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Copy 2011 taxes Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. Copy 2011 taxes 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. Copy 2011 taxes Several assets. Copy 2011 taxes Special situations. Copy 2011 taxes Schedule D (Form 1040). Copy 2011 taxes Form 4797. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes The installment sales method cannot be used for the following. Copy 2011 taxes Sale of inventory. Copy 2011 taxes   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. Copy 2011 taxes See Sale of a Business under Other Rules, later. Copy 2011 taxes Dealer sales. Copy 2011 taxes   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. Copy 2011 taxes This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. Copy 2011 taxes However, the rule does not apply to an installment sale of property used or produced in farming. Copy 2011 taxes Special rule. Copy 2011 taxes   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. Copy 2011 taxes For more information, see section 453(l). Copy 2011 taxes Stock or securities. Copy 2011 taxes   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. Copy 2011 taxes You must report the entire gain on the sale in the year in which the trade date falls. Copy 2011 taxes Installment obligation. Copy 2011 taxes   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. Copy 2011 taxes 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. Copy 2011 taxes See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. Copy 2011 taxes Sale at a loss. Copy 2011 taxes   If your sale results in a loss, you cannot use the installment method. Copy 2011 taxes If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. Copy 2011 taxes Unstated interest. Copy 2011 taxes   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. Copy 2011 taxes See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Copy 2011 taxes 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. Copy 2011 taxes Each payment on an installment sale usually consists of the following three parts. Copy 2011 taxes Interest income. Copy 2011 taxes Return of your adjusted basis in the property. Copy 2011 taxes Gain on the sale. Copy 2011 taxes 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. Copy 2011 taxes You do not include in income the part that is the return of your basis in the property. Copy 2011 taxes Basis is the amount of your investment in the property for installment sale purposes. Copy 2011 taxes Interest Income You must report interest as ordinary income. Copy 2011 taxes Interest is generally not included in a down payment. Copy 2011 taxes 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. Copy 2011 taxes Interest provided in the agreement is called stated interest. Copy 2011 taxes If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Copy 2011 taxes See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Copy 2011 taxes 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. Copy 2011 taxes A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). Copy 2011 taxes Figuring adjusted basis for installment sale purposes. Copy 2011 taxes   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. Copy 2011 taxes 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. Copy 2011 taxes Worksheet A. Copy 2011 taxes Figuring Adjusted Basis and Gross Profit Percentage 1. Copy 2011 taxes Enter the selling price for the property   2. Copy 2011 taxes Enter your adjusted basis for the property     3. Copy 2011 taxes Enter your selling expenses     4. Copy 2011 taxes Enter any depreciation recapture     5. Copy 2011 taxes Add lines 2, 3, and 4. Copy 2011 taxes  This is your adjusted basis for installment sale purposes   6. Copy 2011 taxes Subtract line 5 from line 1. Copy 2011 taxes If zero or less, enter -0-. Copy 2011 taxes  This is your gross profit     If the amount entered on line 6 is zero, stop here. Copy 2011 taxes You cannot use the installment method. Copy 2011 taxes   7. Copy 2011 taxes Enter the contract price for the property   8. Copy 2011 taxes Divide line 6 by line 7. Copy 2011 taxes This is your gross profit percentage   Selling price. Copy 2011 taxes   The selling price is the total cost of the property to the buyer and includes any of the following. Copy 2011 taxes Any money you are to receive. Copy 2011 taxes 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). Copy 2011 taxes 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). Copy 2011 taxes Any of your selling expenses the buyer pays. Copy 2011 taxes   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Copy 2011 taxes Adjusted basis for installment sale purposes. Copy 2011 taxes   Your adjusted basis is the total of the following three items. Copy 2011 taxes Adjusted basis. Copy 2011 taxes Selling expenses. Copy 2011 taxes Depreciation recapture. Copy 2011 taxes Adjusted basis. Copy 2011 taxes   Basis is your investment in the property for installment sale purposes. Copy 2011 taxes The way you figure basis depends on how you acquire the property. Copy 2011 taxes The basis of property you buy is generally its cost. Copy 2011 taxes The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Copy 2011 taxes   While you own property, various events may change your original basis. Copy 2011 taxes Some events, such as adding rooms or making permanent improvements, increase basis. Copy 2011 taxes Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Copy 2011 taxes The result is adjusted basis. Copy 2011 taxes   For more information on how to figure basis and adjusted basis, see Publication 551. Copy 2011 taxes 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. Copy 2011 taxes Selling expenses. Copy 2011 taxes   Selling expenses relate to the sale of the property. Copy 2011 taxes They include commissions, attorney fees, and any other expenses paid on the sale. Copy 2011 taxes Selling expenses are added to the basis of the sold property. Copy 2011 taxes Depreciation recapture. Copy 2011 taxes   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Copy 2011 taxes See Depreciation Recapture Income under Other Rules, later. Copy 2011 taxes Gross profit. Copy 2011 taxes   Gross profit is the total gain you report on the installment method. Copy 2011 taxes   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Copy 2011 taxes If the property you sold was your home, subtract from the gross profit any gain you can exclude. Copy 2011 taxes See Sale of Your Home , later, under Reporting Installment Sale Income. Copy 2011 taxes Contract price. Copy 2011 taxes   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. Copy 2011 taxes Gross profit percentage. Copy 2011 taxes   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Copy 2011 taxes This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Copy 2011 taxes   The gross profit percentage generally remains the same for each payment you receive. Copy 2011 taxes However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. Copy 2011 taxes Example. Copy 2011 taxes You sell property at a contract price of $6,000 and your gross profit is $1,500. Copy 2011 taxes Your gross profit percentage is 25% ($1,500 ÷ $6,000). Copy 2011 taxes 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. Copy 2011 taxes The remainder (balance) of each payment is the tax-free return of your adjusted basis. Copy 2011 taxes Amount to report as installment sale income. Copy 2011 taxes   Multiply the payments you receive each year (less interest) by the gross profit percentage. Copy 2011 taxes The result is your installment sale income for the tax year. Copy 2011 taxes In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Copy 2011 taxes A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Copy 2011 taxes For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. Copy 2011 taxes Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. Copy 2011 taxes You then must refigure the gross profit percentage for the remaining payments. Copy 2011 taxes Refigure your gross profit using Worksheet B. Copy 2011 taxes You will spread any remaining gain over future installments. Copy 2011 taxes Worksheet B. Copy 2011 taxes New Gross Profit Percentage — Selling Price Reduced 1. Copy 2011 taxes Enter the reduced selling  price for the property   2. Copy 2011 taxes Enter your adjusted  basis for the  property     3. Copy 2011 taxes Enter your selling  expenses     4. Copy 2011 taxes Enter any depreciation  recapture     5. Copy 2011 taxes Add lines 2, 3, and 4. Copy 2011 taxes   6. Copy 2011 taxes Subtract line 5 from line 1. Copy 2011 taxes  This is your adjusted  gross profit   7. Copy 2011 taxes Enter any installment sale  income reported in  prior year(s)   8. Copy 2011 taxes Subtract line 7 from line 6   9. Copy 2011 taxes Future installments   10. Copy 2011 taxes Divide line 8 by line 