receive each year (less interest) by the gross profit percentage. Taxes military The result is your installment sale income for the tax year. Taxes military In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Taxes military A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Taxes military For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. Taxes military Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. Taxes military You then must refigure the gross profit percentage for the remaining payments. Taxes military Refigure your gross profit using Worksheet B. Taxes military You will spread any remaining gain over future installments. Taxes military Worksheet B. Taxes military New Gross Profit Percentage — Selling Price Reduced 1. Taxes military Enter the reduced selling  price for the property   2. Taxes military Enter your adjusted  basis for the  property     3. Taxes military Enter your selling  expenses     4. Taxes military Enter any depreciation  recapture     5. Taxes military Add lines 2, 3, and 4. Taxes military   6. Taxes military Subtract line 5 from line 1. Taxes military  This is your adjusted  gross profit   7. Taxes military Enter any installment sale  income reported in  prior year(s)   8. Taxes military Subtract line 7 from line 6   9. Taxes military Future installments   10. Taxes military Divide line 8 by line 9. Taxes 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. Taxes military Example. Taxes military In 2011, you sold land with a basis of $40,000 for $100,000. Taxes military Your gross profit was $60,000. Taxes military You received a $20,000 down payment and the buyer's note for $80,000. Taxes military The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. Taxes military Your gross profit percentage is 60%. Taxes military You reported a gain of $12,000 on each payment received in 2011 and 2012. Taxes 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. Taxes military The new gross profit percentage, 46. Taxes military 67%, is figured on Example—Worksheet B. Taxes military You will report a gain of $7,000 (46. Taxes military 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. Taxes military Example — Worksheet B. Taxes military New Gross Profit Percentage — Selling Price Reduced 1. Taxes military Enter the reduced selling  price for the property 85,000 2. Taxes military Enter your adjusted  basis for the  property 40,000   3. Taxes military Enter your selling  expenses -0-   4. Taxes military Enter any depreciation  recapture -0-   5. Taxes military Add lines 2, 3, and 4. Taxes military 40,000 6. Taxes military Subtract line 5 from line 1. Taxes military  This is your adjusted  gross profit 45,000 7. Taxes military Enter any installment sale  income reported in  prior year(s) 24,000 8. Taxes military Subtract line 7 from line 6 21,000 9. Taxes military Future installments 45,000 10. Taxes military Divide line 8 by line 9. Taxes military  This is your new gross profit percentage* 46. Taxes military 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Taxes 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. Taxes 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. Taxes military See Schedule D (Form 1040) and Form 4797 , later. Taxes military If the property was your main home, you may be able to exclude part or all of the gain. Taxes military See Sale of Your Home , later. Taxes 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. Taxes military Attach it to your tax return for each year. Taxes military Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. Taxes military Which parts to complete. Taxes military   Which part to complete depends on whether you are filing the form for the year of sale or a later year. Taxes military Year of sale. Taxes military   Complete lines 1 through 4, Part I, and Part II. Taxes military If you sold property to a related party during the year, also complete Part III. Taxes military Later years. Taxes military   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. Taxes 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. Taxes military (After December 31, 1986, the installment method is not available for the sale of marketable securities. Taxes military ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Taxes military Complete Part III unless you received the final payment during the tax year. Taxes 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. Taxes 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. Taxes military Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. Taxes 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). Taxes 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. Taxes military Your gain is long-term if you owned the property for more than 1 year when you sold it. Taxes 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. Taxes military All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. Taxes 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. Taxes 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. Taxes 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. Taxes military See Publication 523 for information about excluding the gain. Taxes military If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. Taxes military Seller-financed mortgage. Taxes military   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. Taxes 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. Taxes 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. Taxes military   If either person fails to include the other person's SSN, a $50 penalty will be assessed. Taxes military Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. Taxes military The following topics are discussed. Taxes military Electing out of the installment method. Taxes military Payments received or considered received. Taxes military Escrow account. Taxes military Depreciation recapture income. Taxes military Sale to a related person. Taxes military Like-kind exchange. Taxes military Contingent payment sale. Taxes military Single sale of several assets. Taxes military Sale of a business. Taxes military Unstated interest and original issue discount. Taxes military Disposition of an installment obligation. Taxes military Repossession. Taxes military Interest on deferred tax. Taxes 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. Taxes 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. Taxes military Notes, mortgages, and land contracts are examples of obligations that are included at FMV. Taxes military You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. Taxes 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). Taxes military Example. Taxes military You sold a parcel of land for $50,000. Taxes 