Reporting Installment Sales
Some property sales result in the seller accepting a note from the purchaser and then receiving payments over a period of time. Sellers in this situation are not required to pay tax on all of the gain on the sale of the property in the year of sale when there may not be enough cash to cover the taxes. The installment sale provision in tax law allows cash basis taxpayers to spread the gain over the years in which payments are received. The installment sale reporting cannot be used for regular sales of inventory, or the sale of personal property by dealers.
On an installment sale, the taxable gain reported each year is determined as follows:
Taxpayers receiving payments over a period of time automatically report gain on the installment method, unless they elect to report all the gain in the year of the sale. An election to report all the gain in the year of sale is made by including all the gain in income in the year of the sale. Taxpayers use Form 6252, to report the installment sale gain on their income tax returns.
Example
Stephanie sells land with an adjusted basis of $145,000 for $210,000. She receives $10,000 cash in the year of sale. The buyer assumes Stephanie’s $30,000 mortgage. The balance of the sales price is payable at $17,000 per year for ten years, plus a reasonable amount of interest starting one year after the date of sale. If Stephanie elects not to report under the installment method, the gain in the year of sale would be calculated as follows.
| Cash | $10,000 |
| Note at fair market value | 170,000 |
| Mortgage assumed | 30,000 |
| Amount realized | $210,000 |
| Less: adjusted basis | 145,000 |
| Gain on sale | $65,000 |
If instead, Stephanie decides to use the installment method, she would report a gain of $3,611 in the year of sale, computed as follows. $3,611 = ($65,000/180,000) × $10,000. The contract price is $180,000 consisting of the $10,000 cash plus the $170,000 note.
The contract pricecontract priceIn an installment sale, the contract price is the cash the seller will ultimately collect (does not include debt assumed or interest). used in calculating the taxable gain is the amount the seller will ultimately collect from the purchaser (other than interest). This amount is usually the sales price of the property. However, when a purchaser assumes the seller’s debt on the property, the contract price is computed by subtracting the debt assumed from the selling price. If the debt assumed by the buyer exceeds the adjusted basis of the property, the excess is treated as a cash payment received in the year of sale and must be included in the contract price.
If the sale of property qualifies for installment sales treatment and it also includes sections 1245 or 1250 recapture, the depreciation recapture must be reported as a portion of the gain in the year of sale.
Example
Suzi sells equipment used in her business for $185,000. Her adjusted basis in the property is $125,000 and she claimed $20,000 in depreciation prior to the sale. Suzi receives $15,000 cash in the year of sale and a note receivable that will pay her $17,000 per year for ten years with the first payment due one year after sale at an appropriate rate of interest. Suzi’s gain on the sale is $60,000 = $185,000 – 125,000. The section 1245 recapture is $20,000, which will be taxed at ordinary rates. The gain to be reported in the first year is computed as $60,000 total gain – 20,000 section 1245 recapture = $40,000 total gain to be reported as cash. ($40,000/$185,000 contract price) × $15,000 cash received the first year = $3,243 gain (capital gain) plus the depreciation recapture of $20,000 (ordinary income) = $23,243 gain reported in the first year. In subsequent years, Suzi would report capital gain of $3,676 = $17,000 × ($40,000/$185,000), plus ordinary income for the interest earned.
Installment sales are covered in Publication 537.
Question and Problem
Brienna sells real property receiving $40,000 in cash and a $160,000 ten-year note. Her basis in the property is $80,000, and she receives only the $40,000 cash the year of sale. How much is Brienna’s recognized gain in the year of sale using the installment sales method?
$120,000
$56,000
$40,000
$24,000
$0
Kathy sold an apartment building and received $190,000 cash and a note for $460,000 at 10% interest. The buyer also assumed the mortgage on the property of $100,000. Kathy’s adjusted basis in the building is $250,000, and there is $250,000 in “unrecaptured depreciation.” She collected only the $190,000 down payment in the year of sale.
If Kathy elects to recognize the total gain on the property in the year of sale, what is the amount and nature of the taxable gain? $__________
Assuming Kathy uses the installment sale method, how much taxable income does Kathy report in the year of sale? $__________
Assuming Kathy collects $46,000 (not including interest) of the note principal in the year following the year of sale, calculate the amount of income recognized under the installment sale method. $__________