9. Copy 2011 taxes  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. Copy 2011 taxes Example. Copy 2011 taxes In 2011, you sold land with a basis of $40,000 for $100,000. Copy 2011 taxes Your gross profit was $60,000. Copy 2011 taxes You received a $20,000 down payment and the buyer's note for $80,000. Copy 2011 taxes The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. Copy 2011 taxes Your gross profit percentage is 60%. Copy 2011 taxes You reported a gain of $12,000 on each payment received in 2011 and 2012. Copy 2011 taxes 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. Copy 2011 taxes The new gross profit percentage, 46. Copy 2011 taxes 67%, is figured on Example—Worksheet B. Copy 2011 taxes You will report a gain of $7,000 (46. Copy 2011 taxes 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. Copy 2011 taxes Example — Worksheet B. Copy 2011 taxes New Gross Profit Percentage — Selling Price Reduced 1. Copy 2011 taxes Enter the reduced selling  price for the property 85,000 2. Copy 2011 taxes Enter your adjusted  basis for the  property 40,000   3. Copy 2011 taxes Enter your selling  expenses -0-   4. Copy 2011 taxes Enter any depreciation  recapture -0-   5. Copy 2011 taxes Add lines 2, 3, and 4. Copy 2011 taxes 40,000 6. Copy 2011 taxes Subtract line 5 from line 1. Copy 2011 taxes  This is your adjusted  gross profit 45,000 7. Copy 2011 taxes Enter any installment sale  income reported in  prior year(s) 24,000 8. Copy 2011 taxes Subtract line 7 from line 6 21,000 9. Copy 2011 taxes Future installments 45,000 10. Copy 2011 taxes Divide line 8 by line 9. Copy 2011 taxes  This is your new gross profit percentage* 46. Copy 2011 taxes 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Copy 2011 taxes 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. Copy 2011 taxes You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. Copy 2011 taxes See Schedule D (Form 1040) and Form 4797 , later. Copy 2011 taxes If the property was your main home, you may be able to exclude part or all of the gain. Copy 2011 taxes See Sale of Your Home , later. Copy 2011 taxes 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. Copy 2011 taxes Attach it to your tax return for each year. Copy 2011 taxes Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. Copy 2011 taxes Which parts to complete. Copy 2011 taxes   Which part to complete depends on whether you are filing the form for the year of sale or a later year. Copy 2011 taxes Year of sale. Copy 2011 taxes   Complete lines 1 through 4, Part I, and Part II. Copy 2011 taxes If you sold property to a related party during the year, also complete Part III. Copy 2011 taxes Later years. Copy 2011 taxes   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. Copy 2011 taxes   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. Copy 2011 taxes (After December 31, 1986, the installment method is not available for the sale of marketable securities. Copy 2011 taxes ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Copy 2011 taxes Complete Part III unless you received the final payment during the tax year. Copy 2011 taxes   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. Copy 2011 taxes 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. Copy 2011 taxes Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. Copy 2011 taxes 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). Copy 2011 taxes 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. Copy 2011 taxes Your gain is long-term if you owned the property for more than 1 year when you sold it. Copy 2011 taxes 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. Copy 2011 taxes All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. Copy 2011 taxes See Publication 523 for information about excluding the gain. Copy 2011 taxes If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. Copy 2011 taxes Seller-financed mortgage. Copy 2011 taxes   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. Copy 2011 taxes   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. Copy 2011 taxes   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. Copy 2011 taxes   If either person fails to include the other person's SSN, a $50 penalty will be assessed. Copy 2011 taxes Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. Copy 2011 taxes The following topics are discussed. Copy 2011 taxes Electing out of the installment method. Copy 2011 taxes Payments received or considered received. Copy 2011 taxes Escrow account. Copy 2011 taxes Depreciation recapture income. Copy 2011 taxes Sale to a related person. Copy 2011 taxes Like-kind exchange. Copy 2011 taxes Contingent payment sale. Copy 2011 taxes Single sale of several assets. Copy 2011 taxes Sale of a business. Copy 2011 taxes Unstated interest and original issue discount. Copy 2011 taxes Disposition of an installment obligation. Copy 2011 taxes Repossession. Copy 2011 taxes Interest on deferred tax. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes Notes, mortgages, and land contracts are examples of obligations that are included at FMV. Copy 2011 taxes You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. Copy 2011 taxes 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). Copy 2011 taxes Example. Copy 2011 taxes You sold a parcel of land for $50,000. Copy 2011 taxes 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. Copy 2011 taxes The buyer gave you a note for $40,000. Copy 2011 taxes The note had an FMV of $40,000. Copy 2011 taxes You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. Copy 2011 taxes The land cost $25,000, and you owned it for more than one year. Copy 2011 taxes You decide to elect out of the installment method and report the entire gain in the year of sale. Copy 2011 taxes Gain realized:     Selling price $50,000 Minus: Property's adj. Copy 2011 taxes 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. Copy 2011 taxes basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. Copy 2011 taxes 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. Copy 2011 taxes The interest on the note is ordinary income and is reported as interest income each year. Copy 2011 taxes How to elect out. Copy 2011 taxes   To make this election, do not report your sale on Form 6252. Copy 2011 taxes Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. Copy 2011 taxes When to elect out. Copy 2011 taxes   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Copy 2011 taxes Automatic six-month extension. Copy 2011 taxes   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). Copy 2011 taxes Write “Filed pursuant to section 301. Copy 2011 taxes 9100-2” at the top of the amended return and file it where the original return was filed. Copy 2011 taxes Revoking the election. Copy 2011 taxes   Once made, the election can be revoked only with IRS approval. Copy 2011 taxes A revocation is retroactive. Copy 2011 taxes You will not be allowed to revoke the election if either of the following applies. Copy 2011 taxes One of the purposes is to avoid federal income tax. Copy 2011 taxes The tax year in which any payment was received has closed. Copy 2011 taxes 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. Copy 2011 taxes In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes Include these expenses in the selling and contract prices when figuring the gross profit percentage. Copy 2011 taxes 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. Copy 2011 taxes Mortgage not more than basis. Copy 2011 taxes   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. Copy 2011 taxes It is considered a recovery of your basis. Copy 2011 taxes The contract price is the selling price minus the mortgage. Copy 2011 taxes Example. Copy 2011 taxes You sell property with an adjusted basis of $19,000. Copy 2011 taxes You have selling expenses of $1,000. Copy 2011 taxes 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). Copy 2011 taxes The selling price is $25,000 ($15,000 + $10,000). Copy 2011 taxes Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Copy 2011 taxes The contract price is $10,000 ($25,000 − $15,000 mortgage). Copy 2011 taxes Your gross profit percentage is 50% ($5,000 ÷ $10,000). Copy 2011 taxes You report half of each $2,000 payment received as gain from the sale. Copy 2011 taxes You also report all interest you receive as ordinary income. Copy 2011 taxes Mortgage more than basis. Copy 2011 taxes   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Copy 2011 taxes The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Copy 2011 taxes   To figure the contract price, subtract the mortgage from the selling price. Copy 2011 taxes This is the total amount (other than interest) you will receive directly from the buyer. Copy 2011 taxes Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Copy 2011 taxes The contract price is then