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Irs free file fillable forms 2. Irs free file fillable forms   Electing the Section 179 Deduction Table of Contents Introduction Useful Items - You may want to see: What Property Qualifies?Eligible Property Property Acquired for Business Use Property Acquired by Purchase What Property Does Not Qualify?Land and Improvements Excepted Property How Much Can You Deduct?Dollar Limits Business Income Limit Partnerships and Partners S Corporations Other Corporations How Do You Elect the Deduction? When Must You Recapture the Deduction? Introduction You can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you place the property in service. Irs free file fillable forms This is the section 179 deduction. Irs free file fillable forms You can elect the section 179 deduction instead of recovering the cost by taking depreciation deductions. Irs free file fillable forms Estates and trusts cannot elect the section 179 deduction. Irs free file fillable forms This chapter explains what property does and does not qualify for the section 179 deduction, what limits apply to the deduction (including special rules for partnerships and corporations), and how to elect it. Irs free file fillable forms It also explains when and how to recapture the deduction. Irs free file fillable forms Useful Items - You may want to see: Publication 537 Installment Sales 544 Sales and Other Dispositions of Assets 954 Tax Incentives for Distressed Communities Form (and Instructions) 4562 Depreciation and Amortization 4797 Sales of Business Property See chapter 6 for information about getting publications and forms. Irs free file fillable forms What Property Qualifies? To qualify for the section 179 deduction, your property must meet all the following requirements. Irs free file fillable forms It must be eligible property. Irs free file fillable forms It must be acquired for business use. Irs free file fillable forms It must have been acquired by purchase. Irs free file fillable forms It must not be property described later under What Property Does Not Qualify . Irs free file fillable forms The following discussions provide information about these requirements and exceptions. Irs free file fillable forms Eligible Property To qualify for the section 179 deduction, your property must be one of the following types of depreciable property. Irs free file fillable forms Tangible personal property. Irs free file fillable forms Other tangible property (except buildings and their structural components) used as: An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services, A research facility used in connection with any of the activities in (a) above, or A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities. Irs free file fillable forms Single purpose agricultural (livestock) or horticultural structures. Irs free file fillable forms See chapter 7 of Publication 225 for definitions and information regarding the use requirements that apply to these structures. Irs free file fillable forms Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product of petroleum. Irs free file fillable forms Off-the-shelf computer software. Irs free file fillable forms Qualified real property (described below). Irs free file fillable forms Tangible personal property. Irs free file fillable forms   Tangible personal property is any tangible property that is not real property. Irs free file fillable forms It includes the following property. Irs free file fillable forms Machinery and equipment. Irs free file fillable forms Property contained in or attached to a building (other than structural components), such as refrigerators, grocery store counters, office equipment, printing presses, testing equipment, and signs. Irs free file fillable forms Gasoline storage tanks and pumps at retail service stations. Irs free file fillable forms Livestock, including horses, cattle, hogs, sheep, goats, and mink and other furbearing animals. Irs free file fillable forms   The treatment of property as tangible personal property for the section 179 deduction is not controlled by its treatment under local law. Irs free file fillable forms For example, property may not be tangible personal property for the deduction even if treated so under local law, and some property (such as fixtures) may be tangible personal property for the deduction even if treated as real property under local law. Irs free file fillable forms Off-the-shelf computer software. Irs free file fillable forms   Off-the-shelf computer software placed in service during the tax year is qualifying property for purposes of the section 179 deduction. Irs free file fillable forms This is computer software that is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially modified. Irs free file fillable forms It includes any program designed to cause a computer to perform a desired function. Irs free file fillable forms However, a database or similar item is not considered computer software unless it is in the public domain and is incidental to the operation of otherwise qualifying software. Irs free file fillable forms Qualified real property. Irs free file fillable forms   You can elect to treat certain qualified real property you placed in service as section 179 property for tax years beginning in 2013. Irs free file fillable forms If this election is made, the term “section 179 property” will include any qualified real property that is: Qualified leasehold improvement property, Qualified restaurant property, or Qualified retail improvement property. Irs free file fillable forms The maximum section 179 expense deduction that can be elected for qualified section 179 real property is $250,000 of the maximum section 179 deduction of $500,000 in 2013. Irs free file fillable forms For more information, see Special rules for qualified section 179 real property, later. Irs free file fillable forms Also, see Election for certain qualified section 179 real property, later, for information on how to make this election. Irs free file fillable forms Qualified leasehold improvement property. Irs free file fillable forms   Generally, this is any improvement to an interior part of a building (placed in service before January 1, 2014) that is nonresidential real property, provided all of the requirements discussed in chapter 3 under Qualified leasehold improvement property are met. Irs free file fillable forms   In addition, an improvement made by the lessor does not qualify as qualified leasehold improvement property to any subsequent owner unless it is acquired from the original lessor by reason of the lessor’s death or in any of the following types of transactions. Irs free file fillable forms A transaction to which section 381(a) applies, A mere change in the form of conducting the trade or business so long as the property is retained in the trade or business as qualified leasehold improvement property and the taxpayer retains a substantial interest in the trade or business, A like-kind exchange, involuntary conversion, or re-acquisition of real property to the extent that the basis in the property represents the carryover basis, or Certain nonrecognition transactions to the extent that your basis in the property is determined by reference to the transferor’s or distributor’s basis in the property. Irs free file fillable forms Examples include the following. Irs free file fillable forms A complete liquidation of a subsidiary. Irs free file fillable forms A transfer to a corporation controlled by the transferor. Irs free file fillable forms An exchange of property by a corporation solely for stock or securities in another corporation in a reorganization. Irs free file fillable forms Qualified restaurant property. Irs free file fillable forms   Qualified restaurant property is any section 1250 property that is a building or an improvement to a building placed in service after December 31, 2008, and before January 1, 2014. Irs free file fillable forms Also, more than 50% of the building’s square footage must be devoted to preparation of meals and seating for on-premise consumption of prepared meals. Irs free file fillable forms Qualified retail improvement property. Irs free file fillable forms   Generally, this is any improvement (placed in service after December 31, 2008, and before January 1, 2014) to an interior portion of nonresidential real property if it meets the following requirements. Irs free file fillable forms The portion is open to the general public and is used in the retail trade or business of selling tangible property to the general public. Irs free file fillable forms The improvement is placed in service more than 3 years after the date the building was first placed in service. Irs free file fillable forms The expenses are not for the enlargement of the building, any elevator or escalator, any structural components benefiting a common area, or the internal structural framework of the building. Irs free file fillable forms In addition, an improvement made by the lessor does not qualify as qualified retail improvement property to any subsequent owner unless it is acquired from the original lessor by reason of the lessor’s death or in any of the following types of transactions. Irs free file fillable forms A transaction to which section 381(a) applies, A mere change in the form of conducting the trade or business so long as the property is retained in the trade or business as qualified leasehold improvement property and the taxpayer retains a substantial interest in the trade or business, A like-kind exchange, involuntary conversion, or re-acquisition of real property to the extent that the basis in the property represents the carryover basis, or Certain nonrecognition transactions to the extent that your basis in the property is determined by reference to the transferor’s or distributor’s basis in the property. Irs free file fillable forms Examples include the following. Irs free file fillable forms A complete liquidation of a subsidiary. Irs free file fillable forms A transfer to a corporation controlled by the transferor. Irs free file fillable forms An exchange of property by a corporation solely for stock or securities in another corporation in a reorganization. Irs free file fillable forms Property Acquired for Business Use To qualify for the section 179 deduction, your property must have been acquired for use in your trade or business. Irs free file fillable forms Property you acquire only for the production of income, such as investment property, rental property (if renting property is not your trade or business), and property that produces royalties, does not qualify. Irs free file fillable forms Partial business use. Irs free file fillable forms   When you use property for both business and nonbusiness purposes, you can elect the section 179 deduction only if you use the property more than 50% for business in the year you place it in service. Irs free file fillable forms If you use the property more than 50% for business, multiply the cost of the property by the percentage of business use. Irs free file fillable forms Use the resulting business cost to figure your section 179 deduction. Irs free file fillable forms Example. Irs free file fillable forms May Oak bought and placed in service an item of section 179 property costing $11,000. Irs free file fillable forms She used the property 80% for her business and 20% for personal purposes. Irs free file fillable forms The business part of the cost of the property is $8,800 (80% × $11,000). Irs free file fillable forms Property Acquired by Purchase To qualify for the section 179 deduction, your property must have been acquired by purchase. Irs free file fillable forms For example, property acquired by gift or inheritance does not qualify. Irs free file fillable forms Property is not considered acquired by purchase in the following situations. Irs free file fillable forms It is acquired by one component member of a controlled group from another component member of the same group. Irs free file fillable forms Its basis is determined either— In whole or in part by its adjusted basis in the hands of the person from whom it was acquired, or Under the stepped-up basis rules for property acquired from a decedent. Irs free file fillable forms It is acquired from a related person. Irs free file fillable forms Related persons. Irs free file fillable forms   Related persons are described under Related persons earlier. Irs free file fillable forms However, to determine whether property qualifies for the section 179 deduction, treat as an individual's family only his or her spouse, ancestors, and lineal descendants and substitute "50%" for "10%" each place it appears. Irs free file fillable forms Example. Irs free file fillable forms Ken Larch is a tailor. Irs free file fillable forms He bought two industrial sewing machines from his father. Irs free file fillable forms He placed both