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. Taxes military The buyer gave you a note for $40,000. Taxes military The note had an FMV of $40,000. Taxes military You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. Taxes military The land cost $25,000, and you owned it for more than one year. Taxes military You decide to elect out of the installment method and report the entire gain in the year of sale. Taxes military Gain realized:     Selling price $50,000 Minus: Property's adj. Taxes 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. Taxes military basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. Taxes 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. Taxes military The interest on the note is ordinary income and is reported as interest income each year. Taxes military How to elect out. Taxes military   To make this election, do not report your sale on Form 6252. Taxes military Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. Taxes military When to elect out. Taxes military   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Taxes military Automatic six-month extension. Taxes 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). Taxes military Write “Filed pursuant to section 301. Taxes military 9100-2” at the top of the amended return and file it where the original return was filed. Taxes military Revoking the election. Taxes military   Once made, the election can be revoked only with IRS approval. Taxes military A revocation is retroactive. Taxes military You will not be allowed to revoke the election if either of the following applies. Taxes military One of the purposes is to avoid federal income tax. Taxes military The tax year in which any payment was received has closed. Taxes 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. Taxes military In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Taxes 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. Taxes 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. Taxes 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. Taxes military Include these expenses in the selling and contract prices when figuring the gross profit percentage. Taxes 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. Taxes military Mortgage not more than basis. Taxes 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. Taxes military It is considered a recovery of your basis. Taxes military The contract price is the selling price minus the mortgage. Taxes military Example. Taxes military You sell property with an adjusted basis of $19,000. Taxes military You have selling expenses of $1,000. Taxes 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). Taxes military The selling price is $25,000 ($15,000 + $10,000). Taxes military Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Taxes military The contract price is $10,000 ($25,000 − $15,000 mortgage). Taxes military Your gross profit percentage is 50% ($5,000 ÷ $10,000). Taxes military You report half of each $2,000 payment received as gain from the sale. Taxes military You also report all interest you receive as ordinary income. Taxes military Mortgage more than basis. Taxes military   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Taxes military The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Taxes military   To figure the contract price, subtract the mortgage from the selling price. Taxes military This is the total amount (other than interest) you will receive directly from the buyer. Taxes military Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Taxes military The contract price is then the same as your gross profit from the sale. Taxes 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%. Taxes military Example. Taxes military The selling price for your property is $9,000. Taxes 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. Taxes military Your adjusted basis in the property is $4,400. Taxes military You have selling expenses of $600, for a total installment sale basis of $5,000. Taxes military The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Taxes military This amount is included in the contract price and treated as a payment received in the year of sale. Taxes 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%. Taxes military Report 100% of each payment (less interest) as gain from the sale. Taxes 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. Taxes military Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. Taxes military You are considered to receive a payment equal to the outstanding canceled debt. Taxes military Example. Taxes military Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. Taxes military On April 4, 2013, she bought the land for $70,000. Taxes military At that time, $30,000 of her loan to you was outstanding. Taxes 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. Taxes military She did not assume an existing mortgage. Taxes military She canceled the $30,000 debt you owed her. Taxes military You are considered to have received a $30,000 payment at the time of the sale. Taxes 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. Taxes military If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Taxes military Compare the debt to your installment sale basis in the property being sold. Taxes military If the debt is less than your installment sale basis, none of it is treated as a payment. Taxes military If it is more, only the difference is treated as a payment. Taxes 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. Taxes military These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . Taxes military However, they apply only to the following types of debt the buyer assumes. Taxes military Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Taxes military Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Taxes 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. Taxes military The value of the assumed debt is then considered a payment to you in the year of sale. Taxes 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. Taxes military However, see Like-Kind Exchange , later. Taxes military Generally, the amount of the payment is the property's FMV on the date you receive it. Taxes military Exception. Taxes 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. Taxes military See Unstated Interest and Original Issue Discount (OID) , later. Taxes military Debt not payable on demand. Taxes military   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. Taxes military This is true even if the debt is guaranteed by a third party, including a government agency. Taxes military Fair market value (FMV). Taxes 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. Taxes military Third-party note. Taxes 