the same as your gross profit from the sale. Copy 2011 taxes    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. Copy 2011 taxes Example. Copy 2011 taxes The selling price for your property is $9,000. Copy 2011 taxes The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Copy 2011 taxes Your adjusted basis in the property is $4,400. Copy 2011 taxes You have selling expenses of $600, for a total installment sale basis of $5,000. Copy 2011 taxes The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Copy 2011 taxes This amount is included in the contract price and treated as a payment received in the year of sale. Copy 2011 taxes 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%. Copy 2011 taxes Report 100% of each payment (less interest) as gain from the sale. Copy 2011 taxes 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. Copy 2011 taxes Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. Copy 2011 taxes You are considered to receive a payment equal to the outstanding canceled debt. Copy 2011 taxes Example. Copy 2011 taxes Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. Copy 2011 taxes On April 4, 2013, she bought the land for $70,000. Copy 2011 taxes At that time, $30,000 of her loan to you was outstanding. Copy 2011 taxes 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. Copy 2011 taxes She did not assume an existing mortgage. Copy 2011 taxes She canceled the $30,000 debt you owed her. Copy 2011 taxes You are considered to have received a $30,000 payment at the time of the sale. Copy 2011 taxes 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. Copy 2011 taxes If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Copy 2011 taxes Compare the debt to your installment sale basis in the property being sold. Copy 2011 taxes If the debt is less than your installment sale basis, none of it is treated as a payment. Copy 2011 taxes If it is more, only the difference is treated as a payment. Copy 2011 taxes 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. Copy 2011 taxes These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . Copy 2011 taxes However, they apply only to the following types of debt the buyer assumes. Copy 2011 taxes Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Copy 2011 taxes Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Copy 2011 taxes 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. Copy 2011 taxes The value of the assumed debt is then considered a payment to you in the year of sale. Copy 2011 taxes 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. Copy 2011 taxes However, see Like-Kind Exchange , later. Copy 2011 taxes Generally, the amount of the payment is the property's FMV on the date you receive it. Copy 2011 taxes Exception. Copy 2011 taxes   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. Copy 2011 taxes See Unstated Interest and Original Issue Discount (OID) , later. Copy 2011 taxes Debt not payable on demand. Copy 2011 taxes   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. Copy 2011 taxes This is true even if the debt is guaranteed by a third party, including a government agency. Copy 2011 taxes Fair market value (FMV). Copy 2011 taxes   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. Copy 2011 taxes Third-party note. Copy 2011 taxes   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. Copy 2011 taxes 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. Copy 2011 taxes The excess of the note's face value over its FMV is interest. Copy 2011 taxes Exclude this interest in determining the selling price of the property. Copy 2011 taxes However, see Exception under Property Used As a Payment, earlier. Copy 2011 taxes Example. Copy 2011 taxes You sold real estate in an installment sale. Copy 2011 taxes As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. Copy 2011 taxes The FMV of the third-party note at the time of the sale was $30,000. Copy 2011 taxes This amount, not $50,000, is a payment to you in the year of sale. Copy 2011 taxes 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. Copy 2011 taxes The remaining 40% is interest taxed as ordinary income. Copy 2011 taxes Bond. Copy 2011 taxes   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. Copy 2011 taxes For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. Copy 2011 taxes    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. Copy 2011 taxes However, see Exception under Property Used As a Payment, earlier. Copy 2011 taxes Buyer's note. Copy 2011 taxes   The buyer's note (unless payable on demand) is not considered payment on the sale. Copy 2011 taxes However, its full face value is included when figuring the selling price and the contract price. Copy 2011 taxes Payments you receive on the note are used to figure your gain in the year received. Copy 2011 taxes 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. Copy 2011 taxes This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. Copy 2011 taxes It does not apply to the following dispositions. Copy 2011 taxes Sales of property used or produced in farming. Copy 2011 taxes Sales of personal-use property. Copy 2011 taxes Qualifying sales of time-shares and residential lots. Copy 2011 taxes The net debt proceeds are the gross debt minus the direct expenses of getting the debt. Copy 2011 taxes The amount treated as a payment is considered received on the later of the following dates. Copy 2011 taxes The date the debt becomes secured. Copy 2011 taxes The date you receive the debt proceeds. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes Limit. Copy 2011 taxes   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. Copy 2011 taxes The total contract price on the installment sale. Copy 2011 taxes Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. Copy 2011 taxes Installment payments. Copy 2011 taxes   The pledge rule accelerates the reporting of the installment obligation payments. Copy 2011 taxes 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. Copy 2011 taxes Exception. Copy 2011 taxes   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. Copy 2011 taxes The debt was outstanding on December 17, 1987. Copy 2011 taxes The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. Copy 2011 taxes   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. Copy 2011 taxes   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Copy 2011 taxes Any excess is treated as a payment on the installment obligation. Copy 2011 taxes 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. Copy 2011 taxes These sales cannot be reported on the installment method. Copy 2011 taxes The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. Copy 2011 taxes When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. Copy 2011 taxes Example. Copy 2011 taxes You sell property for $100,000. Copy 2011 taxes 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. Copy 2011 taxes You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. Copy 2011 taxes You report the entire gain in the year of sale. Copy 2011 taxes Escrow established in a later year. Copy 2011 taxes   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. Copy 2011 taxes Substantial restriction. Copy 2011 taxes   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. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Copy 2011 taxes Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. Copy 2011 taxes The recapture income is also included in Part I of Form 6252. Copy 2011 taxes However, the gain equal to the recapture income is reported in full in the year of the sale. Copy 2011 taxes Only the gain greater than the recapture income is reported on the installment method. Copy 2011 taxes For more information on depreciation recapture, see chapter 3 in Publication 544. Copy 2011 taxes 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. Copy 2011 taxes Determining gross profit is discussed under General Rules , earlier. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. Copy 2011 taxes Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Copy 2011 taxes Instead, all payments to be received are considered received in the year of sale. Copy 2011 taxes However, see Exception , below. Copy 2011 taxes Depreciable property for this rule is any property the purchaser can depreciate. Copy 2011 taxes Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. Copy 2011 taxes In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. Copy 2011 taxes The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. Copy 2011 taxes Exception. Copy 2011 taxes   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. Copy 2011 taxes 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. Copy 2011 taxes Related person. Copy 2011 taxes   Related persons include the following. Copy 2011 taxes A person and all controlled entities with respect to that person. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. Copy 2011 taxes   For information about which entities are controlled entities, see section 1239(c). Copy 2011 taxes 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. Copy 2011 taxes The related person makes the second disposition before making all payments on the first disposition. Copy 2011 taxes The related person disposes of the property within 2 years of the first disposition. Copy 2011 taxes This rule does not apply if the property involved is marketable securities. Copy 2011 taxes 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. Copy 2011 taxes See Exception , later. Copy 2011 taxes Related person. Copy 2011 taxes   Related persons include the following. Copy 2011 taxes Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. Copy 2011 taxes A partnership or estate and a partner or beneficiary. Copy 2011 taxes A trust (other than a section 401(a) employees trust) and a beneficiary. Copy 2011 taxes A trust and an owner of the trust. Copy 2011 taxes Two corporations that are members of the same controlled group as defined in section 267(f). Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Copy 2011 taxes Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. Copy 2011 taxes Example 1. Copy 2011 taxes 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. Copy 2011 taxes His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. Copy 2011 taxes His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). Copy 2011 taxes He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. Copy 2011 taxes 50). Copy 2011 taxes Bob made no improvements to the property and sold it to Alfalfa Inc. Copy 2011 taxes , in 2013 for $600,000 after making the payment for that year. Copy 2011 taxes The amount realized from the second disposition is $600,000. Copy 2011 taxes 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 % × . Copy 2011 taxes 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). Copy 2011 taxes Example 2. Copy 2011 taxes Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. Copy 2011 taxes 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 % × . Copy 2011 taxes 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. Copy 2011 taxes 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. Copy 2011 taxes In 2016, he receives the final $100,000 payment. Copy 2011 taxes 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 % × . Copy 2011 taxes 50 Installment sale income for 2016 $ 50,000 Exception. Copy 2011 taxes   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. Copy 2011 taxes 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. Copy 2011 taxes   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. Copy 2011 taxes However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. Copy 2011 taxes   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. Copy 2011 taxes An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes These trades are known as like-kind exchanges. Copy 2011 taxes The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. Copy 2011 taxes You do not have to report any part of your gain if you receive only like-kind property. Copy 2011 taxes 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. Copy 2011 taxes For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. Copy 2011 taxes Installment payments. Copy 2011 taxes   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. Copy 2011 taxes The contract price is reduced by the FMV of the like-kind property received in the trade. Copy 2011 taxes The gross profit is reduced by any gain on the trade that can be postponed. Copy 2011 taxes Like-kind property received in the trade is not considered payment on the installment obligation. Copy 2011 taxes Example. Copy 2011 taxes 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. Copy 2011 taxes He also receives an installment note for $800,000 in the trade. Copy 2011 taxes 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. Copy 2011 taxes George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Copy 2011 taxes His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). Copy 2011 taxes The contract price is $800,000 ($1,000,000 − $200,000). Copy 2011 taxes The gross profit percentage is 75% ($600,000 ÷ $800,000). Copy 2011 taxes He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. Copy 2011 taxes 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). Copy 2011 taxes Deferred exchanges. Copy 2011 taxes   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. Copy 2011 taxes Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. Copy 2011 taxes 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. Copy 2011 taxes See Regulations section 1. Copy 2011 taxes 1031(k)-1(j)(2) for these rules. Copy 2011 taxes 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. Copy 2011 taxes This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. Copy 2011 taxes 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. Copy 2011 taxes For rules on using the installment method for a contingent payment sale, see Regulations section 15a. Copy 2011 taxes 453-1(c). Copy 2011 taxes 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. Copy 2011 taxes You also have to allocate part of the selling price to each asset. Copy 2011 taxes If you sell assets that constitute a trade or business, see Sale of a Business , later. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes This becomes the net FMV. Copy 2011 taxes A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. Copy 2011 taxes However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. Copy 2011 taxes It must be reported separately. Copy 2011 taxes The remaining assets sold at a gain are reported together. Copy 2011 taxes Example. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes Your installment sale basis for each parcel was $15,000. Copy 2011 taxes Your net gain was $85,000 ($130,000 − $45,000). Copy 2011 taxes You report the gain on the installment method. Copy 2011 taxes The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. Copy 2011 taxes The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. Copy 2011 taxes The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. Copy 2011 taxes You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Copy 2011 taxes Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. Copy 2011 taxes However, if parcel C was held for personal use, the loss is not deductible. Copy 2011 taxes 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). Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes Assets sold at a loss. Copy 2011 taxes Real and personal property eligible for the installment method. Copy 2011 taxes Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. Copy 2011 taxes Inventory. Copy 2011 taxes   The sale of inventories of personal property cannot be reported on the installment method. Copy 2011 taxes All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Copy 2011 taxes   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. Copy 2011 taxes If you do not, each payment must be allocated between the inventory and the other assets sold. Copy 2011 taxes   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Copy 2011 taxes Use your basis in the inventory to figure the cost of goods sold. Copy 2011 taxes Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. Copy 2011 taxes Residual method. Copy 2011 taxes   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. Copy 2011 taxes This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. Copy 2011 taxes   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. Copy 2011 taxes 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). Copy 2011 taxes   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. Copy 2011 taxes   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). Copy 2011 taxes The consideration remaining after this reduction must be allocated among the various business assets in a certain order. Copy 2011 taxes   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. Copy 2011 taxes Certificates of deposit, U. Copy 2011 taxes S. Copy 2011 taxes Government securities, foreign currency, and actively traded personal property, including stock and securities. Copy 2011 taxes Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. Copy 2011 taxes However, see Regulations section 1. Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes All other assets except section 197 intangibles. Copy 2011 taxes Section 197 intangibles except goodwill and going concern value. Copy 2011 taxes Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Copy 2011 taxes   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. Copy 2011 taxes For example, if an asset is described in both (4) and (6), include it in (4). Copy 2011 taxes Agreement. Copy 2011 taxes   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. Copy 2011 taxes This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Copy 2011 taxes Reporting requirement. Copy 2011 taxes   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. Copy 2011 taxes Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. Copy 2011 taxes The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Copy 2011 taxes 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. Copy 2011 taxes The sale of a partnership interest is treated as the sale of a single capital asset. Copy 2011 taxes The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. Copy 2011 taxes (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. Copy 2011 taxes ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. Copy 2011 taxes The gain allocated to the other assets can be reported under the installment method. Copy 2011 taxes For more information on the treatment of unrealized receivables and inventory, see Publication 541. Copy 2011 taxes Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. Copy 2011 taxes You received a $100,000 down payment and the buyer's note for $120,000. Copy 2011 taxes The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. Copy 2011 taxes The total selling price is $220,000. Copy 2011 taxes Your selling expenses are $11,000. Copy 2011 taxes The selling expenses are divided among all the assets sold, including inventory. Copy 2011 taxes Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). Copy 2011 taxes The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. Copy 2011 taxes 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). Copy 2011 taxes The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. Copy 2011 taxes 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. Copy 2011 taxes   Sale  Price Sale   Exp. Copy 2011 taxes Adj. Copy 2011 taxes   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. Copy 2011 taxes A 71,000 3,550 63,800 3,650 Mch. Copy 2011 taxes 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. Copy 2011 taxes There is no depreciation recapture income because the building was depreciated using the straight line method. Copy 2011 taxes 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. Copy 2011 taxes Figure depreciation recapture in Part III of Form 4797. Copy 2011 taxes The total depreciation recapture income reported in Part II of Form 4797 is $5,209. Copy 2011 taxes 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). Copy 2011 taxes These gains are reported in full in the year of sale and are not included in the installment sale computation. Copy 2011 taxes Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. Copy 2011 taxes 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. Copy 2011 taxes The selling price equals the contract price for the installment sale ($108,500). Copy 2011 taxes The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. Copy 2011 taxes   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). Copy 2011 taxes The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. Copy 2011 taxes 95 Building— $9,600 ÷ $108,500 8. Copy 2011 taxes 85 Goodwill— $17,575 ÷ $108,500 16. Copy 2011 taxes 20 Total 48. Copy 2011 taxes 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. Copy 2011 taxes The selling price for the installment sale is $108,500. Copy 2011 taxes This is 49. Copy 2011 taxes 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). Copy 2011 taxes The selling price of assets not reported on the installment method is $111,500. Copy 2011 taxes This is 50. Copy 2011 taxes 7% ($111,500 ÷ $220,000) of the total selling price. Copy 2011 taxes Multiply principal payments by 49. Copy 2011 taxes 3% to determine the part of the payment for the installment sale. Copy 2011 taxes The balance, 50. Copy 2011 taxes 7%, is for the part reported in the year of the sale. Copy 2011 taxes The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. Copy 2011 taxes When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Copy 2011 taxes Only the part for the installment sale (49. Copy 2011 taxes 3%) is used in the installment sale computation. Copy 2011 taxes The only payment received in 2013 is the down payment of $100,000. Copy 2011 taxes The part of the payment for the installment sale is $49,300 ($100,000 × 49. Copy 2011 taxes 3%). Copy 2011 taxes This amount is used in the installment sale computation. Copy 2011 taxes Installment income for 2013. Copy 2011 taxes   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. Copy 2011 taxes Income Land—22. Copy 2011 taxes 95% of $49,300 $11,314 Building—8. Copy 2011 taxes 85% of $49,300 4,363 Goodwill—16. Copy 2011 taxes 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. Copy 2011 taxes   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. Copy 2011 taxes 3% of the total payments you receive on the buyer's note during the year. Copy 2011 taxes 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. Copy 2011 taxes Interest provided in the contract is called stated interest. Copy 2011 taxes 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. Copy 2011 taxes If section 483 applies to the contract, this interest is called unstated interest. Copy 2011 taxes If section 1274 applies to the contract, this interest is called original issue discount (OID). Copy 2011 taxes An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). Copy 2011 taxes Treatment of unstated interest and OID. Copy 2011 taxes   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Copy 2011 taxes As a result, the buyer cannot deduct the unstated interest. Copy 2011 taxes The seller must report the unstated interest as income. Copy 2011 taxes   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. Copy 2011 taxes   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. Copy 2011 taxes Rules for the seller. Copy 2011 taxes   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. Copy 2011 taxes If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. Copy 2011 taxes   Include the unstated interest in income based on your regular method of accounting. Copy 2011 taxes Include OID in income over the term of the contract. Copy 2011 taxes   The OID includible in income each year is based on the constant yield method described in section 1272. Copy 2011 taxes (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. Copy 2011 taxes )   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. Copy 2011 taxes Reduce the selling price by any stated principal treated as interest to determine the gain. Copy 2011 taxes   Report unstated interest or OID on your tax return, in addition to stated interest. Copy 2011 taxes Rules for the buyer. Copy 2011 taxes   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. Copy 2011 taxes These rules do not apply to personal-use property (for example, property not used in a trade or business). Copy 2011 taxes Adequate stated interest. Copy 2011 taxes   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. Copy 2011 taxes The present value of a payment is determined based on the test rate of interest, defined next. Copy 2011 taxes (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. Copy 2011 taxes ) 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. Copy 2011 taxes Test rate of interest. Copy 2011 taxes   The test rate of interest for a contract is the 3-month rate. Copy 2011 taxes The 3-month rate is the lower of the following applicable federal rates (AFRs). Copy 2011 taxes 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. Copy 2011 taxes 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. Copy 2011 taxes Applicable federal rate (AFR). Copy 2011 taxes   The AFR depends on the month the binding
 
