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Www irs gov free file Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. Www irs gov free file 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. Www irs gov free file Several assets. Www irs gov free file Special situations. Www irs gov free file Schedule D (Form 1040). Www irs gov free file Form 4797. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file The installment sales method cannot be used for the following. Www irs gov free file Sale of inventory. Www irs gov free file   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. Www irs gov free file See Sale of a Business under Other Rules, later. Www irs gov free file Dealer sales. Www irs gov free file   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. Www irs gov free file This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. Www irs gov free file However, the rule does not apply to an installment sale of property used or produced in farming. Www irs gov free file Special rule. Www irs gov free file   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. Www irs gov free file For more information, see section 453(l). Www irs gov free file Stock or securities. Www irs gov free file   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. Www irs gov free file You must report the entire gain on the sale in the year in which the trade date falls. Www irs gov free file Installment obligation. Www irs gov free file   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. Www irs gov free file 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. Www irs gov free file See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. Www irs gov free file Sale at a loss. Www irs gov free file   If your sale results in a loss, you cannot use the installment method. Www irs gov free file If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. Www irs gov free file Unstated interest. Www irs gov free file   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. Www irs gov free file See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Www irs gov free file 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. Www irs gov free file Each payment on an installment sale usually consists of the following three parts. Www irs gov free file Interest income. Www irs gov free file Return of your adjusted basis in the property. Www irs gov free file Gain on the sale. Www irs gov free file 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. Www irs gov free file You do not include in income the part that is the return of your basis in the property. Www irs gov free file Basis is the amount of your investment in the property for installment sale purposes. Www irs gov free file Interest Income You must report interest as ordinary income. Www irs gov free file Interest is generally not included in a down payment. Www irs gov free file 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. Www irs gov free file Interest provided in the agreement is called stated interest. Www irs gov free file If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Www irs gov free file See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Www irs gov free file 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. Www irs gov free file A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). Www irs gov free file Figuring adjusted basis for installment sale purposes. Www irs gov free file   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. Www irs gov free file 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. Www irs gov free file Worksheet A. Www irs gov free file Figuring Adjusted Basis and Gross Profit Percentage 1. Www irs gov free file Enter the selling price for the property   2. Www irs gov free file Enter your adjusted basis for the property     3. Www irs gov free file Enter your selling expenses     4. Www irs gov free file Enter any depreciation recapture     5. Www irs gov free file Add lines 2, 3, and 4. Www irs gov free file  This is your adjusted basis for installment sale purposes   6. Www irs gov free file Subtract line 5 from line 1. Www irs gov free file If zero or less, enter -0-. Www irs gov free file  This is your gross profit     If the amount entered on line 6 is zero, stop here. Www irs gov free file You cannot use the installment method. Www irs gov free file   7. Www irs gov free file Enter the contract price for the property   8. Www irs gov free file Divide line 6 by line 7. Www irs gov free file This is your gross profit percentage   Selling price. Www irs gov free file   The selling price is the total cost of the property to the buyer and includes any of the following. Www irs gov free file Any money you are to receive. Www irs gov free file 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). Www irs gov free file 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). Www irs gov free file Any of your selling expenses the buyer pays. Www irs gov free file   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Www irs gov free file Adjusted basis for installment sale purposes. Www irs gov free file   Your adjusted basis is the total of the following three items. Www irs gov free file Adjusted basis. Www irs gov free file Selling expenses. Www irs gov free file Depreciation recapture. Www irs gov free file Adjusted basis. Www irs gov free file   Basis is your investment in the property for installment sale purposes. Www irs gov free file The way you figure basis depends on how you acquire the property. Www irs gov free file The basis of property you buy is generally its cost. Www irs gov free file The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Www irs gov free file   While you own property, various events may change your original basis. Www irs gov free file Some events, such as adding rooms or making permanent improvements, increase basis. Www irs gov free file Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Www irs gov free file The result is adjusted basis. Www irs gov free file   For more information on how to figure basis and adjusted basis, see Publication 551. Www irs gov free file 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. Www irs gov free file Selling expenses. Www irs gov free file   Selling expenses relate to the sale of the property. Www irs gov free file They include commissions, attorney fees, and any other expenses paid on the sale. Www irs gov free file Selling expenses are added to the basis of the sold property. Www irs gov free file Depreciation recapture. Www irs gov free file   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Www irs gov free file See Depreciation Recapture Income under Other Rules, later. Www irs gov free file Gross profit. Www irs gov free file   Gross profit is the total gain you report on the installment method. Www irs gov free file   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Www irs gov free file If the property you sold was your home, subtract from the gross profit any gain you can exclude. Www irs gov free file See Sale of Your Home , later, under Reporting Installment Sale Income. Www irs gov free file Contract price. Www irs gov free file   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. Www irs gov free file Gross profit percentage. Www irs gov free file   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Www irs gov free file This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Www irs gov free file   The gross profit percentage generally remains the same for each payment you receive. Www irs gov free file However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. Www irs gov free file Example. Www irs gov free file You sell property at a contract price of $6,000 and your gross profit is $1,500. Www irs gov free file Your gross profit percentage is 25% ($1,500 ÷ $6,000). Www irs gov free file 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. Www irs gov free file The remainder (balance) of each payment is the tax-free return of your adjusted basis. Www irs gov free file Amount to report as installment sale income. Www irs gov free file   Multiply the payments you receive each year (less interest) by the gross profit percentage. Www irs gov free file The result is your installment sale income for the tax year. Www irs gov free file In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Www irs gov free file A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Www irs gov free file For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. Www irs gov free file Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. Www irs gov free file You then must refigure the gross profit percentage for the remaining payments. Www irs gov free file Refigure your gross profit using Worksheet B. Www irs gov free file You will spread any remaining gain over future installments. Www irs gov free file Worksheet B. Www irs gov free file New Gross Profit Percentage — Selling Price Reduced 1. Www irs gov free file Enter the reduced selling  price for the property   2. Www irs gov free file Enter your adjusted  basis for the  property     3. Www irs gov free file Enter your selling  expenses     4. Www irs gov free file Enter any depreciation  recapture     5. Www irs gov free file Add lines 2, 3, and 4. Www irs gov free file   6. Www irs gov free file Subtract line 5 from line 1. Www irs gov free file  This is your adjusted  gross profit   7. Www irs gov free file Enter any installment sale  income reported in  prior year(s)   8. Www irs gov free file Subtract line 7 from line 6   9. Www irs gov