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. Taxes 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. Taxes military The excess of the note's face value over its FMV is interest. Taxes military Exclude this interest in determining the selling price of the property. Taxes military However, see Exception under Property Used As a Payment, earlier. Taxes military Example. Taxes military You sold real estate in an installment sale. Taxes military As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. Taxes military The FMV of the third-party note at the time of the sale was $30,000. Taxes military This amount, not $50,000, is a payment to you in the year of sale. Taxes 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. Taxes military The remaining 40% is interest taxed as ordinary income. Taxes military Bond. Taxes 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. Taxes military For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. Taxes 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. Taxes military However, see Exception under Property Used As a Payment, earlier. Taxes military Buyer's note. Taxes military   The buyer's note (unless payable on demand) is not considered payment on the sale. Taxes military However, its full face value is included when figuring the selling price and the contract price. Taxes military Payments you receive on the note are used to figure your gain in the year received. Taxes 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. Taxes military This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. Taxes military It does not apply to the following dispositions. Taxes military Sales of property used or produced in farming. Taxes military Sales of personal-use property. Taxes military Qualifying sales of time-shares and residential lots. Taxes military The net debt proceeds are the gross debt minus the direct expenses of getting the debt. Taxes military The amount treated as a payment is considered received on the later of the following dates. Taxes military The date the debt becomes secured. Taxes military The date you receive the debt proceeds. Taxes 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. Taxes 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. Taxes military Limit. Taxes 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. Taxes military The total contract price on the installment sale. Taxes military Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. Taxes military Installment payments. Taxes military   The pledge rule accelerates the reporting of the installment obligation payments. Taxes 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. Taxes military Exception. Taxes military   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. Taxes military The debt was outstanding on December 17, 1987. Taxes military The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. Taxes 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. Taxes military   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Taxes military Any excess is treated as a payment on the installment obligation. Taxes 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. Taxes military These sales cannot be reported on the installment method. Taxes military The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. Taxes 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. Taxes military Example. Taxes military You sell property for $100,000. Taxes 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. Taxes military You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. Taxes military You report the entire gain in the year of sale. Taxes military Escrow established in a later year. Taxes 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. Taxes military Substantial restriction. Taxes 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. Taxes 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. Taxes 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. Taxes military Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Taxes military Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. Taxes military The recapture income is also included in Part I of Form 6252. Taxes military However, the gain equal to the recapture income is reported in full in the year of the sale. Taxes military Only the gain greater than the recapture income is reported on the installment method. Taxes military For more information on depreciation recapture, see chapter 3 in Publication 544. Taxes 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. Taxes military Determining gross profit is discussed under General Rules , earlier. Taxes 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. Taxes 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. Taxes military These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. Taxes military Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Taxes military Instead, all payments to be received are considered received in the year of sale. Taxes military However, see Exception , below. Taxes military Depreciable property for this rule is any property the purchaser can depreciate. Taxes military Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. Taxes military In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. Taxes military The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. Taxes military Exception. Taxes 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. Taxes 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. Taxes military Related person. Taxes military   Related persons include the following. Taxes military A person and all controlled entities with respect to that person. Taxes 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. Taxes 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. Taxes 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. Taxes military   For information about which entities are controlled entities, see section 1239(c). Taxes 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. Taxes military The related person makes the second disposition before making all payments on the first disposition. Taxes military The related person disposes of the property within 2 years of the first disposition. Taxes military This rule does not apply if the property involved is marketable securities. Taxes 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. Taxes military See Exception , later. Taxes military Related person. Taxes military   Related persons include the following. Taxes military Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. Taxes military A partnership or estate and a partner or beneficiary. Taxes military A trust (other than a section 401(a) employees trust) and a beneficiary. Taxes