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Copy 2011 taxes Publication 530 - Main Content Table of Contents What You Can and Cannot DeductHardest Hit Fund and Emergency Homeowners' Loan Programs Real Estate Taxes Sales Taxes Home Mortgage Interest Mortgage Insurance Premiums Mortgage Interest CreditFiguring the Credit BasisFiguring Your Basis Adjusted Basis Keeping Records How To Get Tax HelpLow Income Taxpayer Clinics What You Can and Cannot Deduct To deduct expenses of owning a home, you must file Form 1040, U. Copy 2011 taxes S. Copy 2011 taxes Individual Income Tax Return, and itemize your deductions on Schedule A (Form 1040). Copy 2011 taxes If you itemize, you cannot take the standard deduction. Copy 2011 taxes This section explains what expenses you can deduct as a homeowner. Copy 2011 taxes It also points out expenses that you cannot deduct. Copy 2011 taxes There are four primary discussions: real estate taxes, sales taxes, home mortgage interest, and mortgage insurance premiums. Copy 2011 taxes Generally, your real estate taxes, home mortgage interest, and mortgage insurance premiums are included in your house payment. Copy 2011 taxes Your house payment. Copy 2011 taxes   If you took out a mortgage (loan) to finance the purchase of your home, you probably have to make monthly house payments. Copy 2011 taxes Your house payment may include several costs of owning a home. Copy 2011 taxes The only costs you can deduct are real estate taxes actually paid to the taxing authority, interest that qualifies as home mortgage interest, and mortgage insurance premiums. Copy 2011 taxes These are discussed in more detail later. Copy 2011 taxes   Some nondeductible expenses that may be included in your house payment include: Fire or homeowner's insurance premiums, and The amount applied to reduce the principal of the mortgage. Copy 2011 taxes Minister's or military housing allowance. Copy 2011 taxes   If you are a minister or a member of the uniformed services and receive a housing allowance that is not taxable, you still can deduct your real estate taxes and your home mortgage interest. Copy 2011 taxes You do not have to reduce your deductions by your nontaxable allowance. Copy 2011 taxes For more information see Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers, and Publication 3, Armed Forces' Tax Guide. Copy 2011 taxes Nondeductible payments. Copy 2011 taxes   You cannot deduct any of the following items. Copy 2011 taxes Insurance (other than mortgage insurance premiums), including fire and comprehensive coverage, and title insurance. Copy 2011 taxes Wages you pay for domestic help. Copy 2011 taxes Depreciation. Copy 2011 taxes The cost of utilities, such as gas, electricity, or water. Copy 2011 taxes Most settlement costs. Copy 2011 taxes See Settlement or closing costs under Cost as Basis, later, for more information. Copy 2011 taxes Forfeited deposits, down payments, or earnest money. Copy 2011 taxes Hardest Hit Fund and Emergency Homeowners' Loan Programs You can use a special method to compute your deduction for mortgage interest and real estate taxes on your main home if you meet the following two conditions. Copy 2011 taxes You received assistance under: A State Housing Finance Agency (State HFA) Hardest Hit Fund program in which program payments could be used to pay mortgage interest, or An Emergency Homeowners' Loan Program administered by the Department of Housing and Urban Development (HUD) or a state. Copy 2011 taxes You meet the rules to deduct all of the mortgage interest on your loan and all of the real estate taxes on your main home. Copy 2011 taxes If you meet these tests, then you can deduct all of the payments you actually made during the year to your mortgage servicer, the State HFA, or HUD on the home mortgage (including the amount shown on box 3 of Form 1098-MA, Mortgage Assistance Payments), but not more than the sum of the amounts shown on Form 1098, Mortgage Interest Statement, in box 1 (mortgage interest received), box 4 (mortgage insurance premiums) and box 5 (real property taxes). Copy 2011 taxes However, you are not required to use this special method to compute your deduction for mortgage interest and real estate taxes on your main home. Copy 2011 taxes Real Estate Taxes Most state and local governments charge an annual tax on the value of real property. Copy 2011 taxes This is called a real estate tax. Copy 2011 taxes You can deduct the tax if it is assessed uniformly at a like rate on all real property throughout the community. Copy 2011 taxes The proceeds must be for general community or governmental purposes and not be a payment for a special privilege granted or service rendered to you. Copy 2011 taxes Deductible Real Estate Taxes You can deduct real estate taxes imposed on you. Copy 2011 taxes You must have paid them either at settlement or closing, or to a taxing authority (either directly or through an escrow account) during the year. Copy 2011 taxes If you own a cooperative apartment, see Special Rules for Cooperatives , later. Copy 2011 taxes Where to deduct real estate taxes. Copy 2011 taxes   Enter the amount of your deductible real estate taxes on Schedule A (Form 1040), line 6. Copy 2011 taxes Real estate taxes paid at settlement or closing. Copy 2011 taxes   Real estate taxes are generally divided so that you and the seller each pay taxes for the part of the property tax year you owned the home. Copy 2011 taxes Your share of these taxes is fully deductible if you itemize your deductions. Copy 2011 taxes Division of real estate taxes. Copy 2011 taxes   For federal income tax purposes, the seller is treated as paying the property taxes up to, but not including, the date of sale. Copy 2011 taxes You (the buyer) are treated as paying the taxes beginning with the date of sale. Copy 2011 taxes This applies regardless of the lien dates under local law. Copy 2011 taxes Generally, this information is included on the settlement statement you get at closing. Copy 2011 taxes   You and the seller each are considered to have paid your own share of the taxes, even if one or the other paid the entire amount. Copy 2011 taxes You each can deduct your own share, if you itemize deductions, for the year the property is sold. Copy 2011 taxes Example. Copy 2011 taxes You bought your home on September 1. Copy 2011 taxes The property tax year (the period to which the tax relates) in your area is the calendar year. Copy 2011 taxes The tax for the year was $730 and was due and paid by the seller on August 15. Copy 2011 taxes You owned your new home during the property tax year for 122 days (September 1 to December 31, including your date of purchase). Copy 2011 taxes You figure your deduction for real estate taxes on your home as follows. Copy 2011 taxes 1. Copy 2011 taxes Enter the total real estate taxes for the real property tax year $730 2. Copy 2011 taxes Enter the number of days in the property tax year that you owned the property 122 3. Copy 2011 taxes Divide line 2 by 365 . Copy 2011 taxes 3342 4. Copy 2011 taxes Multiply line 1 by line 3. Copy 2011 taxes This is your deduction. Copy 2011 taxes Enter it on Schedule A (Form 1040), line 6 $244   You can deduct $244 on your return for the year if you itemize your deductions. Copy 2011 taxes You are considered to have paid this amount and can deduct it on your return even if, under the contract, you did not have to reimburse the seller. Copy 2011 taxes Delinquent taxes. Copy 2011 taxes   Delinquent taxes are unpaid taxes that were imposed on the seller for an earlier tax year. Copy 2011 taxes If you agree to pay delinquent taxes when you buy your home, you cannot deduct them. Copy 2011 taxes You treat them as part of the cost of your home. Copy 2011 taxes See Real estate taxes , later, under Basis. Copy 2011 taxes Escrow accounts. Copy 2011 taxes   Many monthly house payments include an amount placed in escrow (put in the care of a third party) for real estate taxes. Copy 2011 taxes You may not be able to deduct the total you pay into the escrow account. Copy 2011 taxes You can deduct only the real estate taxes that the lender actually paid from escrow to the taxing authority. Copy 2011 taxes Your real estate tax bill will show this amount. Copy 2011 taxes Refund or rebate of real estate taxes. Copy 2011 taxes   If you receive a refund or rebate of real estate taxes this year for amounts you paid this year, you must reduce your real estate tax deduction by the amount refunded to you. Copy 2011 taxes If the refund or rebate was for real estate taxes paid for a prior year, you may have to include some or all of the refund in your income. Copy 2011 taxes For more information, see Recoveries in Publication 525, Taxable and Nontaxable Income. Copy 2011 taxes Items You Cannot Deduct as Real Estate Taxes The following items are not deductible as real estate taxes. Copy 2011 taxes Charges for services. Copy 2011 taxes   An itemized charge for services to specific property or people is not a tax, even if the charge is paid to the taxing authority. Copy 2011 taxes You cannot deduct the charge as a real estate tax if it is: A unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water you use), A periodic charge for a residential service (such as a $20 per month or $240 annual fee charged for trash collection), or A flat fee charged for a single service provided by your local government (such as a $30 charge for mowing your lawn because it had grown higher than permitted under a local ordinance). Copy 2011 taxes    You must look at your real estate tax bill to decide if any nondeductible itemized charges, such as those listed above, are included in the bill. Copy 2011 taxes If your taxing authority (or lender) does not furnish you a copy of your real estate tax bill, ask for it. Copy 2011 taxes Contact the taxing authority if you need additional information about a specific charge on your real estate tax bill. Copy 2011 taxes Assessments for local benefits. Copy 2011 taxes   You cannot deduct amounts