free file Future installments   10. Www irs gov free file Divide line 8 by line 9. Www irs gov free file  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. Www irs gov free file Example. Www irs gov free file In 2011, you sold land with a basis of $40,000 for $100,000. Www irs gov free file Your gross profit was $60,000. Www irs gov free file You received a $20,000 down payment and the buyer's note for $80,000. Www irs gov free file The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. Www irs gov free file Your gross profit percentage is 60%. Www irs gov free file You reported a gain of $12,000 on each payment received in 2011 and 2012. Www irs gov free file 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. Www irs gov free file The new gross profit percentage, 46. Www irs gov free file 67%, is figured on Example—Worksheet B. Www irs gov free file You will report a gain of $7,000 (46. Www irs gov free file 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. Www irs gov free file Example — Worksheet B. Www irs gov free file New Gross Profit Percentage — Selling Price Reduced 1. Www irs gov free file Enter the reduced selling  price for the property 85,000 2. Www irs gov free file Enter your adjusted  basis for the  property 40,000   3. Www irs gov free file Enter your selling  expenses -0-   4. Www irs gov free file Enter any depreciation  recapture -0-   5. Www irs gov free file Add lines 2, 3, and 4. Www irs gov free file 40,000 6. Www irs gov free file Subtract line 5 from line 1. Www irs gov free file  This is your adjusted  gross profit 45,000 7. Www irs gov free file Enter any installment sale  income reported in  prior year(s) 24,000 8. Www irs gov free file Subtract line 7 from line 6 21,000 9. Www irs gov free file Future installments 45,000 10. Www irs gov free file Divide line 8 by line 9. Www irs gov free file  This is your new gross profit percentage* 46. Www irs gov free file 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Www irs gov free file 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. Www irs gov free file You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. Www irs gov free file See Schedule D (Form 1040) and Form 4797 , later. Www irs gov free file If the property was your main home, you may be able to exclude part or all of the gain. Www irs gov free file See Sale of Your Home , later. Www irs gov free file 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. Www irs gov free file Attach it to your tax return for each year. Www irs gov free file Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. Www irs gov free file Which parts to complete. Www irs gov free file   Which part to complete depends on whether you are filing the form for the year of sale or a later year. Www irs gov free file Year of sale. Www irs gov free file   Complete lines 1 through 4, Part I, and Part II. Www irs gov free file If you sold property to a related party during the year, also complete Part III. Www irs gov free file Later years. Www irs gov free file   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. Www irs gov free file   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. Www irs gov free file (After December 31, 1986, the installment method is not available for the sale of marketable securities. Www irs gov free file ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Www irs gov free file Complete Part III unless you received the final payment during the tax year. Www irs gov free file   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. Www irs gov free file 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. Www irs gov free file Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. Www irs gov free file 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). Www irs gov free file 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. Www irs gov free file Your gain is long-term if you owned the property for more than 1 year when you sold it. Www irs gov free file 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. Www irs gov free file All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. Www irs gov free file See Publication 523 for information about excluding the gain. Www irs gov free file If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. Www irs gov free file Seller-financed mortgage. Www irs gov free file   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. Www irs gov free file   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. Www irs gov free file   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. Www irs gov free file   If either person fails to include the other person's SSN, a $50 penalty will be assessed. Www irs gov free file Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. Www irs gov free file The following topics are discussed. Www irs gov free file Electing out of the installment method. Www irs gov free file Payments received or considered received. Www irs gov free file Escrow account. Www irs gov free file Depreciation recapture income. Www irs gov free file Sale to a related person. Www irs gov free file Like-kind exchange. Www irs gov free file Contingent payment sale. Www irs gov free file Single sale of several assets. Www irs gov free file Sale of a business. Www irs gov free file Unstated interest and original issue discount. Www irs gov free file Disposition of an installment obligation. Www irs gov free file Repossession. Www irs gov free file Interest on deferred tax. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file Notes, mortgages, and land contracts are examples of obligations that are included at FMV. Www irs gov free file You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. Www irs gov free file 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). Www irs gov free file Example. Www irs gov free file You sold a parcel of land for $50,000. Www irs gov free file 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. Www irs gov free file The buyer gave you a note for $40,000. Www irs gov free file The note had an FMV of $40,000. Www irs gov free file You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. Www irs gov free file The land cost $25,000, and you owned it for more than one year. Www irs gov free file You decide to elect out of the installment method and report the entire gain in the year of sale. Www irs gov free file Gain realized:     Selling price $50,000 Minus: Property's adj. Www irs gov free file 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. Www irs gov free file basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. Www irs gov free file 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. Www irs gov free file The interest on the note is ordinary income and is reported as interest income each year. Www irs gov free file How to elect out. Www irs gov free file   To make this election, do not report your sale on Form 6252. Www irs gov free file Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. Www irs gov free file When to elect out. Www irs gov free file   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Www irs gov free file Automatic six-month extension. Www irs gov free file   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). Www irs gov free file Write “Filed pursuant to section 301. Www irs gov free file 9100-2” at the top of the amended return and file it where the original return was filed. Www irs gov free file Revoking the election. Www irs gov free file   Once made, the election can be revoked only with IRS approval. Www irs gov free file A revocation is retroactive. Www irs gov free file You will not be allowed to revoke the election if either of the following applies. Www irs gov free file One of the purposes is to avoid federal income tax. Www irs gov free file The tax year in which any payment was received has closed. Www irs gov free file 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. Www irs gov free file In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file Include these expenses in the selling and contract prices when figuring the gross profit percentage. Www irs gov free file 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. Www irs gov free file Mortgage not more than basis. Www irs gov free file   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. Www irs gov free file It is considered a recovery of your basis. Www irs gov free file The contract price is the selling price minus the mortgage. Www irs gov free file Example. Www irs gov free file You sell property with an adjusted basis of $19,000. Www irs gov free file You have selling expenses of $1,000. Www irs gov free file 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). Www irs gov free file The selling price is $25,000 ($15,000 + $10,000). Www irs gov free file Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Www irs gov free file The contract price is $10,000 ($25,000 − $15,000 mortgage). Www irs gov free file Your gross profit percentage is 50% ($5,000 ÷ $10,000). Www irs gov free file You report half of each $2,000 payment received as gain from the sale. Www irs gov free file You also report all interest you receive as ordinary income. Www irs gov free file Mortgage more than basis. Www irs gov free file   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Www irs gov free file The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Www irs gov free file   To figure the contract price, subtract the mortgage from the selling price. Www irs gov free file This is the total amount (other than interest) you will receive