machines in service in the same year he bought them. Irs free file fillable forms They do not qualify as section 179 property because Ken and his father are related persons. Irs free file fillable forms He cannot claim a section 179 deduction for the cost of these machines. Irs free file fillable forms What Property Does Not Qualify? Certain property does not qualify for the section 179 deduction. Irs free file fillable forms This includes the following. Irs free file fillable forms Land and Improvements Land and land improvements do not qualify as section 179 property. Irs free file fillable forms Land improvements include swimming pools, paved parking areas, wharves, docks, bridges, and fences. Irs free file fillable forms Excepted Property Even if the requirements explained earlier under What Property Qualifies are met, you cannot elect the section 179 deduction for the following property. Irs free file fillable forms Certain property you lease to others (if you are a noncorporate lessor). Irs free file fillable forms Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging. Irs free file fillable forms Air conditioning or heating units. Irs free file fillable forms Property used predominantly outside the United States, except property described in section 168(g)(4) of the Internal Revenue Code. Irs free file fillable forms Property used by certain tax-exempt organizations, except property used in connection with the production of income subject to the tax on unrelated trade or business income. Irs free file fillable forms Property used by governmental units or foreign persons or entities, except property used under a lease with a term of less than 6 months. Irs free file fillable forms Leased property. Irs free file fillable forms   Generally, you cannot claim a section 179 deduction based on the cost of property you lease to someone else. Irs free file fillable forms This rule does not apply to corporations. Irs free file fillable forms However, you can claim a section 179 deduction for the cost of the following property. Irs free file fillable forms Property you manufacture or produce and lease to others. Irs free file fillable forms Property you purchase and lease to others if both the following tests are met. Irs free file fillable forms The term of the lease (including options to renew) is less than 50% of the property's class life. Irs free file fillable forms For the first 12 months after the property is transferred to the lessee, the total business deductions you are allowed on the property (other than rents and reimbursed amounts) are more than 15% of the rental income from the property. Irs free file fillable forms Property used for lodging. Irs free file fillable forms   Generally, you cannot claim a section 179 deduction for property used predominantly to furnish lodging or in connection with the furnishing of lodging. Irs free file fillable forms However, this does not apply to the following types of property. Irs free file fillable forms Nonlodging commercial facilities that are available to those not using the lodging facilities on the same basis as they are available to those using the lodging facilities. Irs free file fillable forms Property used by a hotel or motel in connection with the trade or business of furnishing lodging where the predominant portion of the accommodations is used by transients. Irs free file fillable forms Any certified historic structure to the extent its basis is due to qualified rehabilitation expenditures. Irs free file fillable forms Any energy property. Irs free file fillable forms Energy property. Irs free file fillable forms   Energy property is property that meets the following requirements. Irs free file fillable forms It is one of the following types of property. Irs free file fillable forms Equipment that uses solar energy to generate electricity, to heat or cool a structure, to provide hot water for use in a structure, or to provide solar process heat, except for equipment used to generate energy to heat a swimming pool. Irs free file fillable forms Equipment placed in service after December 31, 2005, and before January 1, 2017, that uses solar energy to illuminate the inside of a structure using fiber-optic distributed sunlight. Irs free file fillable forms Equipment used to produce, distribute, or use energy derived from a geothermal deposit. Irs free file fillable forms For electricity generated by geothermal power, this includes equipment up to (but not including) the electrical transmission stage. Irs free file fillable forms Qualified fuel cell property or qualified microturbine property placed in service after December 31, 2005, and before January 1, 2017. Irs free file fillable forms The construction, reconstruction, or erection of the property must be completed by you. Irs free file fillable forms For property you acquire, the original use of the property must begin with you. Irs free file fillable forms The property must meet the performance and quality standards, if any, prescribed by Income Tax Regulations in effect at the time you get the property. Irs free file fillable forms   For periods before February 14, 2008, energy property does not include any property that is public utility property as defined by section 46(f)(5) of the Internal Revenue Code (as in effect on November 4, 1990). Irs free file fillable forms How Much Can You Deduct? Your section 179 deduction is generally the cost of the qualifying property. Irs free file fillable forms However, the total amount you can elect to deduct under section 179 is subject to a dollar limit and a business income limit. Irs free file fillable forms These limits apply to each taxpayer, not to each business. Irs free file fillable forms However, see Married Individuals under Dollar Limits , later. Irs free file fillable forms For a passenger automobile, the total section 179 deduction and depreciation deduction are limited. Irs free file fillable forms See Do the Passenger Automobile Limits Apply in chapter 5 . Irs free file fillable forms If you deduct only part of the cost of qualifying property as a section 179 deduction, you can generally depreciate the cost you do not deduct. Irs free file fillable forms Trade-in of other property. Irs free file fillable forms   If you buy qualifying property with cash and a trade-in, its cost for purposes of the section 179 deduction includes only the cash you paid. Irs free file fillable forms Example. Irs free file fillable forms Silver Leaf, a retail bakery, traded two ovens having a total adjusted basis of $680 for a new oven costing $1,320. Irs free file fillable forms They received an $800 trade-in allowance for the old ovens and paid $520 in cash for the new oven. Irs free file fillable forms The bakery also traded a used van with an adjusted basis of $4,500 for a new van costing $9,000. Irs free file fillable forms They received a $4,800 trade-in allowance on the used van and paid $4,200 in cash for the new van. Irs free file fillable forms Only the portion of the new property's basis paid by cash qualifies for the section 179 deduction. Irs free file fillable forms Therefore, Silver Leaf's qualifying costs for the section 179 deduction are $4,720 ($520 + $4,200). Irs free file fillable forms Dollar Limits The total amount you can elect to deduct under section 179 for most property placed in service in 2013 generally cannot be more than $500,000. Irs free file fillable forms If you acquire and place in service more than one item of qualifying property during the year, you can allocate the section 179 deduction among the items in any way, as long as the total deduction is not more than $500,000. Irs free file fillable forms You do not have to claim the full $500,000. Irs free file fillable forms Qualified real property (described earlier) that you elected to treat as section 179 real property is limited to $250,000 of the maximum deduction of $500,000 for 2013. Irs free file fillable forms The amount you can elect to deduct is not affected if you place qualifying property in service in a short tax year or if you place qualifying property in service for only a part of a 12-month tax year. Irs free file fillable forms After you apply the dollar limit to determine a tentative deduction, you must apply the business income limit (described later) to determine your actual section 179 deduction. Irs free file fillable forms Example. Irs free file fillable forms In 2013, you bought and placed in service $500,000 in machinery and a $25,000 circular saw for your business. Irs free file fillable forms You elect to deduct $475,000 for the machinery and the entire $25,000 for the saw, a total of $500,000. Irs free file fillable forms This is the maximum amount you can deduct. Irs free file fillable forms Your $25,000 deduction for the saw completely recovered its cost. Irs free file fillable forms Your basis for depreciation is zero. Irs free file fillable forms The basis for depreciation of your machinery is $25,000. Irs free file fillable forms You figure this by subtracting your $475,000 section 179 deduction for the machinery from the $500,000 cost of the machinery. Irs free file fillable forms Situations affecting dollar limit. Irs free file fillable forms   Under certain circumstances, the general dollar limits on the section 179 deduction may be reduced or increased or there may be additional dollar limits. Irs free file fillable forms The general dollar limit is affected by any of the following situations. Irs free file fillable forms The cost of your section 179 property placed in service exceeds $2,000,000. Irs free file fillable forms Your business is an enterprise zone business. Irs free file fillable forms You placed in service a sport utility or certain other vehicles. Irs free file fillable forms You are married filing a joint or separate return. Irs free file fillable forms Costs exceeding $2,000,000 If the cost of your qualifying section 179 property placed in service in a year is more than $2,000,000, you generally must reduce the dollar limit (but not below zero) by the amount of cost over $2,000,000. Irs free file fillable forms If the cost of your section 179 property placed in service during 2013 is $2,500,000 or more, you cannot take a section 179 deduction. Irs free file fillable forms Example. Irs free file fillable forms In 2013, Jane Ash placed in service machinery costing $2,100,000. Irs free file fillable forms This cost is $100,000 more than $2,000,000, so she must reduce her dollar limit to $400,000 ($500,000 − $100,000). Irs free file fillable forms Enterprise Zone Businesses An increased section 179 deduction is available to enterprise zone businesses for qualified zone property placed in service during the tax year, in an empowerment zone. Irs free file fillable forms For more information including the definitions of “enterprise zone business” and “qualified zone property,” see sections 1397A, 1397C, and 1397D of the Internal Revenue Code. Irs free file fillable forms The dollar limit on the section 179 deduction is increased by the smaller of: $35,000, or The cost of section 179 property that is also qualified zone property placed in service before January 1, 2014 (including such property placed in service by your spouse, even if you are filing a separate return). Irs free file fillable forms Note. Irs free file fillable forms   You take into account only 50% (instead of 100%) of the cost of qualified zone property placed in service in a year when figuring the reduced dollar limit for costs exceeding $2,000,000 (explained earlier). Irs free file fillable forms Sport Utility and Certain Other Vehicles You cannot elect to expense more than $25,000 of the cost of any heavy sport utility vehicle (SUV) and certain other vehicles placed in service during the tax year. Irs free file fillable forms This rule applies to any 4-wheeled vehicle primarily designed or used to carry passengers over public streets, roads, or highways, that is rated at more than 6,000 pounds gross vehicle weight and not more than 14,000 pounds gross vehicle weight. Irs free file fillable forms However, the $25,000 limit does not apply to any vehicle: Designed to seat more than nine passengers behind the driver's seat, Equipped with a cargo area (either open or enclosed by a cap) of at least six feet in interior length that is not readily accessible from the passenger compartment, or That has an integral enclosure fully enclosing the driver compartment and load carrying device, does not have seating rearward of the driver's seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield. Irs free file fillable forms Married Individuals If you are married, how you figure your section 179 deduction depends on whether you file jointly or separately. Irs free file fillable forms If you file a joint return, you and your spouse are treated as one taxpayer in determining any reduction to the dollar limit, regardless of