military A trust and an owner of the trust. Taxes military Two corporations that are members of the same controlled group as defined in section 267(f). Taxes 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. Taxes 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. Taxes 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. Taxes 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. Taxes military The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Taxes military Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. Taxes 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. Taxes 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. Taxes military An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. Taxes military Example 1. Taxes 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. Taxes military His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. Taxes military His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). Taxes military He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. Taxes military 50). Taxes military Bob made no improvements to the property and sold it to Alfalfa Inc. Taxes military , in 2013 for $600,000 after making the payment for that year. Taxes military The amount realized from the second disposition is $600,000. Taxes 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 % × . Taxes 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). Taxes military Example 2. Taxes military Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. Taxes 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 % × . Taxes military 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. Taxes 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. Taxes military In 2016, he receives the final $100,000 payment. Taxes 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 % × . Taxes military 50 Installment sale income for 2016 $ 50,000 Exception. Taxes 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. Taxes 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. Taxes 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. Taxes military However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. Taxes military   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. Taxes military An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. Taxes 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. Taxes 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. Taxes military These trades are known as like-kind exchanges. Taxes military The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. Taxes military You do not have to report any part of your gain if you receive only like-kind property. Taxes 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. Taxes military For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. Taxes military Installment payments. Taxes 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. Taxes military The contract price is reduced by the FMV of the like-kind property received in the trade. Taxes military The gross profit is reduced by any gain on the trade that can be postponed. Taxes military Like-kind property received in the trade is not considered payment on the installment obligation. Taxes military Example. Taxes 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. Taxes military He also receives an installment note for $800,000 in the trade. Taxes 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. Taxes military George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Taxes military His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). Taxes military The contract price is $800,000 ($1,000,000 − $200,000). Taxes military The gross profit percentage is 75% ($600,000 ÷ $800,000). Taxes military He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. Taxes 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). Taxes military Deferred exchanges. Taxes 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. Taxes military Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. Taxes 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. Taxes military See Regulations section 1. Taxes military 1031(k)-1(j)(2) for these rules. Taxes 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. Taxes military This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. Taxes 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. Taxes military For rules on using the installment method for a contingent payment sale, see Regulations section 15a. Taxes military 453-1(c). Taxes 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. Taxes military You also have to allocate part of the selling price to each asset. Taxes military If you sell assets that constitute a trade or business, see Sale of a Business , later. Taxes 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. Taxes 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. Taxes military This becomes the net FMV. Taxes 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. Taxes military However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. Taxes military It must be reported separately. Taxes military The remaining assets sold at a gain are reported together. Taxes military Example. Taxes 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. Taxes 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. Taxes military Your installment sale basis for each parcel was $15,000. Taxes military Your net gain was $85,000 ($130,000 − $45,000). Taxes military You report the gain on the installment method. Taxes military The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. Taxes military The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. Taxes 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. Taxes military You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Taxes 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. Taxes 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. Taxes 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. Taxes military You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. Taxes military However, if parcel C was held for personal use, the loss is not deductible. Taxes 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). Taxes 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. Taxes 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. Taxes military Assets sold at a loss. Taxes military Real and personal property eligible for the installment method. Taxes military Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. Taxes military Inventory. Taxes military   The sale of inventories of personal property cannot be reported on the installment method. Taxes military All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Taxes 