directly from the buyer. Www irs gov free file Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Www irs gov free file The contract price is then the same as your gross profit from the sale. Www irs gov free file    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. Www irs gov free file Example. Www irs gov free file The selling price for your property is $9,000. Www irs gov free file The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Www irs gov free file Your adjusted basis in the property is $4,400. Www irs gov free file You have selling expenses of $600, for a total installment sale basis of $5,000. Www irs gov free file The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Www irs gov free file This amount is included in the contract price and treated as a payment received in the year of sale. Www irs gov free file 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%. Www irs gov free file Report 100% of each payment (less interest) as gain from the sale. Www irs gov free file 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. Www irs gov free file Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. Www irs gov free file You are considered to receive a payment equal to the outstanding canceled debt. Www irs gov free file Example. Www irs gov free file Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. Www irs gov free file On April 4, 2013, she bought the land for $70,000. Www irs gov free file At that time, $30,000 of her loan to you was outstanding. Www irs gov free file 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. Www irs gov free file She did not assume an existing mortgage. Www irs gov free file She canceled the $30,000 debt you owed her. Www irs gov free file You are considered to have received a $30,000 payment at the time of the sale. Www irs gov free file 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. Www irs gov free file If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Www irs gov free file Compare the debt to your installment sale basis in the property being sold. Www irs gov free file If the debt is less than your installment sale basis, none of it is treated as a payment. Www irs gov free file If it is more, only the difference is treated as a payment. Www irs gov free file 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. Www irs gov free file These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . Www irs gov free file However, they apply only to the following types of debt the buyer assumes. Www irs gov free file Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Www irs gov free file Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Www irs gov free file 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. Www irs gov free file The value of the assumed debt is then considered a payment to you in the year of sale. Www irs gov free file 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. Www irs gov free file However, see Like-Kind Exchange , later. Www irs gov free file Generally, the amount of the payment is the property's FMV on the date you receive it. Www irs gov free file Exception. Www irs gov free file   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. Www irs gov free file See Unstated Interest and Original Issue Discount (OID) , later. Www irs gov free file Debt not payable on demand. Www irs gov free file   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. Www irs gov free file This is true even if the debt is guaranteed by a third party, including a government agency. Www irs gov free file Fair market value (FMV). Www irs gov free file   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. Www irs gov free file Third-party note. Www irs gov free file   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. Www irs gov free file 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. Www irs gov free file The excess of the note's face value over its FMV is interest. Www irs gov free file Exclude this interest in determining the selling price of the property. Www irs gov free file However, see Exception under Property Used As a Payment, earlier. Www irs gov free file Example. Www irs gov free file You sold real estate in an installment sale. Www irs gov free file As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. Www irs gov free file The FMV of the third-party note at the time of the sale was $30,000. Www irs gov free file This amount, not $50,000, is a payment to you in the year of sale. Www irs gov free file 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. Www irs gov free file The remaining 40% is interest taxed as ordinary income. Www irs gov free file Bond. Www irs gov free file   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. Www irs gov free file For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. Www irs gov free file    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. Www irs gov free file However, see Exception under Property Used As a Payment, earlier. Www irs gov free file Buyer's note. Www irs gov free file   The buyer's note (unless payable on demand) is not considered payment on the sale. Www irs gov free file However, its full face value is included when figuring the selling price and the contract price. Www irs gov free file Payments you receive on the note are used to figure your gain in the year received. Www irs gov free file 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. Www irs gov free file This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. Www irs gov free file It does not apply to the following dispositions. Www irs gov free file Sales of property used or produced in farming. Www irs gov free file Sales of personal-use property. Www irs gov free file Qualifying sales of time-shares and residential lots. Www irs gov free file The net debt proceeds are the gross debt minus the direct expenses of getting the debt. Www irs gov free file The amount treated as a payment is considered received on the later of the following dates. Www irs gov free file The date the debt becomes secured. Www irs gov free file The date you receive the debt proceeds. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file Limit. Www irs gov free file   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. Www irs gov free file The total contract price on the installment sale. Www irs gov free file Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. Www irs gov free file Installment payments. Www irs gov free file   The pledge rule accelerates the reporting of the installment obligation payments. Www irs gov free file 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. Www irs gov free file Exception. Www irs gov free file   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. Www irs gov free file The debt was outstanding on December 17, 1987. Www irs gov free file The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. Www irs gov free file   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. Www irs gov free file   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Www irs gov free file Any excess is treated as a payment on the installment obligation. Www irs gov free file 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. Www irs gov free file These sales cannot be reported on the installment method. Www irs gov free file The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. Www irs gov free file When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. Www irs gov free file Example. Www irs gov free file You sell property for $100,000. Www irs gov free file 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. Www irs gov free file You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. Www irs gov free file You report the entire gain in the year of sale. Www irs gov free file Escrow established in a later year. Www irs gov free file   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. Www irs gov free file Substantial restriction. Www irs gov free file   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. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Www irs gov free file Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. Www irs gov free file The recapture income is also included in Part I of Form 6252. Www irs gov free file However, the gain equal to the recapture income is reported in full in the year of the sale. Www irs gov free file Only the gain greater than the recapture income is reported on the installment method. Www irs gov free file For more information on depreciation recapture, see chapter 3 in Publication 544. Www irs gov free file 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. Www irs gov free file Determining gross profit is discussed under General Rules , earlier. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. Www irs gov free file Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Www irs gov free file Instead, all payments to be received are considered received in the year of sale. Www irs gov free file However, see Exception , below. Www irs gov free file Depreciable property for this rule is any property the purchaser can depreciate. Www irs gov free file Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. Www irs gov free file In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. Www irs gov free file The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. Www irs gov free file Exception. Www irs gov free file   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. Www irs gov free file 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. Www irs gov free file Related person. Www irs gov free file   Related persons include the following. Www irs gov free file A person and all controlled entities with respect to that person. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. Www irs gov free file   For information about which entities are controlled entities, see section 1239(c). Www irs gov free file 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. Www irs gov free file The related person makes the second disposition before making all payments on the first disposition. Www irs gov free file The related person disposes of the property within 2 years of the first disposition. Www irs gov free file This rule does not apply if the property involved is marketable securities. Www irs gov free file 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. Www irs gov free file See Exception , later. Www irs gov free file Related person. Www irs gov free file   Related persons include the following. Www irs gov free file Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. Www irs gov free file A partnership or estate and a partner or beneficiary. Www irs gov free file A trust (other than a section 401(a) employees trust) and a beneficiary. Www irs gov free file A trust and an owner of the trust. Www irs gov free file Two corporations that are members of the same controlled group as defined in section 267(f). Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Www irs gov free file Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. Www irs gov free file Example 1. Www irs gov free file 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. Www irs gov free file His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. Www irs gov free file His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). Www irs gov free file He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. Www irs gov free file 50). Www irs gov free file Bob made no improvements to the property and sold it to Alfalfa Inc. Www irs gov free file , in 2013 for $600,000 after making the payment for that year. Www irs gov free file The amount realized from the second disposition is $600,000. Www irs gov free file 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 % × . Www irs gov free file 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). Www irs gov free file Example 2. Www irs gov free file Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. Www irs gov free file 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 % × . Www irs gov free file 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. Www irs gov free file 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. Www irs gov free file In 2016, he receives the final $100,000 payment. Www irs gov free file 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 % × . Www irs gov free file 50 Installment sale income for 2016 $ 50,000 Exception. Www irs gov free file   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. Www irs gov free file 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. Www irs gov free file   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. Www irs gov free file However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. Www irs gov free file   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. Www irs gov free file An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file These trades are known as like-kind exchanges. Www irs gov free file The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. Www irs gov free file You do not have to report any part of your gain if you receive only like-kind property. Www irs gov free file 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. Www irs gov free file For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. Www irs gov free file Installment payments. Www irs gov free file   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. Www irs gov free file The contract price is reduced by the FMV of the like-kind property received in the trade. Www irs gov free file The gross profit is reduced by any gain on the trade that can be postponed. Www irs gov free file Like-kind property received in the trade is not considered payment on the installment obligation. Www irs gov free file Example. Www irs gov free file 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. Www irs gov free file He also receives an installment note for $800,000 in the trade. Www irs gov free file 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. Www irs gov free file George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Www irs gov free file His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). Www irs gov free file The contract price is $800,000 ($1,000,000 − $200,000). Www irs gov free file The gross profit percentage is 75% ($600,000 ÷ $800,000). Www irs gov free file He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. Www irs gov free file 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). Www irs gov free file Deferred exchanges. Www irs gov free file   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. Www irs gov free file Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. Www irs gov free file 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. Www irs gov free file See Regulations section 1. Www irs gov free file 1031(k)-1(j)(2) for these rules. Www irs gov free file 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. Www irs gov free file This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. Www irs gov free file 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. Www irs gov free file For rules on using the installment method for a contingent payment sale, see Regulations section 15a. Www irs gov free file 453-1(c). Www irs gov free file 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. Www irs gov free file You also have to allocate part of the selling price to each asset. Www irs gov free file If you sell assets that constitute a trade or business, see Sale of a Business , later. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file This becomes the net FMV. Www irs gov free file A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. Www irs gov free file However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. Www irs gov free file It must be reported separately. Www irs gov free file The remaining assets sold at a gain are reported together. Www irs gov free file Example. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file Your installment sale basis for each parcel was $15,000. Www irs gov free file Your net gain was $85,000 ($130,000 − $45,000). Www irs gov free file You report the gain on the installment method. Www irs gov free file The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. Www irs gov free file The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. Www irs gov free file The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. Www irs gov free file You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Www irs gov free file Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. Www irs gov free file However, if parcel C was held for personal use, the loss is not deductible. Www irs gov free file 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). Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file Assets sold at a loss. Www irs gov free file Real and personal property eligible for the installment method. Www irs gov free file Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. Www irs gov free file Inventory. Www irs gov free file   The sale of inventories of personal property cannot be reported on the installment method. Www irs gov free file All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Www irs gov free file   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. Www irs gov free file If you do not, each payment must be allocated between the inventory and the other assets sold. Www irs gov free file   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Www irs gov free file Use your basis in the inventory to figure the cost of goods sold. Www irs gov free file Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. Www irs gov free file Residual method. Www irs gov free file   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. Www irs gov free file This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. Www irs gov free file   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. Www irs gov free file 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). Www irs gov free file   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. Www irs gov free file   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). Www irs gov free file The consideration remaining after this reduction must be allocated among the various business assets in a certain order. Www irs gov free file   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. Www irs gov free file Certificates of deposit, U. Www irs gov free file S. Www irs gov free file Government securities, foreign currency, and actively traded personal property, including stock and securities. Www irs gov free file Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. Www irs gov free file However, see Regulations section 1. Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file All other assets except section 197 intangibles. Www irs gov free file Section 197 intangibles except goodwill and going concern value. Www irs gov free file Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Www irs gov free file   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. Www irs gov free file For example, if an asset is described in both (4) and (6), include it in (4). Www irs gov free file Agreement. Www irs gov free file   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. Www irs gov free file This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Www irs gov free file Reporting requirement. Www irs gov free file   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. Www irs gov free file Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. Www irs gov free file The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Www irs gov free file 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. Www irs gov free file The sale of a partnership interest is treated as the sale of a single capital asset. Www irs gov free file The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. Www irs gov free file (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. Www irs gov free file ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. Www irs gov free file The gain allocated to the other assets can be reported under the installment method. Www irs gov free file For more information on the treatment of unrealized receivables and inventory, see Publication 541. Www irs gov free file Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. Www irs gov free file You received a $100,000 down payment and the buyer's note for $120,000. Www irs gov free file The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. Www irs gov free file The total selling price is $220,000. Www irs gov free file Your selling expenses are $11,000. Www irs gov free file The selling expenses are divided among all the assets sold, including inventory. Www irs gov free file Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). Www irs gov free file The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. Www irs gov free file 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). Www irs gov free file The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. Www irs gov free file 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. Www irs gov free file   Sale  Price Sale   Exp. Www irs gov free file Adj. Www irs gov free file   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. Www irs gov free file A 71,000 3,550 63,800 3,650 Mch. Www irs gov free file 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. Www irs gov free file There is no depreciation recapture income because the building was depreciated using the straight line method. Www irs gov free file 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. Www irs gov free file Figure depreciation recapture in Part III of Form 4797. Www irs gov free file The total depreciation recapture income reported in Part II of Form 4797 is $5,209. Www irs gov free file 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). Www irs gov free file These gains are reported in full in the year of sale and are not included in the installment sale computation. Www irs gov free file Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. Www irs gov free file 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. Www irs gov free file The selling price equals the contract price for the installment sale ($108,500). Www irs gov free file The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. Www irs gov free file   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). Www irs gov free file The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. Www irs gov free file 95 Building— $9,600 ÷ $108,500 8. Www irs gov free file 85 Goodwill— $17,575 ÷ $108,500 16. Www irs gov free file 20 Total 48. Www irs gov free file 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. Www irs gov free file The selling price for the installment sale is $108,500. Www irs gov free file This is 49. Www irs gov free file 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). Www irs gov free file The selling price of assets not reported on the installment method is $111,500. Www irs gov free file This is 50. Www irs gov free file 7% ($111,500 ÷ $220,000) of the total selling price. Www irs gov free file Multiply principal payments by 49. Www irs gov free file 3% to determine the part of the payment for the installment sale. Www irs gov free file The balance, 50. Www irs gov free file 7%, is for the part reported in the year of the sale. Www irs gov free file The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. Www irs gov free file When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Www irs gov free file Only the part for the installment sale (49. Www irs gov free file 3%) is used in the installment sale computation. Www irs gov free file The only payment received in 2013 is the down payment of $100,000. Www irs gov free file The part of the payment for the installment sale is $49,300 ($100,000 × 49. Www irs gov free file 3%). Www irs gov free file This amount is used in the installment sale computation. Www irs gov free file Installment income for 2013. Www irs gov free file   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. Www irs gov free file Income Land—22. Www irs gov free file 95% of $49,300 $11,314 Building—8. Www irs gov free file 85% of $49,300 4,363 Goodwill—16. Www irs gov free file 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. Www irs gov free file   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. Www irs gov free file 3% of the total payments you receive on the buyer's note during the year. Www irs gov free file 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. Www irs gov free file Interest provided in the contract is called stated interest. Www irs gov free file 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. Www irs gov free file If section 483 applies to the contract, this interest is called unstated interest. Www irs gov free file If section 1274 applies to the contract, this interest is called original issue discount (OID). Www irs gov free file An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). Www irs gov free file Treatment of unstated interest and OID. Www irs gov free file   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Www irs gov free file As a result, the buyer cannot deduct the unstated interest. Www irs gov free file The seller must report the unstated interest as income. Www irs gov free file   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. Www irs gov free file   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. Www irs gov free file Rules for the seller. Www irs gov free file   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. Www irs gov free file If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. Www irs gov free file   Include the unstated interest in income based on your regular method of accounting. Www irs gov free file Include OID in income over the term of the contract. Www irs gov free file   The OID includible in income each year is based on the constant yield method described in section 1272. Www irs gov free file (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. Www irs gov free file )   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. Www irs gov free file Reduce the selling price by any stated principal treated as interest to determine the gain. Www irs gov free file   Report unstated interest or OID on your tax return, in addition to stated interest. Www irs gov free file Rules for the buyer. Www irs gov free file   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. Www irs gov free file These rules do not apply to personal-use property (for example, property not used in a trade or business). Www irs gov free file Adequate stated interest. Www irs gov free file   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. Www irs gov free file The present value of a payment is determined based on the test rate of interest, defined next. Www irs gov free file (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. Www irs gov free file ) 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. Www irs gov free file Test rate of interest. Www irs gov free file   The test rate of interest for a contract is the 3-month rate. Www irs gov free file The 3-month rate is the lower of the following applicable federal rates (AFRs). Www irs gov free file 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. Www irs gov free file 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. Www irs gov free file Applicable federal rate (AFR). Www irs gov free file   The AFR depends on the month the binding