which of you purchased the property or placed it in service. Irs free file fillable forms If you and your spouse file separate returns, you are treated as one taxpayer for the dollar limit, including the reduction for costs over $2,000,000. Irs free file fillable forms You must allocate the dollar limit (after any reduction) between you equally, unless you both elect a different allocation. Irs free file fillable forms If the percentages elected by each of you do not total 100%, 50% will be allocated to each of you. Irs free file fillable forms Example. Irs free file fillable forms Jack Elm is married. Irs free file fillable forms He and his wife file separate returns. Irs free file fillable forms Jack bought and placed in service $2,000,000 of qualified farm machinery in 2013. Irs free file fillable forms His wife has her own business, and she bought and placed in service $30,000 of qualified business equipment. Irs free file fillable forms Their combined dollar limit is $470,000. Irs free file fillable forms This is because they must figure the limit as if they were one taxpayer. Irs free file fillable forms They reduce the $500,000 dollar limit by the $30,000 excess of their costs over $2,000,000. Irs free file fillable forms They elect to allocate the $470,000 dollar limit as follows. Irs free file fillable forms $446,500 ($470,000 x 95%) to Mr. Irs free file fillable forms Elm's machinery. Irs free file fillable forms $23,500 ($470,000 x 5%) to Mrs. Irs free file fillable forms Elm's equipment. Irs free file fillable forms If they did not make an election to allocate their costs in this way, they would have to allocate $235,000 ($470,000 × 50%) to each of them. Irs free file fillable forms Joint return after filing separate returns. Irs free file fillable forms   If you and your spouse elect to amend your separate returns by filing a joint return after the due date for filing your return, the dollar limit on the joint return is the lesser of the following amounts. Irs free file fillable forms The dollar limit (after reduction for any cost of section 179 property over $2,000,000). Irs free file fillable forms The total cost of section 179 property you and your spouse elected to expense on your separate returns. Irs free file fillable forms Example. Irs free file fillable forms The facts are the same as in the previous example except that Jack elected to deduct $30,000 of the cost of section 179 property on his separate return and his wife elected to deduct $2,000. Irs free file fillable forms After the due date of their returns, they file a joint return. Irs free file fillable forms Their dollar limit for the section 179 deduction is $32,000. Irs free file fillable forms This is the lesser of the following amounts. Irs free file fillable forms $470,000—The dollar limit less the cost of section 179 property over $2,000,000. Irs free file fillable forms $32,000—The total they elected to expense on their separate returns. Irs free file fillable forms Business Income Limit The total cost you can deduct each year after you apply the dollar limit is limited to the taxable income from the active conduct of any trade or business during the year. Irs free file fillable forms Generally, you are considered to actively conduct a trade or business if you meaningfully participate in the management or operations of the trade or business. Irs free file fillable forms Any cost not deductible in one year under section 179 because of this limit can be carried to the next year. Irs free file fillable forms Special rules apply to a 2013 deduction of qualified section 179 real property that is disallowed because of the business income limit. Irs free file fillable forms See Special rules for qualified section 179 property under Carryover of disallowed deduction, later. Irs free file fillable forms Taxable income. Irs free file fillable forms   In general, figure taxable income for this purpose by totaling the net income and losses from all trades and businesses you actively conducted during the year. Irs free file fillable forms Net income or loss from a trade or business includes the following items. Irs free file fillable forms Section 1231 gains (or losses). Irs free file fillable forms Interest from working capital of your trade or business. Irs free file fillable forms Wages, salaries, tips, or other pay earned as an employee. Irs free file fillable forms For information about section 1231 gains and losses, see chapter 3 in Publication 544. Irs free file fillable forms   In addition, figure taxable income without regard to any of the following. Irs free file fillable forms The section 179 deduction. Irs free file fillable forms The self-employment tax deduction. Irs free file fillable forms Any net operating loss carryback or carryforward. Irs free file fillable forms Any unreimbursed employee business expenses. Irs free file fillable forms Two different taxable income limits. Irs free file fillable forms   In addition to the business income limit for your section 179 deduction, you may have a taxable income limit for some other deduction. Irs free file fillable forms You may have to figure the limit for this other deduction taking into account the section 179 deduction. Irs free file fillable forms If so, complete the following steps. Irs free file fillable forms Step Action 1 Figure taxable income without the section 179 deduction or the other deduction. Irs free file fillable forms 2 Figure a hypothetical section 179 deduction using the taxable income figured in Step 1. Irs free file fillable forms 3 Subtract the hypothetical section 179 deduction figured in Step 2 from the taxable income figured in Step 1. Irs free file fillable forms 4 Figure a hypothetical amount for the other deduction using the amount figured in Step 3 as taxable income. Irs free file fillable forms 5 Subtract the hypothetical other deduction figured in Step 4 from the taxable income figured in Step 1. Irs free file fillable forms 6 Figure your actual section 179 deduction using the taxable income figured in Step 5. Irs free file fillable forms 7 Subtract your actual section 179 deduction figured in Step 6 from the taxable income figured in Step 1. Irs free file fillable forms 8 Figure your actual other deduction using the taxable income figured in Step 7. Irs free file fillable forms Example. Irs free file fillable forms On February 1, 2013, the XYZ corporation purchased and placed in service qualifying section 179 property that cost $500,000. Irs free file fillable forms It elects to expense the entire $500,000 cost under section 179. Irs free file fillable forms In June, the corporation gave a charitable contribution of $10,000. Irs free file fillable forms A corporation's limit on charitable contributions is figured after subtracting any section 179 deduction. Irs free file fillable forms The business income limit for the section 179 deduction is figured after subtracting any allowable charitable contributions. Irs free file fillable forms XYZ's taxable income figured without the section 179 deduction or the deduction for charitable contributions is $520,000. Irs free file fillable forms XYZ figures its section 179 deduction and its deduction for charitable contributions as follows. Irs free file fillable forms Step 1– Taxable income figured without either deduction is $520,000. Irs free file fillable forms Step 2– Using $520,000 as taxable income, XYZ's hypothetical section 179 deduction is $500,000. Irs free file fillable forms Step 3– $20,000 ($520,000 − $500,000). Irs free file fillable forms Step 4– Using $20,000 (from Step 3) as taxable income, XYZ's hypothetical charitable contribution (limited to 10% of taxable income) is $2,000. Irs free file fillable forms Step 5– $518,000 ($520,000 − $2,000). Irs free file fillable forms Step 6– Using $518,000 (from Step 5) as taxable income, XYZ figures the actual section 179 deduction. Irs free file fillable forms Because the taxable income is at least $500,000, XYZ can take a $500,000 section 179 deduction. Irs free file fillable forms Step 7– $20,000 ($520,000 − $500,000). Irs free file fillable forms Step 8– Using $20,000 (from Step 7) as taxable income, XYZ's actual charitable contribution (limited to 10% of taxable income) is $2,000. Irs free file fillable forms Carryover of disallowed deduction. Irs free file fillable forms   You can carry over for an unlimited number of years the cost of any section 179 property you elected to expense but were unable to because of the business income limit. Irs free file fillable forms This disallowed deduction amount is shown on line 13 of Form 4562. Irs free file fillable forms You use the amount you carry over to determine your section 179 deduction in the next year. Irs free file fillable forms Enter that amount on line 10 of your Form 4562 for the next year. Irs free file fillable forms   If you place more than one property in service in a year, you can select the properties for which all or a part of the costs will be carried forward. Irs free file fillable forms Your selections must be shown in your books and records. Irs free file fillable forms For this purpose, treat section 179 costs allocated from a partnership or an S corporation as one item of section 179 property. Irs free file fillable forms If you do not make a selection, the total carryover will be allocated equally among the properties you elected to expense for the year. Irs free file fillable forms   If costs from more than one year are carried forward to a subsequent year in which only part of the total carryover can be deducted, you must deduct the costs being carried forward from the earliest year first. Irs free file fillable forms Special rules for qualified section 179 real property. Irs free file fillable forms   You can carry over to 2013 a 2012 deduction attributable to qualified section 179 real property that you elected to expense but were unable to take because of the business income limitation. Irs free file fillable forms Any such 2012 carryover amounts that are not deducted in 2013, plus any 2013 disallowed section 179 expense deductions attributable to qualified real property, are not carried over to 2014. Irs free file fillable forms Instead these amounts are treated as property placed in service on the first day of 2013 for purposes of computing depreciation (including the special depreciation allowance, if applicable). Irs free file fillable forms See section 179(f) of the Internal Revenue Code and Notice 2013-59 for more information. Irs free file fillable forms If there is a sale or other disposition of your property (including a transfer at death) before you can use the full amount of any outstanding carryover of your disallowed section 179 deduction, neither you nor the new owner can deduct any of the unused amount. Irs free file fillable forms Instead, you must add it back to the property's basis. Irs free file fillable forms Partnerships and Partners The section 179 deduction limits apply both to the partnership and to each partner. Irs free file fillable forms The partnership determines its section 179 deduction subject to the limits. Irs free file fillable forms It then allocates the deduction among its partners. Irs free file fillable forms Each partner adds the amount allocated from partnerships (shown on Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc. Irs free file fillable forms ) to his or her nonpartnership section 179 costs and then applies the dollar limit to this total. Irs free file fillable forms To determine any reduction in the dollar limit for costs over $2,000,000, the partner does not include any of the cost of section 179 property placed in service by the partnership. Irs free file fillable forms After the dollar limit (reduced for any nonpartnership section 179 costs over $2,000,000) is applied, any remaining cost of the partnership and nonpartnership section 179 property is subject to the business income limit. Irs free file fillable forms Partnership's taxable income. Irs free file fillable forms   For purposes of the business income limit, figure the partnership's taxable income by adding together the net income and losses from all trades or businesses actively conducted by the partnership during the year. Irs free file fillable forms See the Instructions for Form 1065 for information on how to figure partnership net income (or loss). Irs free file fillable forms However, figure taxable income without regard to credits, tax-exempt income, the section 179 deduction, and guaranteed payments under section 707(c) of the Internal Revenue Code. Irs free file fillable forms Partner's share of partnership's taxable income. Irs free file fillable forms   For purposes of the business income limit, the taxable income of a partner engaged in the active conduct of one or more of a partnership's trades or businesses includes his or her allocable share of taxable income derived from the partnership's