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Tax Act 1040x

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Tax Act 1040x

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

Free phone forums featuring IRS employees discussing exempt organizations topics.


Upcoming Phone Forum

Topic Day and Time Links for Materials

Veterans Organizations: Help from the IRS on Key Rules

Topics include:

  • Exemption requirements
  • Exempt Activities
  • Unrelated Business Income (including Gaming)
  • Recordkeeping
  • Employment Issues
  • Group Rulings
  • Filing Requirements


Helpful publication: Publication 3386: Veterans’ Organizations Tax Guide

 

March 27, 2014
2 p.m. EDT

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Form 990-N and 990-EZ filing tips (Part 1 on the Form 990-Series)
This presentation explains the preliminary steps each exempt organization should take before preparing its Form 990-series information return
February 20, 2014
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Good Governance Makes Sense for Exempt Organizations
Presentation topics include: Why public trust is a charity’s greatest asset and the importance of having a knowledgeable and engaged governing board.
 
January 23, 2014
2 p.m. ET

 



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ABCs of charitable contributions for  501(c)(3) organizations
This phone forum will help charity leaders, tax practitioners and others understand the rules involving charitable donations.
 
December 19
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.Stay exempt: A guide for charitable
organizations with changing leadership
: Helps organizations stay tax exempt - organized and operated exclusively for exempt purposes. 
 
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501(c)(7) Social Clubs: What they need to know to qualify for and maintain tax-exempt status: Learn how organizations like fraternities, country clubs and sports clubs differ from other nonprofit organizations.
 
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Veterans Organizations – Complying with IRS Rules: Tips to help veterans organizations stay tax exempt.
 
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Charities and their volunteers: Tax rules that come into play in the sometimes complex relationships between charities and their volunteers.
 
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