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Www irs gov free file 4. Www irs gov free file   Detailed Examples Table of Contents These examples use actual forms to help you prepare your income tax return. Www irs gov free file However, the information shown on the filled-in forms is not from any actual person or scenario. Www irs gov free file Example 1—Mortgage loan modification. Www irs gov free file    In 2007, Nancy Oak bought a main home for $435,000. Www irs gov free file Nancy took out a $420,000 mortgage loan to buy the home and made a down payment of $15,000. Www irs gov free file The loan was secured by the home. Www irs gov free file The mortgage loan was a recourse debt, meaning that Nancy was personally liable for the debt. Www irs gov free file In 2008, Nancy took out a second mortgage loan (also a recourse debt) in the amount of $30,000 that was used to substantially improve her kitchen. Www irs gov free file    In 2011, when the outstanding principal of the first and second mortgage loans was $440,000, Nancy refinanced the two recourse loans into one recourse loan in the amount of $475,000. Www irs gov free file The FMV of Nancy's home at the time of the refinancing was $500,000. Www irs gov free file Nancy used the additional $35,000 debt ($475,000 new mortgage loan minus $440,000 outstanding principal of Nancy's first and second mortgage loans immediately before the refinancing) to pay off personal credit cards and to pay college tuition for her son. Www irs gov free file After the refinancing, Nancy has qualified principal residence indebtedness in the amount of $440,000 because the refinanced debt is qualified principal residence indebtedness only to the extent the amount of debt is not more than the old mortgage principal just before the refinancing. Www irs gov free file   In 2013, Nancy was unable to make her mortgage loan payments. Www irs gov free file On August 31, 2013, when the outstanding balance of her refinanced mortgage loan was still $475,000 and the FMV of the property was $425,000, Nancy's bank agreed to a loan modification (a “workout”) that resulted in a $40,000 reduction in the principal balance of her loan. Www irs gov free file Nancy was neither insolvent nor in bankruptcy at the time of the loan modification. Www irs gov free file   Nancy received a 2013 Form 1099-C from her bank in January 2014 showing canceled debt of $40,000 in box 2. Www irs gov free file Identifiable event code "F" appears in box 6. Www irs gov free file This box shows the reason the creditor has filed Form 1099-C. Www irs gov free file To determine if she must include the canceled debt in her income, Nancy must determine whether she meets any of the exceptions or exclusions that apply to canceled debts. Www irs gov free file Nancy determines that the only exception or exclusion that applies to her is the qualified principal residence indebtedness exclusion. Www irs gov free file   Next, Nancy determines the amount, if any, of the $40,000 of canceled debt that was qualified principal residence indebtedness. Www irs gov free file Although Nancy has $440,000 of qualified principal residence indebtedness, part of her loan ($35,000) was not qualified principal residence indebtedness because it was used to pay off personal credit cards and college tuition for her son. Www irs gov free file Applying the ordering rule, the qualified principal residence indebtedness exclusion applies only to the extent the amount canceled is more than the amount of the debt (immediately before the cancellation) that is not qualified principal residence indebtedness. Www irs gov free file Thus, Nancy can exclude only $5,000 of the canceled debt as qualified principal residence indebtedness ($40,000 amount canceled minus $35,000 nonqualified debt). Www irs gov free file   Because Nancy does not meet any other exception or exclusion, she checks only the box on line 1e of Form 982 and enters $5,000 on line 2. Www irs gov free file Nancy must also enter $5,000 on line 10b and reduce the basis of her main home by the $5,000 she excluded from income, bringing the adjusted basis in her home to $460,000 ($435,000 purchase price plus $30,000 substantial improvement minus $5,000). Www irs gov free file Nancy must also include the $35,000 nonqualified debt portion in income on Form 1040, line 21. Www irs gov free file You can see Nancy's Form 1099-C and a portion of her Form 1040 below. Www irs gov free file Nancy's 2013 Form 1099-C, Cancellation of Debt This image is too large to be displayed in the current screen. Www irs gov free file Please click the link to view the image. Www irs gov free file Form 1099-C, Cancellation of Debt Nancy's 2013 Form 1040 This image is too large to be displayed in the current screen. Www irs gov free file Please click the link to view the image. Www irs gov free file Form 1040, U. Www irs gov free file S. Www irs gov free file Individual Income Tax Nancy's Form 982 This image is too large to be displayed in the current screen. Www irs gov free file Please click the link to view the image. Www irs gov free file Form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)              Example 2—Mortgage loan foreclosure. Www irs gov free file    In 2005, John and Mary Elm bought a main home for $335,000. Www irs gov free file John and Mary took out a $320,000 mortgage loan to buy the home and made a down payment of $15,000. Www irs gov free file The loan was secured by the home and is a recourse debt, meaning John and Mary are personally liable for the debt. Www irs gov free file   John and Mary became unable to make their mortgage loan payments and on March 1, 2013, when the outstanding balance of the mortgage loan was $315,000 and the FMV of the property was $290,000, the bank foreclosed on the property and simultaneously canceled the remaining mortgage debt. Www irs gov free file Immediately before the foreclosure, John and Mary's only other assets and liabilities were a checking account with a balance of $6,000, retirement savings of $13,000, and credit card debt of $5,500. Www irs gov free file   John and Mary received a 2013 Form 1099-C showing canceled debt of $25,000 in box 2 ($315,000 outstanding balance minus $290,000 FMV) and an FMV of $290,000 in box 7. Www irs gov free file Identifiable event code "D" appears in box 6. Www irs gov free file This box shows the reason the creditor has filed Form 1099-C. Www irs gov free file In order to determine if John and Mary must include the canceled debt in income, they must first determine whether they meet any of the exceptions or exclusions that apply to canceled debts. Www irs gov free file In this example, John and Mary meet both the insolvency and qualified principal residence indebtedness exclusions. Www irs gov free file Their sample Form 1099-C is shown on this page. Www irs gov free file   John and Mary complete the insolvency worksheet and determine that they were insolvent immediately before the cancellation because at that time their liabilities exceeded the FMV of their assets by $11,500 ($320,500 total liabilities minus $309,000 FMV of total assets). Www irs gov free file However, because the entire debt canceled is qualified principal residence indebtedness, the insolvency exclusion only applies if John and Mary elect to apply the insolvency exclusion instead of the qualified principal residence exclusion. Www irs gov free file   John and Mary do not elect to apply the insolvency exclusion instead of the qualified principal residence exclusion because under the insolvency exclusion their exclusion would be limited to the amount by which they were insolvent ($11,500). Www irs gov free file Instead, John and Mary check box 1e of Form 982 to exclude the canceled debt under the qualified principal residence exclusion. Www irs gov free file Under the qualified principal residence exclusion, the amount that John and Mary can exclude is not limited because their qualified principal residence indebtedness is not more than $2 million and no portion of the loan was nonqualified debt. Www irs gov free file As a result, John and Mary enter the full $25,000 of canceled debt on line 2 of Form 982. Www irs gov free file Because John and Mary no longer own the home due to the foreclosure, John and Mary have no remaining basis in the home at the time of the debt cancellation. Www irs gov free file Thus, John and Mary leave line 10b of Form 982 blank. Www irs gov free file   John and Mary must also determine whether they have a gain or loss from the foreclosure. Www irs gov free file John and Mary complete Table 1-1 (shown below) and find that they have a $45,000 loss from the foreclosure. Www irs gov free file Because this loss relates to their home, it is a nondeductible loss. Www irs gov free file   John and Mary's Form 1099-C, Insolvency Worksheet, and Form 982 follow. Www irs gov free file John and Mary's 2013 Form 1099-C, Cancellation of Debt This image is too large to be displayed in the current screen. Www irs gov free file Please click the link to view the image. Www irs gov free file Form 1099-C, Cancellation of Debt Table 1-1. Www irs gov free file Worksheet for Foreclosures and Repossessions (for John and Mary Elm) Part 1. Www irs gov free file Complete Part 1 only if you were personally liable for the debt (even if none of the debt was canceled). Www irs gov free file Otherwise, go to Part 2. Www irs gov free file 1. Www irs gov free file Enter the amount of outstanding debt immediately before the transfer of property reduced by any amount for which you remain personally liable immediately after the transfer of property $315,000. Www irs gov free file 00 2. Www irs gov free file Enter the fair market value of the transferred property $290,000. Www irs gov free file 00 3. Www irs gov free file Ordinary income from the cancellation of debt upon foreclosure or repossession. Www irs gov free file * Subtract line 2 from line 1. Www irs gov free file If less than zero, enter zero. Www irs gov free file Next, go to Part 2 $ 25,000. Www irs gov free file 00 Part 2. Www irs gov free file Gain or loss from foreclosure or repossession. Www irs gov free file   4. Www irs gov free file Enter the smaller of line 1 or line 2. Www irs gov free file If you did not complete Part 1 (because you were not personally liable for the debt), enter the amount of outstanding debt immediately before the transfer of property $290,000. Www irs gov free file 00 5. Www irs gov free file Enter any proceeds you received from the foreclosure sale   6. Www irs gov free file Add line 4 and line 5 $290,000. Www irs gov free file 00 7. Www irs gov free file Enter the adjusted basis of the transferred