active conduct of any trade or business. Irs free file fillable forms Example. Irs free file fillable forms In 2013, Beech Partnership placed in service section 179 property with a total cost of $2,025,000. Irs free file fillable forms The partnership must reduce its dollar limit by $25,000 ($2,025,000 − $2,000,000). Irs free file fillable forms Its maximum section 179 deduction is $475,000 ($500,000 − $25,000), and it elects to expense that amount. Irs free file fillable forms The partnership's taxable income from the active conduct of all its trades or businesses for the year was $600,000, so it can deduct the full $475,000. Irs free file fillable forms It allocates $40,000 of its section 179 deduction and $50,000 of its taxable income to Dean, one of its partners. Irs free file fillable forms In addition to being a partner in Beech Partnership, Dean is also a partner in the Cedar Partnership, which allocated to him a $30,000 section 179 deduction and $35,000 of its taxable income from the active conduct of its business. Irs free file fillable forms He also conducts a business as a sole proprietor and, in 2013, placed in service in that business qualifying section 179 property costing $55,000. Irs free file fillable forms He had a net loss of $5,000 from that business for the year. Irs free file fillable forms Dean does not have to include section 179 partnership costs to figure any reduction in his dollar limit, so his total section 179 costs for the year are not more than $2,000,000 and his dollar limit is not reduced. Irs free file fillable forms His maximum section 179 deduction is $500,000. Irs free file fillable forms He elects to expense all of the $70,000 in section 179 deductions allocated from the partnerships ($40,000 from Beech Partnership plus $30,000 from Cedar Partnership), plus $55,000 of his sole proprietorship's section 179 costs, and notes that information in his books and records. Irs free file fillable forms However, his deduction is limited to his business taxable income of $80,000 ($50,000 from Beech Partnership, plus $35,000 from Cedar Partnership minus $5,000 loss from his sole proprietorship). Irs free file fillable forms He carries over $45,000 ($125,000 − $80,000) of the elected section 179 costs to 2014. Irs free file fillable forms He allocates the carryover amount to the cost of section 179 property placed in service in his sole proprietorship, and notes that allocation in his books and records. Irs free file fillable forms Different tax years. Irs free file fillable forms   For purposes of the business income limit, if the partner's tax year and that of the partnership differ, the partner's share of the partnership's taxable income for a tax year is generally the partner's distributive share for the partnership tax year that ends with or within the partner's tax year. Irs free file fillable forms Example. Irs free file fillable forms John and James Oak are equal partners in Oak Partnership. Irs free file fillable forms Oak Partnership uses a tax year ending January 31. Irs free file fillable forms John and James both use a tax year ending December 31. Irs free file fillable forms For its tax year ending January 31, 2013, Oak Partnership's taxable income from the active conduct of its business is $80,000, of which $70,000 was earned during 2012. Irs free file fillable forms John and James each include $40,000 (each partner's entire share) of partnership taxable income in computing their business income limit for the 2013 tax year. Irs free file fillable forms Adjustment of partner's basis in partnership. Irs free file fillable forms   A partner must reduce the basis of his or her partnership interest by the total amount of section 179 expenses allocated from the partnership even if the partner cannot currently deduct the total amount. Irs free file fillable forms If the partner disposes of his or her partnership interest, the partner's basis for determining gain or loss is increased by any outstanding carryover of disallowed section 179 expenses allocated from the partnership. Irs free file fillable forms Adjustment of partnership's basis in section 179 property. Irs free file fillable forms   The basis of a partnership's section 179 property must be reduced by the section 179 deduction elected by the partnership. Irs free file fillable forms This reduction of basis must be made even if a partner cannot deduct all or part of the section 179 deduction allocated to that partner by the partnership because of the limits. Irs free file fillable forms S Corporations Generally, the rules that apply to a partnership and its partners also apply to an S corporation and its shareholders. Irs free file fillable forms The deduction limits apply to an S corporation and to each shareholder. Irs free file fillable forms The S corporation allocates its deduction to the shareholders who then take their section 179 deduction subject to the limits. Irs free file fillable forms Figuring taxable income for an S corporation. Irs free file fillable forms   To figure taxable income (or loss) from the active conduct by an S corporation of any trade or business, you total the net income and losses from all trades or businesses actively conducted by the S corporation during the year. Irs free file fillable forms   To figure the net income (or loss) from a trade or business actively conducted by an S corporation, you take into account the items from that trade or business that are passed through to the shareholders and used in determining each shareholder's tax liability. Irs free file fillable forms However, you do not take into account any credits, tax-exempt income, the section 179 deduction, and deductions for compensation paid to shareholder-employees. Irs free file fillable forms For purposes of determining the total amount of S corporation items, treat deductions and losses as negative income. Irs free file fillable forms In figuring the taxable income of an S corporation, disregard any limits on the amount of an S corporation item that must be taken into account when figuring a shareholder's taxable income. Irs free file fillable forms Other Corporations A corporation's taxable income from its active conduct of any trade or business is its taxable income figured with the following changes. Irs free file fillable forms It is figured before deducting the section 179 deduction, any net operating loss deduction, and special deductions (as reported on the corporation's income tax return). Irs free file fillable forms It is adjusted for items of income or deduction included in the amount figured in 1, above, not derived from a trade or business actively conducted by the corporation during the tax year. Irs free file fillable forms How Do You Elect the Deduction? You elect to take the section 179 deduction by completing Part I of Form 4562. Irs free file fillable forms If you elect the deduction for listed property (described in chapter 5), complete Part V of Form 4562 before completing Part I. Irs free file fillable forms For property placed in service in 2013, file Form 4562 with either of the following. Irs free file fillable forms Your original 2013 tax return, whether or not you file it timely. Irs free file fillable forms An amended return for 2013 filed within the time prescribed by law. Irs free file fillable forms An election made on an amended return must specify the item of section 179 property to which the election applies and the part of the cost of each such item to be taken into account. Irs free file fillable forms The amended return must also include any resulting adjustments to taxable income. Irs free file fillable forms You must keep records that show the specific identification of each piece of qualifying section 179 property. Irs free file fillable forms These records must show how you acquired the property, the person you acquired it from, and when you placed it in service. Irs free file fillable forms Election for certain qualified section 179 real property. Irs free file fillable forms   You can elect to expense certain qualified real property that you placed in service as section 179 property for tax years beginning in 2013. Irs free file fillable forms If you elect to treat this property as section 179 property, you must elect the application of the special rules for qualified real property described in section 179(f) of the Internal Revenue Code. Irs free file fillable forms   To make the election, attach a statement indicating you are “electing the application of section 179(f) of the Internal Revenue Code” with either of the following. Irs free file fillable forms Your original 2013 tax return, whether or not you file it timely. Irs free file fillable forms An amended return for 2013 filed within the time prescribed by law. Irs free file fillable forms The amended return must also include any adjustments to taxable income. Irs free file fillable forms   The statement should indicate your election to expense certain qualified real property under section 179(f) on your return. Irs free file fillable forms It must specify one or more of the three types of qualified property (described under Qualified real property ) to which the election applies, the cost of each such type, and the portion of the cost of each such property to be taken into account. Irs free file fillable forms Also, report this on line 6 of Form 4562. Irs free file fillable forms    The maximum section 179 expense deduction that can be taken for qualified section 179 real property is limited to $250,000. Irs free file fillable forms Revoking an election. Irs free file fillable forms   An election (or any specification made in the election) to take a section 179 deduction for 2013 can be revoked without IRS approval by filing an amended return. Irs free file fillable forms The amended return must be filed within the time prescribed by law. Irs free file fillable forms The amended return must also include any resulting adjustments to taxable income. Irs free file fillable forms Once made, the revocation is irrevocable. Irs free file fillable forms When Must You Recapture the Deduction? You may have to recapture the section 179 deduction if, in any year during the property's recovery period, the percentage of business use drops to 50% or less. Irs free file fillable forms In the year the business use drops to 50% or less, you include the recapture amount as ordinary income in Part IV of Form 4797. Irs free file fillable forms You also increase the basis of the property by the recapture amount. Irs free file fillable forms Recovery periods for property are discussed under Which Recovery Period Applies in chapter 4 . Irs free file fillable forms If you sell, exchange, or otherwise dispose of the property, do not figure the recapture amount under the rules explained in this discussion. Irs free file fillable forms Instead, use the rules for recapturing depreciation explained in chapter 3 of Publication 544 under Section 1245 Property. Irs free file fillable forms For qualified real property (described earlier), see Notice 2013-59 for determining the portion of the gain that is attributable to section 1245 property upon the sale or other disposition of qualified real property. Irs free file fillable forms If the property is listed property (described in chapter 5 ), do not figure the recapture amount under the rules explained in this discussion when the percentage of business use drops to 50% or less. Irs free file fillable forms Instead, use the rules for recapturing excess depreciation in chapter 5 under What Is the Business-Use Requirement. Irs free file fillable forms Figuring the recapture amount. Irs free file fillable forms   To figure the amount to recapture, take the following steps. Irs free file fillable forms Figure the depreciation that would have been allowable on the section 179 deduction you claimed. Irs free file fillable forms Begin with the year you placed the property in service and include the year of recapture. Irs free file fillable forms Subtract the depreciation figured in (1) from the section 179 deduction you claimed. Irs free file fillable forms The result is the amount you must recapture. Irs free file fillable forms Example. Irs free file fillable forms In January 2011, Paul Lamb, a calendar year taxpayer, bought and placed in service section 179 property costing $10,000. Irs free file fillable forms The property is not listed property. Irs free file fillable forms The property is 3-year property. Irs free file fillable forms He elected a $5,000 section 179 deduction for the property and also elected not to claim a special depreciation allowance. Irs free file fillable forms He used the property only for business in 2011 and 2012. Irs free file fillable forms In 2013, he used the property 40% for business and 60% for personal use. Irs free file fillable forms He figures his recapture amount as follows. Irs free file fillable forms Section 179 deduction claimed (2011) $5,000. Irs free file fillable forms 00 Minus: Allowable depreciation using Table A-1 (instead of section 179 deduction):   2011 $1,666. Irs free file fillable forms 50   2012 2,222. Irs free file fillable forms 50   2013 ($740. Irs free file fillable forms 50 × 40% (business)) 296. Irs free file fillable forms 20 4,185. Irs free file fillable forms 20 2013 — Recapture amount $ 814. Irs free file fillable forms 80 Paul must include $814. Irs free file fillable forms 80 in income for 2013. Irs free file fillable forms If any qualified zone property placed in service during the year ceases to be used in an empowerment zone by an enterprise zone business in a later year, the benefit of the increased section 179 deduction must be reported as other income on your return. Irs free file fillable forms Prev  Up  Next   Home   More Online Publications