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. Taxes military If you do not, each payment must be allocated between the inventory and the other assets sold. Taxes military   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Taxes military Use your basis in the inventory to figure the cost of goods sold. Taxes military Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. Taxes military Residual method. Taxes 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. Taxes military This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. Taxes 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. Taxes 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). Taxes 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. Taxes 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). Taxes military The consideration remaining after this reduction must be allocated among the various business assets in a certain order. Taxes 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. Taxes military Certificates of deposit, U. Taxes military S. Taxes military Government securities, foreign currency, and actively traded personal property, including stock and securities. Taxes military Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. Taxes military However, see Regulations section 1. Taxes 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. Taxes 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. Taxes military All other assets except section 197 intangibles. Taxes military Section 197 intangibles except goodwill and going concern value. Taxes military Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Taxes military   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. Taxes military For example, if an asset is described in both (4) and (6), include it in (4). Taxes military Agreement. Taxes 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. Taxes military This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Taxes military Reporting requirement. Taxes 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. Taxes military Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. Taxes military The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Taxes 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. Taxes military The sale of a partnership interest is treated as the sale of a single capital asset. Taxes military The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. Taxes military (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. Taxes military ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. Taxes military The gain allocated to the other assets can be reported under the installment method. Taxes military For more information on the treatment of unrealized receivables and inventory, see Publication 541. Taxes military Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. Taxes military You received a $100,000 down payment and the buyer's note for $120,000. Taxes military The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. Taxes military The total selling price is $220,000. Taxes military Your selling expenses are $11,000. Taxes military The selling expenses are divided among all the assets sold, including inventory. Taxes military Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). Taxes military The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. Taxes 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). Taxes military The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. Taxes 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. Taxes military   Sale  Price Sale   Exp. Taxes military Adj. Taxes 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. Taxes military A 71,000 3,550 63,800 3,650 Mch. Taxes 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. Taxes military There is no depreciation recapture income because the building was depreciated using the straight line method. Taxes 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. Taxes military Figure depreciation recapture in Part III of Form 4797. Taxes military The total depreciation recapture income reported in Part II of Form 4797 is $5,209. Taxes 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). Taxes military These gains are reported in full in the year of sale and are not included in the installment sale computation. Taxes military Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. Taxes 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. Taxes military The selling price equals the contract price for the installment sale ($108,500). Taxes military The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. Taxes 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). Taxes military The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. Taxes military 95 Building— $9,600 ÷ $108,500 8. Taxes military 85 Goodwill— $17,575 ÷ $108,500 16. Taxes military 20 Total 48. Taxes 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. Taxes military The selling price for the installment sale is $108,500. Taxes military This is 49. Taxes military 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). Taxes military The selling price of assets not reported on the installment method is $111,500. Taxes military This is 50. Taxes military 7% ($111,500 ÷ $220,000) of the total selling price. Taxes military Multiply principal payments by 49. Taxes military 3% to determine the part of the payment for the installment sale. Taxes military The balance, 50. Taxes military 7%, is for the part reported in the year of the sale. Taxes military The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. Taxes 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. Taxes military Only the part for the installment sale (49. Taxes military 3%) is used in the installment sale computation. Taxes military The only payment received in 2013 is the down payment of $100,000. Taxes military The part of the payment for the installment sale is $49,300 ($100,000 × 49. Taxes military 3%). Taxes military This amount is used in the installment sale computation. Taxes military Installment income for 2013. Taxes military   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. Taxes military Income Land—22. Taxes military 95% of $49,300 $11,314 Building—8. Taxes military 85% of $49,300 4,363 Goodwill—16. Taxes military 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. Taxes military   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. Taxes military 3% of the total payments you receive on the buyer's note during the year. Taxes 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. Taxes military Interest provided in the contract is called stated interest. Taxes 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. Taxes military If