property $335,000. Www irs gov free file 00 8. Www irs gov free file Gain or loss from foreclosure or repossession. Www irs gov free file Subtract line 7 from line 6 ($ 45,000. Www irs gov free file 00) * The income may not be taxable. Www irs gov free file See chapter 1 for more details. Www irs gov free file Insolvency Worksheet—John and Mary Elm Date debt was canceled (mm/dd/yy) 03/01/13 Part I. Www irs gov free file Total liabilities immediately before the cancellation (do not include the same liability in more than one category) Liabilities (debts) Amount Owed Immediately Before the Cancellation 1. Www irs gov free file Credit card debt $ 5,500 2. Www irs gov free file Mortgage(s) on real property (including first and second mortgages and home equity loans) (mortgage(s) can be on personal residence, any additional residence, or property held for investment or used in a trade or business) $ 315,000 3. Www irs gov free file Car and other vehicle loans $ 4. Www irs gov free file Medical bills owed $ 5. Www irs gov free file Student loans $ 6. Www irs gov free file Accrued or past-due mortgage interest $ 7. Www irs gov free file Accrued or past-due real estate taxes $ 8. Www irs gov free file Accrued or past-due utilities (water, gas, electric) $ 9. Www irs gov free file Accrued or past-due child care costs $ 10. Www irs gov free file Federal or state income taxes remaining due (for prior tax years) $ 11. Www irs gov free file Judgments $ 12. Www irs gov free file Business debts (including those owed as a sole proprietor or partner) $ 13. Www irs gov free file Margin debt on stocks and other debt to purchase or secured by investment assets other than real property $ 14. Www irs gov free file Other liabilities (debts) not included above $ 15. Www irs gov free file Total liabilities immediately before the cancellation. Www irs gov free file Add lines 1 through 14. Www irs gov free file $ 320,500 Part II. Www irs gov free file Fair market value (FMV) of assets owned immediately before the cancellation (do not include the FMV of the same asset in more than one category) Assets FMV Immediately Before  the Cancellation 16. Www irs gov free file Cash and bank account balances $ 6,000 17. Www irs gov free file Real property, including the value of land (can be main home, any additional home, or property held for investment or used in a trade or business) $ 290,000 18. Www irs gov free file Cars and other vehicles $ 19. Www irs gov free file Computers $ 20. Www irs gov free file Household goods and furnishings (for example, appliances, electronics, furniture, etc. Www irs gov free file ) $ 21. Www irs gov free file Tools $ 22. Www irs gov free file Jewelry $ 23. Www irs gov free file Clothing $ 24. Www irs gov free file Books $ 25. Www irs gov free file Stocks and bonds $ 26. Www irs gov free file Investments in coins, stamps, paintings, or other collectibles $ 27. Www irs gov free file Firearms, sports, photographic, and other hobby equipment $ 28. Www irs gov free file Interest in retirement accounts (IRA accounts, 401(k) accounts, and other retirement accounts) $ 13,000 29. Www irs gov free file Interest in a pension plan $ 30. Www irs gov free file Interest in education accounts $ 31. Www irs gov free file Cash value of life insurance $ 32. Www irs gov free file Security deposits with landlords, utilities, and others $ 33. Www irs gov free file Interests in partnerships $ 34. Www irs gov free file Value of investment in a business $ 35. Www irs gov free file Other investments (for example, annuity contracts, guaranteed investment contracts, mutual funds, commodity accounts, interests in hedge funds, and options) $ 36. Www irs gov free file Other assets not included above $ 37. Www irs gov free file FMV of total assets immediately before the cancellation. Www irs gov free file Add lines 16 through 36. Www irs gov free file $ 309,000 Part III. Www irs gov free file Insolvency 38. Www irs gov free file Amount of Insolvency. Www irs gov free file Subtract line 37 from line 15. Www irs gov free file If zero or less, you are not insolvent. Www irs gov free file $ 11,500 John and Mary's Form 982 This image is too large to be displayed in the current screen. Www irs gov free file Please click the link to view the image. Www irs gov free file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)          Example 3—Mortgage loan foreclosure with debt exceeding $2 million limit. Www irs gov free file    In 2011, Kathy and Frank Willow got married and entered into a contract with Hive Construction Corporation to build a house for $3,000,000 to be used as their main home. Www irs gov free file Kathy and Frank made a $400,000 down payment and took out a $2,600,000 mortgage to finance the remaining cost of the house. Www irs gov free file Kathy and Frank are personally liable for the mortgage loan, which is secured by the home. Www irs gov free file   In November 2013, when the outstanding principal balance on the mortgage loan was $2,500,000, the FMV of the property fell to $1,750,000 and Kathy and Frank abandoned the property by permanently moving out. Www irs gov free file The lender foreclosed on the property and, on December 5, 2013, sold the property to another buyer for $1,750,000. Www irs gov free file On December 26, 2013, the lender canceled the remaining debt. Www irs gov free file Kathy and Frank have no tax attributes other than basis of personal-use property. Www irs gov free file   The lender issued a 2013 Form 1099-C to Kathy and Frank showing canceled debt of $750,000 in box 2 (the remaining balance on the $2,500,000 mortgage debt after application of the foreclosure sale proceeds) and $1,750,000 in box 7 (FMV of the property). Www irs gov free file Identifiable event code "D" appears in box 6. Www irs gov free file This box shows the reason the creditor has filed Form 1099-C. Www irs gov free file Although Kathy and Frank abandoned the property, the lender did not need to also file a Form 1099-A because the lender canceled the debt in connection with the foreclosure in the same calendar year. Www irs gov free file Kathy and Frank are filing a joint return for 2013. Www irs gov free file   Because the foreclosure occurred prior to the debt cancellation, Kathy and Frank first calculate their gain or loss from the foreclosure using Table 1-1. Www irs gov free file Because Kathy and Frank remained personally liable for the $750,000 debt remaining after the foreclosure ($2,500,000 outstanding debt immediately before the foreclosure minus $1,750,000 satisfied through the sale of the home), Kathy and Frank enter $1,750,000 on line 1 of Table 1-1 ($2,500,000 outstanding debt immediately before the foreclosure minus the $750,000 for which they remained liable). Www irs gov free file Completing Table 1-1, Kathy and Frank find that they have no ordinary income from the cancellation of debt upon foreclosure and that they have a $1,250,000 loss. Www irs gov free file Because this loss relates to their home, it is a nondeductible loss. Www irs gov free file   Because the lender later canceled the remaining amount of the debt, Kathy and Frank must also determine whether that canceled debt is taxable. Www irs gov free file Immediately before the cancellation, Kathy and Frank had $15,000 in a savings account, household furnishings with an FMV of $17,000, a car with an FMV of $10,000, and $18,000 in credit card debt. Www irs gov free file Kathy and Frank also had the $750,000 remaining balance on the mortgage loan at that time. Www irs gov free file The household furnishings originally cost $30,000. Www irs gov free file The car had been fully paid off (so there was no related outstanding debt) and was originally purchased for $16,000. Www irs gov free file Kathy and Frank had no adjustments to the cost basis of the car. Www irs gov free file Kathy and Frank had no other assets or liabilities at the time of the cancellation. Www irs gov free file Kathy and Frank complete the insolvency worksheet to calculate that they were insolvent to the extent of $726,000 immediately before the cancellation ($768,000 of total liabilities minus $42,000 FMV of total assets). Www irs gov free file   At the beginning of 2014, Kathy and Frank had $9,000 in their savings account and $15,000 in credit card debt. Www irs gov free file Kathy and Frank also owned the same car at that time (still with an FMV of $10,000 and basis of $16,000) and the same household furnishings (still with an FMV of $17,000 and a basis of $30,000). Www irs gov free file Kathy and Frank had no other assets or liabilities at that time. Www irs gov free file Kathy and Frank no longer own the home because the lender foreclosed on it in 2013. Www irs gov free file   Because the canceled debt is qualified principal residence indebtedness, the insolvency exclusion does not apply unless Kathy and Frank elect to apply the insolvency exclusion instead of the qualified principal residence indebtedness exclusion. Www irs gov free file The maximum amount that Kathy and Frank can treat as qualified principal residence indebtedness is $2,000,000. Www irs gov free file The remaining $500,000 ($2,500,000 outstanding mortgage loan minus $2,000,000 limit on qualified principal residence indebtedness) is not qualified principal residence indebtedness. Www irs gov free file Because only a part of the loan is qualified principal residence indebtedness, Kathy and Frank must apply the ordering rule to the canceled debt. Www irs gov free file Under the ordering rule, the qualified principal residence