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Irs free file fillable forms Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. Irs free file fillable forms 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. Irs free file fillable forms Several assets. Irs free file fillable forms Special situations. Irs free file fillable forms Schedule D (Form 1040). Irs free file fillable forms Form 4797. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms The installment sales method cannot be used for the following. Irs free file fillable forms Sale of inventory. Irs free file fillable forms   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. Irs free file fillable forms See Sale of a Business under Other Rules, later. Irs free file fillable forms Dealer sales. Irs free file fillable forms   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. Irs free file fillable forms This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. Irs free file fillable forms However, the rule does not apply to an installment sale of property used or produced in farming. Irs free file fillable forms Special rule. Irs free file fillable forms   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. Irs free file fillable forms For more information, see section 453(l). Irs free file fillable forms Stock or securities. Irs free file fillable forms   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. Irs free file fillable forms You must report the entire gain on the sale in the year in which the trade date falls. Irs free file fillable forms Installment obligation. Irs free file fillable forms   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. Irs free file fillable forms 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. Irs free file fillable forms See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. Irs free file fillable forms Sale at a loss. Irs free file fillable forms   If your sale results in a loss, you cannot use the installment method. Irs free file fillable forms If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. Irs free file fillable forms Unstated interest. Irs free file fillable forms   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. Irs free file fillable forms See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Irs free file fillable forms 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. Irs free file fillable forms Each payment on an installment sale usually consists of the following three parts. Irs free file fillable forms Interest income. Irs free file fillable forms Return of your adjusted basis in the property. Irs free file fillable forms Gain on the sale. Irs free file fillable forms 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. Irs free file fillable forms You do not include in income the part that is the return of your basis in the property. Irs free file fillable forms Basis is the amount of your investment in the property for installment sale purposes. Irs free file fillable forms Interest Income You must report interest as ordinary income. Irs free file fillable forms Interest is generally not included in a down payment. Irs free file fillable forms 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. Irs free file fillable forms Interest provided in the agreement is called stated interest. Irs free file fillable forms If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Irs free file fillable forms See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Irs free file fillable forms 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. Irs free file fillable forms A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). Irs free file fillable forms Figuring adjusted basis for installment sale purposes. Irs free file fillable forms   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. Irs free file fillable forms 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. Irs free file fillable forms Worksheet A. Irs free file fillable forms Figuring Adjusted Basis and Gross Profit Percentage 1. Irs free file fillable forms Enter the selling price for the property   2. Irs free file fillable forms Enter your adjusted basis for the property     3. Irs free file fillable forms Enter your selling expenses     4. Irs free file fillable forms Enter any depreciation recapture     5. Irs free file fillable forms Add lines 2, 3, and 4. Irs free file fillable forms  This is your adjusted basis for installment sale purposes   6. Irs free file fillable forms Subtract line 5 from line 1. Irs free file fillable forms If zero or less, enter -0-. Irs free file fillable forms  This is your gross profit     If the amount entered on line 6 is zero, stop here. Irs free file fillable forms You cannot use the installment method. Irs free file fillable forms   7. Irs free file fillable forms Enter the contract price for the property   8. Irs free file fillable forms Divide line 6 by line 7. Irs free file fillable forms This is your gross profit percentage   Selling price. Irs free file fillable forms   The selling price is the total cost of the property to the buyer and includes any of the following. Irs free file fillable forms Any money you are to receive. Irs free file fillable forms 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). Irs free file fillable forms 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). Irs free file fillable forms Any of your selling expenses the buyer pays. Irs free file fillable forms   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Irs free file fillable forms Adjusted basis for installment sale purposes. Irs free file fillable forms   Your adjusted basis is the total of the following three items. Irs free file fillable forms Adjusted basis. Irs free file fillable forms Selling expenses. Irs free file fillable forms Depreciation recapture. Irs free file fillable forms Adjusted basis. Irs free file fillable forms   Basis is your investment in the property for installment sale purposes. Irs free file fillable forms The way you figure basis depends on how you acquire the property. Irs free file fillable forms The basis of property you buy is generally its cost. Irs free file fillable forms The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Irs free file fillable forms   While you own property, various events may change your original basis. Irs free file fillable forms Some events, such as adding rooms or making permanent improvements, increase basis. Irs free file fillable forms Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Irs free file fillable forms The result is adjusted basis. Irs free file fillable forms   For more information on how to figure basis and adjusted basis, see Publication 551. Irs free file fillable forms 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. Irs free file fillable forms Selling expenses. Irs free file fillable forms   Selling expenses relate to the sale of the property. Irs free file fillable forms They include commissions, attorney fees, and any other expenses paid on the sale. Irs free file fillable forms Selling expenses are added to the basis of the sold property. Irs free file fillable forms Depreciation recapture. Irs free file fillable forms   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Irs free file fillable forms See Depreciation Recapture Income under Other Rules, later. Irs free file fillable forms Gross profit. Irs free file fillable forms   Gross profit is the total gain you report on the installment method. Irs free file fillable forms   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Irs free file fillable forms If the property you sold was your home, subtract from the gross profit any gain you can exclude. Irs free file fillable forms See Sale of Your Home , later, under Reporting Installment Sale Income. Irs free file fillable forms Contract price. Irs free file fillable forms   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. Irs free file fillable forms Gross profit percentage. Irs free file fillable forms   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Irs free file fillable forms This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Irs free file fillable forms   The gross profit percentage generally remains the same for each payment you receive. Irs free file fillable forms However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. Irs free file fillable forms Example. Irs free file fillable forms You sell property at a contract price of $6,000 and your gross profit is $1,500. Irs free file fillable forms Your gross profit percentage is 25% ($1,500 ÷ $6,000). Irs free file fillable forms 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. Irs free file fillable forms The remainder (balance) of each payment is the tax-free return of your adjusted basis. Irs free file fillable forms Amount to report as installment sale income. Irs free file fillable forms   Multiply the payments you receive each year (less interest) by the gross profit percentage. Irs free file fillable forms The result is your installment sale income for the tax year. Irs free file fillable forms In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Irs free file fillable forms A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Irs free file fillable forms For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. Irs free file fillable forms Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. Irs free file fillable forms You then must refigure the gross profit percentage for the remaining payments. Irs free file fillable forms Refigure your gross profit using Worksheet B. Irs free file fillable forms You will spread any remaining gain over future installments. Irs free file fillable forms Worksheet B. Irs free file fillable forms New Gross Profit Percentage — Selling Price Reduced 1. Irs free file fillable forms Enter the reduced selling  price for the property   2. Irs free file fillable forms Enter your adjusted  basis for the  property     3. Irs free file fillable forms Enter your selling  expenses     4. Irs free file fillable forms Enter any depreciation  recapture     5. Irs free file fillable forms Add lines 2, 3, and 4. Irs free file fillable forms   6. Irs free file fillable forms Subtract line 5 from line 1. Irs free file fillable forms  This is your adjusted  gross profit   7. Irs free file fillable forms Enter any installment sale  income reported in  prior year(s)   8. Irs free file fillable forms Subtract line 7 from line 6   9. Irs free file fillable forms Future installments   10. Irs free file fillable forms Divide line 8 by line 9. Irs free file fillable forms  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. Irs free file fillable forms Example. Irs free file fillable forms In 2011, you sold land with a basis of $40,000 for $100,000. Irs free file fillable forms Your gross profit was $60,000. Irs free file fillable forms You received a $20,000 down payment and the buyer's note for $80,000. Irs free file fillable forms The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. Irs free file fillable forms Your gross profit percentage is 60%. Irs free file fillable forms You reported a gain of $12,000 on each payment received in 2011 and 2012. Irs free file fillable forms 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. Irs free file fillable forms The new gross profit percentage, 46. Irs free file fillable forms 67%, is figured on Example—Worksheet B. Irs free file fillable forms You will report a gain of $7,000 (46. Irs free file fillable forms 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. Irs free file fillable forms Example — Worksheet B. Irs free file fillable forms New Gross Profit Percentage — Selling Price Reduced 1. Irs free file fillable forms Enter the reduced selling  price for the property 85,000 2. Irs free file fillable forms Enter your adjusted  basis for the  property 40,000   3. Irs free file fillable forms Enter your selling  expenses -0-   4. Irs free file fillable forms Enter any depreciation  recapture -0-   5. Irs free file fillable forms Add lines 2, 3, and 