section 483 applies to the contract, this interest is called unstated interest. Taxes military If section 1274 applies to the contract, this interest is called original issue discount (OID). Taxes 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). Taxes military Treatment of unstated interest and OID. Taxes military   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Taxes military As a result, the buyer cannot deduct the unstated interest. Taxes military The seller must report the unstated interest as income. Taxes 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. Taxes 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. Taxes military Rules for the seller. Taxes 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. Taxes military If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. Taxes military   Include the unstated interest in income based on your regular method of accounting. Taxes military Include OID in income over the term of the contract. Taxes military   The OID includible in income each year is based on the constant yield method described in section 1272. Taxes 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. Taxes 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. Taxes military Reduce the selling price by any stated principal treated as interest to determine the gain. Taxes military   Report unstated interest or OID on your tax return, in addition to stated interest. Taxes military Rules for the buyer. Taxes 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. Taxes military These rules do not apply to personal-use property (for example, property not used in a trade or business). Taxes military Adequate stated interest. Taxes 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. Taxes military The present value of a payment is determined based on the test rate of interest, defined next. Taxes military (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. Taxes 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. Taxes military Test rate of interest. Taxes military   The test rate of interest for a contract is the 3-month rate. Taxes military The 3-month rate is the lower of the following applicable federal rates (AFRs). Taxes 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. Taxes 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. Taxes military Applicable federal rate (AFR). Taxes military   The AFR depends on the month the binding
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The Taxes Military

Taxes military Publication 600 - Main Contents Table of Contents Actual Expenses Optional Sales Tax Tables Instructions for the State and Local General Sales Tax Deduction WorksheetWhat if you lived in more than one state? What if you lived in more than one locality? What if your local general sales tax rate changed during 2006? What if you lived in more than one locality in the same state during 2006? Actual Expenses Generally, you can deduct the actual state and local general sales taxes (including compensating use taxes) you paid in 2006 if the tax rate was the same as the general sales tax rate. Taxes military However, sales taxes on food, clothing, medical supplies, and motor vehicles are deductible as a general sales tax even if the tax rate was less than the general sales tax rate. Taxes military If you paid sales tax on a motor vehicle at a rate higher than the general sales tax rate, you can deduct only the amount of tax that you would have paid at the general sales tax rate on that vehicle. Taxes military Motor vehicles include cars, motorcycles, motor homes, recreational vehicles, sport utility vehicles, trucks, vans, and off-road vehicles. Taxes military Also include any state and local general sales taxes paid for a leased motor vehicle. Taxes military Do not include sales taxes paid on items used in your trade or business. Taxes military To deduct your actual expenses, enter the amount on Schedule A, line 5, and enter “ST” on the dotted line to the left of the line 5 entry space. Taxes military You must keep your actual receipts showing general sales taxes paid to use this method. Taxes military Refund of general sales taxes. Taxes military   If you received a refund of state or local general sales taxes in 2006 for amounts paid in 2006, reduce your actual 2006 state and local general sales taxes by this amount. Taxes military If you received a refund of state or local general sales taxes in 2006 for prior year purchases, do not reduce your 2006 state and local general sales taxes by this amount. Taxes military But if you deducted your actual state and local general sales taxes in the earlier year and the deduction reduced your tax, you may have to include the refund in income on Form 1040, line 21. Taxes military See Recoveries in Pub. Taxes military 525 for details. Taxes military Optional Sales Tax Tables Instead of using your actual expenses, you can use the tables on pages 5 through 7 to figure your state and local general sales tax deduction. Taxes military You may also be able to add the state and local general sales taxes paid on certain specified items. Taxes military To figure your state and local general sales tax deduction using the tables, complete the worksheet below. Taxes military If your filing status is married filing separately, both you and your spouse elect to deduct sales taxes, and your spouse elects to use the optional sales tax tables, you also must use the tables to figure your state and local general sales tax deduction. Taxes military State and Local General Sales Tax Deduction Worksheet (See the instructions that begin on page 3. Taxes military ) Before you begin: See the instructions for line 1 on page 3 if: You lived in more than one state during 2006, or You had any nontaxable income in 2006. Taxes military   1. Taxes military Enter your state general sales taxes from the applicable table on page 5 or 6 (see page 3 of the instructions) 1. Taxes military $     Next. Taxes military If, for all of 2006, you lived only in Connecticut, the District of Columbia, Hawaii, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, Rhode Island, Virginia, or West Virginia, skip lines 2 through 5, enter -0- on line 6, and go to line 7. Taxes military Otherwise, go to line 2       2. Taxes military Did you live in Alaska, Arizona, Arkansas (Texarkana only), California (Los Angeles County only), Colorado, Georgia, Illinois, Louisiana, New York State, or North Carolina in 2006?         