indebtedness exclusion applies only to the extent that the amount canceled ($750,000) exceeds the amount of the loan (immediately before the cancellation) that is not qualified principal residence indebtedness ($500,000). Www irs gov free file This means that Kathy and Frank can only exclude $250,000 ($750,000 amount canceled minus $500,000 nonqualified debt) under the qualified principal residence indebtedness exclusion. Www irs gov free file   Kathy and Frank do not elect to have the insolvency exclusion apply instead of the qualified principal residence exclusion. Www irs gov free file Nonetheless, they can still apply the insolvency exclusion to the $500,000 nonqualified debt because it is not qualified principal residence indebtedness. Www irs gov free file Kathy and Frank can exclude the remaining $500,000 canceled debt under the insolvency exclusion because they were insolvent immediately before the cancellation to the extent of $726,000. Www irs gov free file Thus, Kathy and Frank check the boxes on lines 1b and 1e of Form 982 and enter $750,000 on line 2 ($250,000 excluded under the qualified principal residence indebtedness exclusion plus $500,000 excluded under the insolvency exclusion). Www irs gov free file   Next, Kathy and Frank reduce their tax attributes using Part II of Form 982. Www irs gov free file Because Kathy and Frank no longer own the home due to the foreclosure, Kathy and Frank have no remaining basis in the home at the time of the debt cancellation. Www irs gov free file Thus, Kathy and Frank leave line 10b of Form 982 blank. Www irs gov free file However, Kathy and Frank are also excluding nonqualified debt under the insolvency exclusion. Www irs gov free file As a result, Kathy and Frank must reduce the basis of property they own based on the amount of canceled debt they are excluding from income under the insolvency rules. Www irs gov free file Because Kathy and Frank have no tax attributes other than basis of personal-use property to reduce, Kathy and Frank figure the amount they must include on line 10a of Form 982 by taking the smallest of: The $46,000 bases of their personal-use property held at the beginning of 2014 ($16,000 basis in the car plus $30,000 basis in household furnishings), The $500,000 of the nonbusiness debt (other than qualified principal residence indebtedness) that they are excluding from income on line 2 of Form 982, or The $43,000 excess of the total bases of the property and the amount of money they held immediately after the cancellation over their total liabilities immediately after the cancellation ($15,000 in savings account plus $30,000 basis in household furnishings plus $16,000 adjusted basis in car minus $18,000 credit card debt). Www irs gov free file Kathy and Frank enter $43,000 on Form 982, line 10a and reduce their bases in the car and the household furnishings in proportion to the total adjusted bases in all their property. Www irs gov free file Kathy and Frank reduce the basis in the car by $14,956. Www irs gov free file 52 ($43,000 x $16,000/$46,000). Www irs gov free file And they reduce the basis in the household furnishings by $28,043. Www irs gov free file 48 ($43,000 x $30,000/$46,000). Www irs gov free file   Following are Kathy and Frank's sample forms and worksheets. Www irs gov free file Frank and Kathy's 2013 Form 1099-C, Cancellation of Debt This image is too large to be displayed in the current screen. Www irs gov free file Please click the link to view the image. Www irs gov free file Form 1099-C, Cancellation of Debt Table 1-1. Www irs gov free file Worksheet for Foreclosures and Repossessions (for Frank and Kathy Willow) Part 1. Www irs gov free file Complete Part 1 only if you were personally liable for the debt (even if none of the debt was canceled). Www irs gov free file Otherwise, go to Part 2. Www irs gov free file 1. Www irs gov free file Enter the amount of outstanding debt immediately before the transfer of property reduced by any amount for which you remain personally liable immediately after the transfer of property $1,750,000. Www irs gov free file 00 2. Www irs gov free file Enter the fair market value of the transferred property $1,750,000. Www irs gov free file 00 3. Www irs gov free file Ordinary income from the cancellation of debt upon foreclosure or repossession. Www irs gov free file * Subtract line 2 from line 1. Www irs gov free file If less than zero, enter zero. Www irs gov free file Next, go to Part 2 $0. Www irs gov free file 00 Part 2. Www irs gov free file Gain or loss from foreclosure or repossession. Www irs gov free file   4. Www irs gov free file Enter the smaller of line 1 or line 2. Www irs gov free file If you did not complete Part 1 (because you were not personally liable for the debt), enter the amount of outstanding debt immediately before the transfer of property. Www irs gov free file $1,750,000. Www irs gov free file 00 5. Www irs gov free file Enter any proceeds you received from the foreclosure sale   6. Www irs gov free file Add line 4 and line 5 $1,750,000. Www irs gov free file 00 7. Www irs gov free file Enter the adjusted basis of the transferred property $3,000,000. Www irs gov free file 00 8. Www irs gov free file Gain or loss from foreclosure or repossession. Www irs gov free file Subtract line 7 from line 6 ($1,250,000. Www irs gov free file 00) * The income may not be taxable. Www irs gov free file See chapter 1 for more details. Www irs gov free file    Insolvency Worksheet—Frank and Kathy Willow Date debt was canceled (mm/dd/yy) 12/26/13 Part I. Www irs gov free file Total liabilities immediately before the cancellation (do not include the same liability in more than one category) Liabilities (debts) Amount Owed Immediately Before the Cancellation 1. Www irs gov free file Credit card debt $ 18,000 2. Www irs gov free file Mortgage(s) on real property (including first and second mortgages and home equity loans) (mortgage(s) can be on personal residence, any additional residence, or property held for investment or used in a trade or business) $ 750,000 3. Www irs gov free file Car and other vehicle loans $ 4. Www irs gov free file Medical bills owed $ 5. Www irs gov free file Student loans $ 6. Www irs gov free file Accrued or past-due mortgage interest $ 7. Www irs gov free file Accrued or past-due real estate taxes $ 8. Www irs gov free file Accrued or past-due utilities (water, gas, electric) $ 9. Www irs gov free file Accrued or past-due child care costs $ 10. Www irs gov free file Federal or state income taxes remaining due (for prior tax years) $ 11. Www irs gov free file Judgments $ 12. Www irs gov free file Business debts (including those owed as a sole proprietor or partner) $ 13. Www irs gov free file Margin debt on stocks and other debt to purchase or secured by investment assets other than real property $ 14. Www irs gov free file Other liabilities (debts) not included above $ 15. Www irs gov free file Total liabilities immediately before the cancellation. Www irs gov free file Add lines 1 through 14. Www irs gov free file $ 768,000 Part II. Www irs gov free file Fair market value (FMV) of assets owned immediately before the cancellation (do not include the FMV of the same asset in more than one category) Assets FMV Immediately Before  the Cancellation 16. Www irs gov free file Cash and bank account balances $ 15,000 17. Www irs gov free file Real property, including the value of land (can be main home, any additional home, or property held for investment or used in a trade or business) $ 18. Www irs gov free file Cars and other vehicles $ 10,000 19. Www irs gov free file Computers $ 20. Www irs gov free file Household goods and furnishings (for example, appliances, electronics, furniture, etc. Www irs gov free file ) $ 17,000 21. Www irs gov free file Tools $ 22. Www irs gov free file Jewelry $ 23. Www irs gov free file Clothing $ 24. Www irs gov free file Books $ 25. Www irs gov free file Stocks and bonds $ 26. Www irs gov free file Investments in coins, stamps, paintings, or other collectibles $ 27. Www irs gov free file Firearms, sports, photographic, and other hobby equipment $ 28. Www irs gov free file Interest in retirement accounts (IRA accounts, 401(k) accounts, and other retirement accounts) $ 29. Www irs gov free file Interest in a pension plan $ 30. Www irs gov free file Interest in education accounts $ 31. Www irs gov free file Cash value of life insurance $ 32. Www irs gov free file Security deposits with landlords, utilities, and others $ 33. Www irs gov free file Interests in partnerships $ 34. Www irs gov free file Value of investment in a business $ 35. Www irs gov free file Other investments (for example, annuity contracts, guaranteed investment contracts, mutual funds, commodity accounts, interests in hedge funds, and options) $ 36. Www irs gov free file Other assets not included above $ 37. Www irs gov free file FMV of total assets immediately before the cancellation. Www irs gov free file Add lines 16 through 36. Www irs gov free file $ 42,000 Part III. Www irs gov free file Insolvency 38. Www irs gov free file Amount of Insolvency. Www irs gov free file Subtract line 37 from line 15. Www irs gov free file If zero or less, you are not insolvent. Www irs gov free file $ 726,000    Frank and Kathy's Form 982 This image is too large to be displayed in the current screen. Www irs gov free file Please click the link to view the image. Www irs gov free file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) Prev  Up  Next   Home   More Online Publications