4. Irs free file fillable forms 40,000 6. Irs free file fillable forms Subtract line 5 from line 1. Irs free file fillable forms  This is your adjusted  gross profit 45,000 7. Irs free file fillable forms Enter any installment sale  income reported in  prior year(s) 24,000 8. Irs free file fillable forms Subtract line 7 from line 6 21,000 9. Irs free file fillable forms Future installments 45,000 10. Irs free file fillable forms Divide line 8 by line 9. Irs free file fillable forms  This is your new gross profit percentage* 46. Irs free file fillable forms 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Irs free file fillable forms 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. Irs free file fillable forms You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. Irs free file fillable forms See Schedule D (Form 1040) and Form 4797 , later. Irs free file fillable forms If the property was your main home, you may be able to exclude part or all of the gain. Irs free file fillable forms See Sale of Your Home , later. Irs free file fillable forms 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. Irs free file fillable forms Attach it to your tax return for each year. Irs free file fillable forms Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. Irs free file fillable forms Which parts to complete. Irs free file fillable forms   Which part to complete depends on whether you are filing the form for the year of sale or a later year. Irs free file fillable forms Year of sale. Irs free file fillable forms   Complete lines 1 through 4, Part I, and Part II. Irs free file fillable forms If you sold property to a related party during the year, also complete Part III. Irs free file fillable forms Later years. Irs free file fillable forms   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. Irs free file fillable forms   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. Irs free file fillable forms (After December 31, 1986, the installment method is not available for the sale of marketable securities. Irs free file fillable forms ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Irs free file fillable forms Complete Part III unless you received the final payment during the tax year. Irs free file fillable forms   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. Irs free file fillable forms 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. Irs free file fillable forms Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. Irs free file fillable forms 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). Irs free file fillable forms 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. Irs free file fillable forms Your gain is long-term if you owned the property for more than 1 year when you sold it. Irs free file fillable forms 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. Irs free file fillable forms All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. Irs free file fillable forms See Publication 523 for information about excluding the gain. Irs free file fillable forms If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. Irs free file fillable forms Seller-financed mortgage. Irs free file fillable forms   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. Irs free file fillable forms   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. Irs free file fillable forms   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. Irs free file fillable forms   If either person fails to include the other person's SSN, a $50 penalty will be assessed. Irs free file fillable forms Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. Irs free file fillable forms The following topics are discussed. Irs free file fillable forms Electing out of the installment method. Irs free file fillable forms Payments received or considered received. Irs free file fillable forms Escrow account. Irs free file fillable forms Depreciation recapture income. Irs free file fillable forms Sale to a related person. Irs free file fillable forms Like-kind exchange. Irs free file fillable forms Contingent payment sale. Irs free file fillable forms Single sale of several assets. Irs free file fillable forms Sale of a business. Irs free file fillable forms Unstated interest and original issue discount. Irs free file fillable forms Disposition of an installment obligation. Irs free file fillable forms Repossession. Irs free file fillable forms Interest on deferred tax. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms Notes, mortgages, and land contracts are examples of obligations that are included at FMV. Irs free file fillable forms You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. Irs free file fillable forms 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). Irs free file fillable forms Example. Irs free file fillable forms You sold a parcel of land for $50,000. Irs free file fillable forms 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. Irs free file fillable forms The buyer gave you a note for $40,000. Irs free file fillable forms The note had an FMV of $40,000. Irs free file fillable forms You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. Irs free file fillable forms The land cost $25,000, and you owned it for more than one year. Irs free file fillable forms You decide to elect out of the installment method and report the entire gain in the year of sale. Irs free file fillable forms Gain realized:     Selling price $50,000 Minus: Property's adj. Irs free file fillable forms 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. Irs free file fillable forms basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. Irs free file fillable forms 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. Irs free file fillable forms The interest on the note is ordinary income and is reported as interest income each year. Irs free file fillable forms How to elect out. Irs free file fillable forms   To make this election, do not report your sale on Form 6252. Irs free file fillable forms Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. Irs free file fillable forms When to elect out. Irs free file fillable forms   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Irs free file fillable forms Automatic six-month extension. Irs free file fillable forms   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). Irs free file fillable forms Write “Filed pursuant to section 301. Irs free file fillable forms 9100-2” at the top of the amended return and file it where the original return was filed. Irs free file fillable forms Revoking the election. Irs free file fillable forms   Once made, the election can be revoked only with IRS approval. Irs free file fillable forms A revocation is retroactive. Irs free file fillable forms You will not be allowed to revoke the election if either of the following applies. Irs free file fillable forms One of the purposes is to avoid federal income tax. Irs free file fillable forms The tax year in which any payment was received has closed. Irs free file fillable forms 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. Irs free file fillable forms In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms Include these expenses in the selling and contract prices when figuring the gross profit percentage. Irs free file fillable forms 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. Irs free file fillable forms Mortgage not more than basis. Irs free file fillable forms   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. Irs free file fillable forms It is considered a recovery of your basis. Irs free file fillable forms The contract price is the selling price minus the mortgage. Irs free file fillable forms Example. Irs free file fillable forms You sell property with an adjusted basis of $19,000. Irs free file fillable forms You have selling expenses of $1,000. Irs free file fillable forms 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). Irs free file fillable forms The selling price is $25,000 ($15,000 + $10,000). Irs free file fillable forms Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Irs free file fillable forms The contract price is $10,000 ($25,000 − $15,000 mortgage). Irs free file fillable forms Your gross profit percentage is 50% ($5,000 ÷ $10,000). Irs free file fillable forms You report half of each $2,000 payment received as gain from the sale. Irs free file fillable forms You also report all interest you receive as ordinary income. Irs free file fillable forms Mortgage more than basis. Irs free file fillable forms   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Irs free file fillable forms The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Irs free file fillable forms   To figure the contract price, subtract the mortgage from the selling price. Irs free file fillable forms This is the total amount (other than interest) you will receive directly from the buyer. Irs free file fillable forms Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Irs free file fillable forms The contract price is then the same as your gross profit from the sale. Irs free file fillable forms    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. Irs free file fillable forms Example. Irs free file fillable forms The selling price for your property is $9,000. Irs free file fillable forms The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Irs free file fillable forms Your adjusted basis in the property is $4,400. Irs free file fillable forms You have selling expenses of $600, for a total installment sale basis of $5,000. Irs free file fillable forms The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Irs free file fillable forms This amount is included in the contract price and treated as a payment received in the year of sale. Irs free file fillable forms 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%. Irs free file fillable forms Report 100% of each payment (less interest) as gain from the sale. Irs free file fillable forms 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. Irs free file fillable forms Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. Irs free file fillable forms You are considered to receive a payment equal to the outstanding canceled debt. Irs free file fillable forms Example. Irs free file fillable forms Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. Irs free file fillable forms On April 4, 2013, she bought the land for $70,000. Irs free file fillable forms At that time, $30,000 of her loan to you was outstanding. Irs free file fillable forms 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. Irs free file fillable forms She did not assume an existing mortgage. Irs free file fillable forms She canceled the $30,000 debt you owed her. Irs free file fillable forms You are considered to have received a $30,000 payment at the time of the sale. Irs free file fillable forms 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. Irs free file fillable forms If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Irs free file fillable forms Compare the debt to your installment sale basis in the property being sold. Irs free file fillable forms If the debt is less than your installment sale basis, none of it is treated as a payment. Irs free file fillable forms If it is more, only the difference is treated as a payment. Irs free file fillable forms 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. Irs free file fillable forms These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . Irs free file fillable forms However, they apply only to the following types of debt the buyer assumes. Irs free file fillable forms Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Irs free file fillable forms Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Irs free file fillable forms 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. Irs free file fillable forms The value of the assumed debt is then considered a payment to you in the year of sale. Irs free file fillable forms 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. Irs free file fillable forms However, see Like-Kind Exchange , later. Irs free file fillable forms Generally, the amount of the payment is the property's FMV on the date you receive it. Irs free file fillable forms Exception. Irs free file fillable forms   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. Irs free file fillable forms See Unstated Interest and Original Issue Discount (OID) , later. Irs free file fillable forms Debt not payable on demand. Irs free file fillable forms   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. Irs free file fillable forms This is true even if the debt is guaranteed by a third party, including a government agency. Irs free file fillable forms Fair market value (FMV). Irs free file fillable forms   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. Irs free file fillable forms Third-party note. Irs free file fillable forms   