An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. The installment sales rules do not apply to the regular sale of inventory.
If you finance the purchase of your property, instead of having the buyer get a loan or mortgage from a third party, you probably have an installment sale. It is not an installment sale if the buyer borrows the money from a third party and then pays you the total selling price.
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, or
- You use an accrual method of accounting.
If you use an accrual method of accounting, you cannot use the installment method to report gain on any property sold or disposed of after December 16, 1999. However, this rule does not apply to the following sales.
- Sale of property used or produced in farming
- Sale of timeshares or residential lots if you elect to pay a special interest charge. Refer to IRC section 453(I).
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 buyer's debt to you.
Sales of personal property by a person who regularly sells or otherwise disposes of the same type of property on the installment plan cannot be reported under the installment method. This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. However, the rule does not apply to an installment sale of property used or produced in farming.
Special Rule - Dealers of timeshares and residential lots can report certain sales on the installment method if they elect to pay a special interest charge. For more information refer to IRC section 453(I).
Figuring Installment Income
Each payment on an installment sale usually consists of the following three parts.
- Interest income
- Returns of your adjusted basis in the property
- Gain on the sale
In each year you receive a payment, you must include the interest part in income, as well as the part that is your gain on the sale. You do not include in income the part that is the return of your basis in the property. For additional information, see Publication 537, Installment Sales.
Installment Sale Basis
The three items that comprise of installment sale basis are:
- Adjustment basis - Basis is a way of measuring your investment in the property. The way you figure basis depends on how you first acquired the property. The basis of property you bought is generally its cost. The basis of property you inherited, received as a gift, built yourself, or received in a tax-free exchange is figured differently. While owning personal-use property, various events may change your original basis such as adding rooms or making permanent improvements increase your basis. Others such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis.
- Selling Expenses - Selling expenses are any expenses that relate to the sale of the property. They include commissions, attorney fees, and any other expenses paid on the sale. Selling expenses are added to the basis of the sold property.
- Depreciation Recapture - If you took depreciation deductions on the asset, you may need to recapture part of the gain on the sale as ordinary income.
The Form 6252 will help you determine the following:
- Gross Profit - The total gain you report on using the installment method.
- Contract Price - The total of all principal payments you are to receive on the installment sale
- Gross Profit Percentage - A certain percentage of each payment (after subtracting interest) is reported as a gain from the sale. It is figured by dividing your gross profit from the sale by the contract price.
Reporting Installment Income
Use Form 6252 to report an installment sale in the year it takes place and to report payments received in later years. Attach it to your tax return for each year.
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.
To figure the gain to report, use the fair market value (FMV) of the buyer's installment obligation. Notes, mortgages, and land contract are examples of obligations that are included at FMV.
You must figure the FMV of the buyer's Installment obligation, whether or not you would actually be able to sell it. If you use the cash method of accounting, the FMV of the obligation will never be considered to be less that the FMV of the property sold (minus any other consideration received).
How to Elect Out
To elect out of this method, do not report your sale on Form 6252 (PDF). Instead, report it on Schedule D (Form 1040) (PDF) or Form 4797 (PDF), whichever applies.
When to Elect Out
You must make the election by the due date, including extensions, for filing your tax return for the year the sale takes place.