No. Taxes military Enter -0-                   Yes. Taxes military Enter your local general sales taxes from the applicable table on page 7 (see page 3 of the instructions)     2. Taxes military $       3. Taxes military Did your locality impose a local general sales tax in 2006? Residents of California, Nevada, and Texarkana, Arkansas, see page 3 of the instructions             No. Taxes military Skip lines 3 through 5, enter -0- on line 6, and go to line 7             Yes. Taxes military Enter your local general sales tax rate, but omit the percentage sign. Taxes military For example, if your local general sales tax rate was 2. Taxes military 5%, enter 2. Taxes military 5. Taxes military If your local general sales tax rate changed or you lived in more than one locality in the same state during 2006, see page 3 of the instructions. Taxes military (If you do not know your local general sales tax rate, contact your local government. Taxes military ) 3. Taxes military . Taxes military       4. Taxes military Did you enter -0- on line 2 above?             No. Taxes military Skip lines 4 and 5 and go to line 6             Yes. Taxes military Enter your state general sales tax rate (shown in the table heading for your state), but omit the percentage sign. Taxes military For example, if your state general sales tax rate is 6%, enter 6. Taxes military 0 4. Taxes military . Taxes military       5. Taxes military Divide line 3 by line 4. Taxes military Enter the result as a decimal (rounded to at least three places) 5. Taxes military . Taxes military       6. Taxes military Did you enter -0- on line 2 above?             No. Taxes military Multiply line 2 by line 3   6. Taxes military $     Yes. Taxes military Multiply line 1 by line 5. Taxes military If you lived in more than one locality in the same state during 2006, see page 4 of the instructions           7. Taxes military Enter your state and local general sales taxes paid on specified items, if any (see page 4 of the instructions) 7. Taxes military $   8. Taxes military Deduction for general sales taxes. Taxes military Add lines 1, 6, and 7. Taxes military Enter the result here and the total from all your state and local general sales tax deduction worksheets, if you completed more than one, on Schedule A, line 5. Taxes military Be sure to enter “ST” on the dotted line to the left of the entry space 8. Taxes military $     Instructions for the State and Local General Sales Tax Deduction Worksheet Line 1. Taxes military    If you lived in the same state for all of 2006, enter the applicable amount, based on your 2006 income and exemptions, from the optional state sales tax table for your state on page 5 or 6. Taxes military Read down the “At least-But less than” columns for your state and find the line that includes your 2006 income. Taxes military If married filing separately, do not include your spouse's income. Taxes military Your 2006 income is the amount shown on your Form 1040, line 38, plus any nontaxable items, such as the following. Taxes military Tax-exempt interest. Taxes military Veterans' benefits. Taxes military Nontaxable combat pay. Taxes military Workers' compensation. Taxes military Nontaxable part of social security and railroad retirement benefits. Taxes military Nontaxable part of IRA, pension, or annuity distributions. Taxes military Do not include rollovers. Taxes military Public assistance payments. Taxes military The exemptions column refers to the number of exemptions claimed on Form 1040, line 6d. Taxes military Do not include any additional exemptions you listed on Form 8914 for individuals displaced by Hurricane Katrina. Taxes military What if you lived in more than one state?    If you lived in more than one state during 2006, look up the table amount for each state using the above rules. Taxes military If there is no table for your state, the table amount is considered to be zero. Taxes military Multiply the table amount for each state you lived in by a fraction. Taxes military The numerator of the fraction is the number of days you lived in the state during 2006 and the denominator is the total number of days in the year (365). Taxes military Enter the total of the prorated table amounts for each state on line 1. Taxes military However, if you also lived in a locality during 2006 that imposed a local general sales tax, do not enter the total on line 1. Taxes military Instead, complete a separate worksheet for each state you lived in and enter the prorated amount for that state on line 1. Taxes military Example. Taxes military You lived in State A from January 1 through August 31, 2006 (243 days), and in State B from September 1 through December 31, 2006 (122 days). Taxes military The table amount for State A is $500. Taxes military The table amount for State B is $400. Taxes military You would figure your state general sales tax as follows. Taxes military State A: $500 x 243/365 = $333   State B: $400 x 122/365 = 134   Total = $467   If none of the localities in which you lived during 2006 imposed a local general sales tax, enter $467 on line 1 of your worksheet. Taxes military Otherwise, complete a separate worksheet for State A and State B. Taxes military Enter $333 on line 1 of the State A worksheet and $134 on line 1 of the State B worksheet. Taxes military Line 2. Taxes military   If you checked the “No” box, enter -0- on line 2, and go to line 3. Taxes military If you checked the “Yes” box and lived in the same locality for all of 2006, enter the applicable amount, based on your 2006 income and exemptions, from the optional local sales tax table for your locality on page 7. Taxes military Read down the “At least-But less than” columns for your locality and find the line that includes your 2006 income. Taxes military See the line 1 instructions on this page to figure your 2006 income. Taxes military The exemptions column refers to the number of exemptions claimed on Form 1040, line 6d. Taxes military Do not include any additional exemptions you listed on Form 8914 for individuals displaced by Hurricane Katrina. Taxes military What if you lived in more than one locality?   