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. Irs free file fillable forms 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. Irs free file fillable forms The excess of the note's face value over its FMV is interest. Irs free file fillable forms Exclude this interest in determining the selling price of the property. Irs free file fillable forms However, see Exception under Property Used As a Payment, earlier. Irs free file fillable forms Example. Irs free file fillable forms You sold real estate in an installment sale. Irs free file fillable forms As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. Irs free file fillable forms The FMV of the third-party note at the time of the sale was $30,000. Irs free file fillable forms This amount, not $50,000, is a payment to you in the year of sale. Irs free file fillable forms 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. Irs free file fillable forms The remaining 40% is interest taxed as ordinary income. Irs free file fillable forms Bond. Irs free file fillable forms   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. Irs free file fillable forms For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. Irs free file fillable forms    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. Irs free file fillable forms However, see Exception under Property Used As a Payment, earlier. Irs free file fillable forms Buyer's note. Irs free file fillable forms   The buyer's note (unless payable on demand) is not considered payment on the sale. Irs free file fillable forms However, its full face value is included when figuring the selling price and the contract price. Irs free file fillable forms Payments you receive on the note are used to figure your gain in the year received. Irs free file fillable forms 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. Irs free file fillable forms This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. Irs free file fillable forms It does not apply to the following dispositions. Irs free file fillable forms Sales of property used or produced in farming. Irs free file fillable forms Sales of personal-use property. Irs free file fillable forms Qualifying sales of time-shares and residential lots. Irs free file fillable forms The net debt proceeds are the gross debt minus the direct expenses of getting the debt. Irs free file fillable forms The amount treated as a payment is considered received on the later of the following dates. Irs free file fillable forms The date the debt becomes secured. Irs free file fillable forms The date you receive the debt proceeds. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms Limit. Irs free file fillable forms   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. Irs free file fillable forms The total contract price on the installment sale. Irs free file fillable forms Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. Irs free file fillable forms Installment payments. Irs free file fillable forms   The pledge rule accelerates the reporting of the installment obligation payments. Irs free file fillable forms 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. Irs free file fillable forms Exception. Irs free file fillable forms   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. Irs free file fillable forms The debt was outstanding on December 17, 1987. Irs free file fillable forms The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. Irs free file fillable forms   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. Irs free file fillable forms   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Irs free file fillable forms Any excess is treated as a payment on the installment obligation. Irs free file fillable forms 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. Irs free file fillable forms These sales cannot be reported on the installment method. Irs free file fillable forms The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. Irs free file fillable forms When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. Irs free file fillable forms Example. Irs free file fillable forms You sell property for $100,000. Irs free file fillable forms 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. Irs free file fillable forms You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. Irs free file fillable forms You report the entire gain in the year of sale. Irs free file fillable forms Escrow established in a later year. Irs free file fillable forms   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. Irs free file fillable forms Substantial restriction. Irs free file fillable forms   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. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Irs free file fillable forms Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. Irs free file fillable forms The recapture income is also included in Part I of Form 6252. Irs free file fillable forms However, the gain equal to the recapture income is reported in full in the year of the sale. Irs free file fillable forms Only the gain greater than the recapture income is reported on the installment method. Irs free file fillable forms For more information on depreciation recapture, see chapter 3 in Publication 544. Irs free file fillable forms 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. Irs free file fillable forms Determining gross profit is discussed under General Rules , earlier. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. Irs free file fillable forms Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Irs free file fillable forms Instead, all payments to be received are considered received in the year of sale. Irs free file fillable forms However, see Exception , below. Irs free file fillable forms Depreciable property for this rule is any property the purchaser can depreciate. Irs free file fillable forms Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. Irs free file fillable forms In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. Irs free file fillable forms The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. Irs free file fillable forms Exception. Irs free file fillable forms   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. Irs free file fillable forms 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. Irs free file fillable forms Related person. Irs free file fillable forms   Related persons include the following. Irs free file fillable forms A person and all controlled entities with respect to that person. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. Irs free file fillable forms   For information about which entities are controlled entities, see section 1239(c). Irs free file fillable forms 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. Irs free file fillable forms The related person makes the second disposition before making all payments on the first disposition. Irs free file fillable forms The related person disposes of the property within 2 years of the first disposition. Irs free file fillable forms This rule does not apply if the property involved is marketable securities. Irs free file fillable forms 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. Irs free file fillable forms See Exception , later. Irs free file fillable forms Related person. Irs free file fillable forms   Related persons include the following. Irs free file fillable forms Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. Irs free file fillable forms A partnership or estate and a partner or beneficiary. Irs free file fillable forms A trust (other than a section 401(a) employees trust) and a beneficiary. Irs free file fillable forms A trust and an owner of the trust. Irs free file fillable forms Two corporations that are members of the same controlled group as defined in section 267(f). Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Irs free file fillable forms Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. Irs free file fillable forms Example 1. Irs free file fillable forms 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. Irs free file fillable forms His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. Irs free file fillable forms His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). Irs free file fillable forms He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. Irs free file fillable forms 50). Irs free file fillable forms Bob made no improvements to the property and sold it to Alfalfa Inc. Irs free file fillable forms , in 2013 for $600,000 after making the payment for that year. Irs free file fillable forms The amount realized from the second disposition is $600,000. Irs free file fillable forms 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 % × . Irs free file fillable forms 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). Irs free file fillable forms Example 2. Irs free file fillable forms Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. Irs free file fillable forms 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 % × . Irs free file fillable forms 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. Irs free file fillable forms 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. Irs free file fillable forms In 2016, he receives the final $100,000 payment. Irs free file fillable forms 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 % × . Irs free file fillable forms 50 Installment sale income for 2016 $ 50,000 Exception. Irs free file fillable forms   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. Irs free file fillable forms 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. Irs free file fillable forms   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. Irs free file fillable forms However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. Irs free file fillable forms   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. Irs free file fillable forms An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms These trades are known as like-kind exchanges. Irs free file fillable forms The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. Irs free file fillable forms You do not have to report any part of your gain if you receive only like-kind property. Irs free file fillable forms 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. Irs free file fillable forms For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. Irs free file fillable forms Installment payments. Irs free file fillable forms   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. Irs free file fillable forms The contract price is reduced by the FMV of the like-kind property received in the trade. Irs free file fillable forms The gross profit is reduced by any gain on the trade that can be postponed. Irs free file fillable forms Like-kind property received in the trade is not considered payment on the installment obligation. Irs free file fillable forms Example. Irs free file fillable forms 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. Irs free file fillable forms He also receives an installment note for $800,000 in the trade. Irs free file fillable forms 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. Irs free file fillable forms George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Irs free file fillable forms His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). Irs free file fillable forms The contract price is $800,000 ($1,000,000 − $200,000). Irs free file fillable forms The gross profit percentage is 75% ($600,000 ÷ $800,000). Irs free file fillable forms He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. Irs free file fillable forms 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). Irs free file fillable forms Deferred exchanges. Irs free file fillable forms   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. Irs free file fillable forms Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. Irs free file fillable forms 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. Irs free file fillable forms See Regulations section 1. Irs free file fillable forms 1031(k)-1(j)(2) for these rules. Irs free file fillable forms 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. Irs free file fillable forms This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. Irs free file fillable forms 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. Irs free file fillable forms For rules on using the installment method for a contingent payment sale, see Regulations section 15a. Irs free file fillable forms 453-1(c). Irs free file fillable forms 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. Irs free file fillable forms You also have to allocate part of the selling price to each asset. Irs free file fillable forms If you sell assets that constitute a trade or business, see Sale of a Business , later. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms This becomes the net FMV. Irs free file fillable forms A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. Irs free file fillable forms However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. Irs free file fillable forms It must be reported separately. Irs free file fillable forms The remaining assets sold at a gain are reported together. Irs free file fillable forms Example. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms Your installment sale basis for each parcel was $15,000. Irs free file fillable forms Your net gain was $85,000 ($130,000 − $45,000). Irs free file fillable forms You report the gain on the installment method. Irs free file fillable forms The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. Irs free file fillable forms The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. Irs free file fillable forms The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. Irs free file fillable forms You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Irs free file fillable forms Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. Irs free file fillable forms However, if parcel C was held for personal use, the loss is not deductible. Irs free file fillable forms 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). Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms Assets sold at a loss. Irs free file fillable forms Real and personal property eligible for the installment method. Irs free file fillable forms Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. Irs free file fillable forms Inventory. Irs free file fillable forms   The sale of inventories of personal property cannot be reported on the installment method. Irs free file fillable forms All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Irs free file fillable forms   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. Irs free file fillable forms If you do not, each payment must be allocated between the inventory and the other assets sold. Irs free file fillable forms   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Irs free file fillable forms Use your basis in the inventory to figure the cost of goods sold. Irs free file fillable forms Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. Irs free file fillable forms Residual method. Irs free file fillable forms   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. Irs free file fillable forms This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. Irs free file fillable forms   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. Irs free file fillable forms 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). Irs free file fillable forms   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. Irs free file fillable forms   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). Irs free file fillable forms The consideration remaining after this reduction must be allocated among the various business assets in a certain order. Irs free file fillable forms   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. Irs free file fillable forms Certificates of deposit, U. Irs free file fillable forms S. Irs free file fillable forms Government securities, foreign currency, and actively traded personal property, including stock and securities. Irs free file fillable forms Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. Irs free file fillable forms However, see Regulations section 1. Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms All other assets except section 197 intangibles. Irs free file fillable forms Section 197 intangibles except goodwill and going concern value. Irs free file fillable forms Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Irs free file fillable forms   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. Irs free file fillable forms For example, if an asset is described in both (4) and (6), include it in (4). Irs free file fillable forms Agreement. Irs free file fillable forms   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. Irs free file fillable forms This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Irs free file fillable forms Reporting requirement. Irs free file fillable forms   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. Irs free file fillable forms Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. Irs free file fillable forms The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Irs free file fillable forms 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. Irs free file fillable forms The sale of a partnership interest is treated as the sale of a single capital asset. Irs free file fillable forms The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. Irs free file fillable forms (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. Irs free file fillable forms ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. Irs free file fillable forms The gain allocated to the other assets can be reported under the installment method. Irs free file fillable forms For more information on the treatment of unrealized receivables and inventory, see Publication 541. Irs free file fillable forms Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. Irs free file fillable forms You received a $100,000 down payment and the buyer's note for $120,000. Irs free file fillable forms The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. Irs free file fillable forms The total selling price is $220,000. Irs free file fillable forms Your selling expenses are $11,000. Irs free file fillable forms The selling expenses are divided among all the assets sold, including inventory. Irs free file fillable forms Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). Irs free file fillable forms The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. Irs free file fillable forms 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). Irs free file fillable forms The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. Irs free file fillable forms 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. Irs free file fillable forms   Sale  Price Sale   Exp. Irs free file fillable forms Adj. Irs free file fillable forms   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. Irs free file fillable forms A 71,000 3,550 63,800 3,650 Mch. Irs free file fillable forms 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. Irs free file fillable forms There is no depreciation recapture income because the building was depreciated using the straight line method. Irs free file fillable forms 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. Irs free file fillable forms Figure depreciation recapture in Part III of Form 4797. Irs free file fillable forms The total depreciation recapture income reported in Part II of Form 4797 is $5,209. Irs free file fillable forms 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). Irs free file fillable forms These gains are reported in full in the year of sale and are not included in the installment sale computation. Irs free file fillable forms Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. Irs free file fillable forms 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. Irs free file fillable forms The selling price equals the contract price for the installment sale ($108,500). Irs free file fillable forms The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. Irs free file fillable forms   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). Irs free file fillable forms The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. Irs free file fillable forms 95 Building— $9,600 ÷ $108,500 8. Irs free file fillable forms 85 Goodwill— $17,575 ÷ $108,500 16. Irs free file fillable forms 20 Total 48. Irs free file fillable forms 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. Irs free file fillable forms The selling price for the installment sale is $108,500. Irs free file fillable forms This is 49. Irs free file fillable forms 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). Irs free file fillable forms The selling price of assets not reported on the installment method is $111,500. Irs free file fillable forms This is 50. Irs free file fillable forms 7% ($111,500 ÷ $220,000) of the total selling price. Irs free file fillable forms Multiply principal payments by 49. Irs free file fillable forms 3% to determine the part of the payment for the installment sale. Irs free file fillable forms The balance, 50. Irs free file fillable forms 7%, is for the part reported in the year of the sale. Irs free file fillable forms The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. Irs free file fillable forms When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Irs free file fillable forms Only the part for the installment sale (49. Irs free file fillable forms 3%) is used in the installment sale computation. Irs free file fillable forms The only payment received in 2013 is the down payment of $100,000. Irs free file fillable forms The part of the payment for the installment sale is $49,300 ($100,000 × 49. Irs free file fillable forms 3%). Irs free file fillable forms This amount is used in the installment sale computation. Irs free file fillable forms Installment income for 2013. Irs free file fillable forms   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. Irs free file fillable forms Income Land—22. Irs free file fillable forms 95% of $49,300 $11,314 Building—8. Irs free file fillable forms 85% of $49,300 4,363 Goodwill—16. Irs free file fillable forms 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. Irs free file fillable forms   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. Irs free file fillable forms 3% of the total payments you receive on the buyer's note during the year. Irs free file fillable forms 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. Irs free file fillable forms Interest provided in the contract is called stated interest. Irs free file fillable forms 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. Irs free file fillable forms If section 483 applies to the contract, this interest is called unstated interest. Irs free file fillable forms If section 1274 applies to the contract, this interest is called original issue discount (OID). Irs free file fillable forms An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). Irs free file fillable forms Treatment of unstated interest and OID. Irs free file fillable forms   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Irs free file fillable forms As a result, the buyer cannot deduct the unstated interest. Irs free file fillable forms The seller must report the unstated interest as income. Irs free file fillable forms   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. Irs free file fillable forms   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. Irs free file fillable forms Rules for the seller. Irs free file fillable forms   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. Irs free file fillable forms If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. Irs free file fillable forms   Include the unstated interest in income based on your regular method of accounting. Irs free file fillable forms Include OID in income over the term of the contract. Irs free file fillable forms   The OID includible in income each year is based on the constant yield method described in section 1272. Irs free file fillable forms (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. Irs free file fillable forms )   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. Irs free file fillable forms Reduce the selling price by any stated principal treated as interest to determine the gain. Irs free file fillable forms   Report unstated interest or OID on your tax return, in addition to stated interest. Irs free file fillable forms Rules for the buyer. Irs free file fillable forms   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. Irs free file fillable forms These rules do not apply to personal-use property (for example, property not used in a trade or business). Irs free file fillable forms Adequate stated interest. Irs free file fillable forms   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. Irs free file fillable forms The present value of a payment is determined based on the test rate of interest, defined next. Irs free file fillable forms (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. Irs free file fillable forms ) 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. Irs free file fillable forms Test rate of interest. Irs free file fillable forms   The test rate of interest for a contract is the 3-month rate. Irs free file fillable forms The 3-month rate is the lower of the following applicable federal rates (AFRs). Irs free file fillable forms 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. Irs free file fillable forms 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. Irs free file fillable forms Applicable federal rate (AFR). Irs free file fillable forms   The AFR depends on the month the binding