you pay for local benefits that tend to increase the value of your property. Copy 2011 taxes Local benefits include the construction of streets, sidewalks, or water and sewer systems. Copy 2011 taxes You must add these amounts to the basis of your property. Copy 2011 taxes   You can, however, deduct assessments (or taxes) for local benefits if they are for maintenance, repair, or interest charges related to those benefits. Copy 2011 taxes An example is a charge to repair an existing sidewalk and any interest included in that charge. Copy 2011 taxes   If only a part of the assessment is for maintenance, repair, or interest charges, you must be able to show the amount of that part to claim the deduction. Copy 2011 taxes If you cannot show what part of the assessment is for maintenance, repair, or interest charges, you cannot deduct any of it. Copy 2011 taxes   An assessment for a local benefit may be listed as an item in your real estate tax bill. Copy 2011 taxes If so, use the rules in this section to find how much of it, if any, you can deduct. Copy 2011 taxes Transfer taxes (or stamp taxes). Copy 2011 taxes   You cannot deduct transfer taxes and similar taxes and charges on the sale of a personal home. Copy 2011 taxes If you are the buyer and you pay them, include them in the cost basis of the property. Copy 2011 taxes If you are the seller and you pay them, they are expenses of the sale and reduce the amount realized on the sale. Copy 2011 taxes Homeowners association assessments. Copy 2011 taxes   You cannot deduct these assessments because the homeowners association, rather than a state or local government, imposes them. Copy 2011 taxes Special Rules for Cooperatives If you own a cooperative apartment, some special rules apply to you, though you generally receive the same tax treatment as other homeowners. Copy 2011 taxes As an owner of a cooperative apartment, you own shares of stock in a corporation that owns or leases housing facilities. Copy 2011 taxes You can deduct your share of the corporation's deductible real estate taxes if the cooperative housing corporation meets the following conditions: The corporation has only one class of stock outstanding, Each stockholder, solely because of ownership of the stock, can live in a house, apartment, or house trailer owned or leased by the corporation, No stockholder can receive any distribution out of capital, except on a partial or complete liquidation of the corporation, and At least one of the following: At least 80% of the corporation's gross income for the tax year was paid by the tenant-stockholders. Copy 2011 taxes For this purpose, gross income means all income received during the entire tax year, including any received before the corporation changed to cooperative ownership. Copy 2011 taxes At least 80% of the total square footage of the corporation's property must be available for use by the tenant-stockholders during the entire tax year. Copy 2011 taxes At least 90% of the expenditures paid or incurred by the corporation were used for the acquisition, construction, management, maintenance, or care of the property for the benefit of the tenant-shareholders during the entire tax year. Copy 2011 taxes Tenant-stockholders. Copy 2011 taxes   A tenant-stockholder can be any entity (such as a corporation, trust, estate, partnership, or association) as well as an individual. Copy 2011 taxes The tenant-stockholder does not have to live in any of the cooperative's dwelling units. Copy 2011 taxes The units that the tenant-stockholder has the right to occupy can be rented to others. Copy 2011 taxes Deductible taxes. Copy 2011 taxes   You figure your share of real estate taxes in the following way. Copy 2011 taxes Divide the number of your shares of stock by the total number of shares outstanding, including any shares held by the corporation. Copy 2011 taxes Multiply the corporation's deductible real estate taxes by the number you figured in (1). Copy 2011 taxes This is your share of the real estate taxes. Copy 2011 taxes   Generally, the corporation will tell you your share of its real estate tax. Copy 2011 taxes This is the amount you can deduct if it reasonably reflects the cost of real estate taxes for your dwelling unit. Copy 2011 taxes Refund of real estate taxes. Copy 2011 taxes   If the corporation receives a refund of real estate taxes it paid in an earlier year, it must reduce the amount of real estate taxes paid this year when it allocates the tax expense to you. Copy 2011 taxes Your deduction for real estate taxes the corporation paid this year is reduced by your share of the refund the corporation received. Copy 2011 taxes Sales Taxes Generally, you can elect to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction on Schedule A (Form 1040). Copy 2011 taxes Deductible sales taxes may include sales taxes paid on your home (including mobile and prefabricated), or home building materials if the tax rate was the same as the general sales tax rate. Copy 2011 taxes For information on figuring your deduction, see the Instructions for Schedule A (Form 1040). Copy 2011 taxes If you elect to deduct the sales taxes paid on your home, or home building materials, you cannot include them as part of your cost basis in the home. Copy 2011 taxes Home Mortgage Interest This section of the publication gives you basic information about home mortgage interest, including information on interest paid at settlement, points, and Form 1098, Mortgage Interest Statement. Copy 2011 taxes Most home buyers take out a mortgage (loan) to buy their home. Copy 2011 taxes They then make monthly payments to either the mortgage holder or someone collecting the payments for the mortgage holder. Copy 2011 taxes Usually, you can deduct the entire part of your payment that is for mortgage interest, if you itemize your deductions on Schedule A (Form 1040). Copy 2011 taxes However, your deduction may be limited if: Your total mortgage balance is more than $1 million ($500,000 if married filing separately), or You took out a mortgage for reasons other than to buy, build, or improve your home. Copy 2011 taxes If either of these situations applies to you, see Publication 936 for more information. Copy 2011 taxes Also see Publication 936 if you later refinance your mortgage or buy a second home. Copy 2011 taxes Refund of home mortgage interest. Copy 2011 taxes   If you receive a refund of home mortgage interest that you deducted in an earlier year and that reduced your tax, you generally must include the refund in income in the year you receive it. Copy 2011 taxes For more information, see Recoveries in Publication 525. Copy 2011 taxes The amount of the refund will usually be shown on the mortgage interest statement you receive from your mortgage lender. Copy 2011 taxes See Mortgage Interest Statement , later. Copy 2011 taxes Deductible Mortgage Interest To be deductible, the interest you pay must be on a loan secured by your main home or a second home. Copy 2011 taxes The loan can be a first or second mortgage, a home improvement loan, or a home equity loan. Copy 2011 taxes Prepaid interest. Copy 2011 taxes   If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies. Copy 2011 taxes Generally, you can deduct in each year only the interest that qualifies as home mortgage interest for that year. Copy 2011 taxes An exception (discussed later) applies to points. Copy 2011 taxes Late payment charge on mortgage payment. Copy 2011 taxes   You can deduct as home mortgage interest a late payment charge if it was not for a specific service in connection with your mortgage loan. Copy 2011 taxes Mortgage prepayment penalty. Copy 2011 taxes   If you pay off your home mortgage early, you may have to pay a penalty. Copy 2011 taxes You can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with your mortgage loan. Copy 2011 taxes Ground rent. Copy 2011 taxes   In some states (such as Maryland), you may buy your home subject to a ground rent. Copy 2011 taxes A ground rent is an obligation you assume to pay a fixed amount per year on the property. Copy 2011 taxes Under this arrangement, you are leasing (rather than buying) the land on which your home is located. Copy 2011 taxes Redeemable ground rents. Copy 2011 taxes   If you make annual or periodic rental payments on a redeemable ground rent, you can deduct the payments as mortgage interest. Copy 2011 taxes The ground rent is a redeemable ground rent only if all of the following are true. Copy 2011 taxes Your lease, including renewal periods, is for more than 15 years. Copy 2011 taxes You can freely assign the lease. Copy 2011 taxes You have a present or future right (under state or local law) to end the lease and buy the lessor's entire interest in the land by paying a specified amount. Copy 2011 taxes The lessor's interest in the land is primarily a