If you lived in more than one locality during 2006, look up the table amount for each locality using the above rules. Taxes military If there is no table for your locality, the table amount is considered to be zero. Taxes military Multiply the table amount for each locality you lived in by a fraction. Taxes military The numerator of the fraction is the number of days you lived in the locality during 2006 and the denominator is the total number of days in the year (365). Taxes military If you lived in more than one locality in the same state and the local general sales tax rate was the same for each locality, enter the total of the prorated table amounts for each locality in that state on line 2. Taxes military Otherwise, complete a separate worksheet for lines 2 through 6 for each locality and enter each prorated table amount on line 2 of the applicable worksheet. Taxes military Example. Taxes military You lived in Locality 1 from January 1 through August 31, 2006 (243 days), and in Locality 2 from September 1 through December 31, 2006 (122 days). Taxes military The table amount for Locality 1 is $100. Taxes military The table amount for Locality 2 is $150. Taxes military You would figure the amount to enter on line 2 as follows. Taxes military Note that this amount may not equal your local sales tax deduction, which is figured on line 6 of the worksheet. Taxes military Locality 1: $100 x 243/365 = $67   Locality 2: $150 x 122/365 = 50   Total = $117   Line 3. Taxes military   If you lived in California, check the “No” box if your combined state and local general sales tax rate is 7. Taxes military 25%. Taxes military Otherwise, check the “Yes” box and include on line 3 only the part of the combined rate that is more than 7. Taxes military 25%. Taxes military   If you lived in Nevada, check the “No” box if your combined state and local general sales tax rate is 6. Taxes military 5%. Taxes military Otherwise, check the “Yes” box and include on line 3 only the part of the combined rate that is more than 6. Taxes military 5%. Taxes military   If you lived in Texarkana, Arkansas, check the “Yes” box and enter “4. Taxes military 0” on line 3. Taxes military Your local general sales tax rate of 4. Taxes military 0% includes the additional 1. Taxes military 0% Arkansas state sales tax rate for Texarkana and the 1. Taxes military 5% sales tax rate for Miller County. Taxes military What if your local general sales tax rate changed during 2006?    If you checked the “Yes” box and your local general sales tax rate changed during 2006, figure the rate to enter on line 3 as follows. Taxes military Multiply each tax rate for the period it was in effect by a fraction. Taxes military The numerator of the fraction is the number of days the rate was in effect during 2006 and the denominator is the total number of days in the year (365). Taxes military Enter the total of the prorated tax rates on line 3. Taxes military Example. Taxes military Locality 1 imposed a 1% local general sales tax from January 1 through September 30, 2006 (273 days). Taxes military The rate increased to 1. Taxes military 75% for the period from October 1 through December 31, 2006 (92 days). Taxes military You would enter “1. Taxes military 189” on line 3, figured as follows. Taxes military January 1 - September 30: 1. Taxes military 00 x 273/365 = 0. Taxes military 748   October 1 - December 31: 1. Taxes military 75 x 92/365 = 0. Taxes military 441   Total = 1. Taxes military 189   What if you lived in more than one locality in the same state during 2006?    Complete a separate worksheet for lines 2 through 6 for each locality in your state if you lived in more than one locality in the same state during 2006 and either of the following applies. Taxes military Each locality did not have the same local general sales tax rate. Taxes military You lived in Texarkana, AR, or Los Angeles County, CA. Taxes military   To figure the amount to enter on line 3 of the worksheet for each locality in which you lived (except a locality for which you used the table on page 7 to figure your local general sales tax deduction), multiply the local general sales tax rate by a fraction. Taxes military The numerator of the fraction is the number of days you lived in the locality during 2006 and the denominator is the total number of days in the year (365). Taxes military Example. Taxes military You lived in Locality 1 from January 1 through August 31, 2006 (243 days), and in Locality 2 from September 1 through December 31, 2006 (122 days). Taxes military The local general sales tax rate for Locality 1 is 1%. Taxes military The rate for Locality 2 is 1. Taxes military 75%. Taxes military You would enter “0. Taxes military 666” on line 3 for the Locality 1 worksheet and “0. Taxes military 585” for the Locality 2 worksheet, figured as follows. Taxes military Locality 1: 1. Taxes military 00 x 243/365 = 0. Taxes military 666   Locality 2: 1. Taxes military 75 x 122/365 = 0. Taxes military 585   Line 6. Taxes military   If you lived in more than one locality in the same state during 2006, you should have completed line 1 only on the first worksheet for that state and separate worksheets for lines 2 through 6 for any other locality within that state in which you lived during 2006. Taxes military If you checked the “Yes” box on line 6 of any of those worksheets, multiply line 5 of that worksheet by the amount that you entered on line 1 for that state on the first worksheet. Taxes military Line 7. Taxes military    Enter on line 7 any state and local general sales taxes paid on the following specified items. Taxes military If you are completing more than one worksheet, include the total for line 7 on only one of the worksheets. Taxes military A motor vehicle (including a car, motorcycle, motor home, recreational vehicle, sport utility vehicle, truck, van, and off-road vehicle). Taxes military Also include any state and local general sales taxes paid for a leased motor vehicle. Taxes military If the state sales tax rate on these items is higher than the general sales tax rate, only include the amount of tax you would have paid at the general sales tax rate. Taxes military An aircraft or boat, if the tax rate was the same as the general sales tax rate. Taxes military A home (including a mobile home or prefabricated home) or substantial addition to or major renovation of a home, but only if the tax rate was the same as the general sales tax rate and any of the following applies. Taxes military Your state or locality imposes a general sales tax directly on the sale of a home or on the cost of a substantial addition or major renovation. Taxes military You purchased the materials to build a home or substantial addition or to perform a major renovation and paid the sales tax directly. Taxes military Under your state law, your contractor is considered your agent in the construction of the home or substantial addition or the performance of a major renovation. Taxes military The contract must state that the contractor is authorized to act in your name and must follow your directions on construction decisions. Taxes military In this case, you will be considered to have purchased any items subject to a sales tax and to have paid the sales tax directly. Taxes military   Do not include sales taxes paid on items used in your trade or business. Taxes military If you received a refund of state or local general sales taxes in 2006, see Refund of general sales taxes on page 1. Taxes military Prev  Up  Next   Home   More Online Publications