security interest to protect the rental payments to which he or she is entitled. Copy 2011 taxes   Payments made to end the lease and buy the lessor's entire interest in the land are not redeemable ground rents. Copy 2011 taxes You cannot deduct them. Copy 2011 taxes Nonredeemable ground rents. Copy 2011 taxes   Payments on a nonredeemable ground rent are not mortgage interest. Copy 2011 taxes You can deduct them as rent only if they are a business expense or if they are for rental property. Copy 2011 taxes Cooperative apartment. Copy 2011 taxes   You can usually treat the interest on a loan you took out to buy stock in a cooperative housing corporation as home mortgage interest if you own a cooperative apartment, and the cooperative housing corporation meets the conditions described earlier under Special Rules for Cooperatives . Copy 2011 taxes In addition, you can treat as home mortgage interest your share of the corporation's deductible mortgage interest. Copy 2011 taxes Figure your share of mortgage interest the same way that is shown for figuring your share of real estate taxes in the Example under Division of real estate taxes, earlier. Copy 2011 taxes For more information on cooperatives, see Special Rule for Tenant-Stockholders in Cooperative Housing Corporations in Publication 936. Copy 2011 taxes Refund of cooperative's mortgage interest. Copy 2011 taxes   You must reduce your mortgage interest deduction by your share of any cash portion of a patronage dividend that the cooperative receives. Copy 2011 taxes The patronage dividend is a partial refund to the cooperative housing corporation of mortgage interest it paid in a prior year. Copy 2011 taxes   If you receive a Form 1098 from the cooperative housing corporation, the form should show only the amount you can deduct. Copy 2011 taxes Mortgage Interest Paid at Settlement One item that normally appears on a settlement or closing statement is home mortgage interest. Copy 2011 taxes You can deduct the interest that you pay at settlement if you itemize your deductions on Schedule A (Form 1040). Copy 2011 taxes This amount should be included in the mortgage interest statement provided by your lender. Copy 2011 taxes See the discussion under Mortgage Interest Statement , later. Copy 2011 taxes Also, if you pay interest in advance, see Prepaid interest , earlier, and Points , next. Copy 2011 taxes Points The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Copy 2011 taxes Points also may be called loan origination fees, maximum loan charges, loan discount, or discount points. Copy 2011 taxes A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. Copy 2011 taxes See Points paid by the seller , later. Copy 2011 taxes General rule. Copy 2011 taxes   You cannot deduct the full amount of points in the year paid. Copy 2011 taxes They are prepaid interest, so you generally must deduct them over the life (term) of the mortgage. Copy 2011 taxes Exception. Copy 2011 taxes   You can deduct the full amount of points in the year paid if you meet all the following tests. Copy 2011 taxes Your loan is secured by your main home. Copy 2011 taxes (Generally, your main home is the one you live in most of the time. Copy 2011 taxes ) Paying points is an established business practice in the area where the loan was made. Copy 2011 taxes The points paid were not more than the points generally charged in that area. Copy 2011 taxes You use the cash method of accounting. Copy 2011 taxes This means you report income in the year you receive it and deduct expenses in the year you pay them. Copy 2011 taxes Most individuals use this method. Copy 2011 taxes The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes. Copy 2011 taxes The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. Copy 2011 taxes The funds you provided are not required to have been applied to the points. Copy 2011 taxes They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. Copy 2011 taxes You cannot have borrowed these funds. Copy 2011 taxes You use your loan to buy or build your main home. Copy 2011 taxes The points were computed as a percentage of the principal amount of the mortgage. Copy 2011 taxes The amount is clearly shown on the settlement statement (such as the Uniform Settlement Statement, Form HUD-1) as points charged for the mortgage. Copy 2011 taxes The points may be shown as paid from either your funds or the seller's. Copy 2011 taxes Note. Copy 2011 taxes If you meet all of the tests listed above and you itemize your deductions in the year you get the loan, you can either deduct the full amount of points in the year paid or deduct them over the life of the loan, beginning in the year you get the loan. Copy 2011 taxes If you do not itemize your deductions in the year you get the loan, you can spread the points over the life of the loan and deduct the appropriate amount in each future year, if any, when you do itemize your deductions. Copy 2011 taxes Home improvement loan. Copy 2011 taxes   You can also fully deduct in the year paid points paid on a loan to improve your main home, if you meet the first six tests listed earlier. Copy 2011 taxes Refinanced loan. Copy 2011 taxes   If you use part of the refinanced mortgage proceeds to improve your main home and you meet the first six tests listed earlier, you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds. Copy 2011 taxes You can deduct the rest of the points over the life of the loan. Copy 2011 taxes Points not fully deductible in year paid. Copy 2011 taxes    If you do not qualify under the exception to deduct the full amount of points in the year paid (or choose not to do so), see Points in Publication 936 for the rules on when and how much you can deduct. Copy 2011 taxes Figure A. Copy 2011 taxes   You can use Figure A, next, as a quick guide to see whether your points are fully deductible in the year paid. Copy 2011 taxes    Please click here for the text description of the image. Copy 2011 taxes Figure A. Copy 2011 taxes Are my points fully deductible this year? Amounts charged for services. Copy 2011 taxes   Amounts charged by the lender for specific services connected to the loan are not interest. Copy 2011 taxes Examples of these charges are: Appraisal fees, Notary fees, and Preparation costs for the mortgage note or deed of trust. Copy 2011 taxes You cannot deduct these amounts as points either in the year paid or over the life of the mortgage. Copy 2011 taxes For information about the tax treatment of these amounts and other settlement fees and closing costs, see Basis , later. Copy 2011 taxes Points paid by the seller. Copy 2011 taxes   The term “points” includes loan placement fees that the seller pays to the lender to arrange financing for the buyer. Copy 2011 taxes Treatment by seller. Copy 2011 taxes   The seller cannot deduct these fees as interest. Copy 2011 taxes However, they are a selling expense that reduces the seller's amount realized. Copy 2011 taxes See Publication 523 for more information. Copy 2011 taxes Treatment by buyer. Copy 2011 taxes   The buyer treats seller-paid points as if he or she had paid them. Copy 2011 taxes If all the tests listed earlier under Exception are met, the buyer can deduct the points in the year paid. Copy 2011 taxes If any of those tests are not met, the buyer must deduct the points over the life of the loan. Copy 2011 taxes   The buyer must also reduce the basis of the home by the amount of the seller-paid points. Copy 2011 taxes For more information about the basis of your home, see Basis , later. Copy 2011 taxes Funds provided are less than points. Copy 2011 taxes   If you meet all the tests listed earlier under Exception except that the funds you provided were less than the points charged to you (test 6), you can deduct the points in the year paid up to the amount of funds you provided. Copy 2011 taxes In addition, you can deduct any points paid by the seller. Copy 2011 taxes Example 1. Copy 2011 taxes When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). Copy 2011 taxes You meet all the tests for deducting points in the year paid (see Exception , earlier), except the only funds you provided were a $750 down payment. Copy 2011 taxes Of the $1,000 you were charged for points, you can deduct $750 in the year paid. Copy 2011 taxes You spread the remaining $250 over the life of the mortgage. Copy 2011 taxes Example 2. Copy 2011 taxes The facts are the same as in Example 1 , except that the person who sold you your home also paid one point ($1,000) to help you get your mortgage. Copy 2011 taxes In the year paid, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). Copy 2011 taxes You spread the remaining $250 over the life of the mortgage. Copy 2011 taxes You must reduce the basis of your home by the $1,000 paid by the seller. Copy 2011 taxes Excess points. Copy 2011 taxes   If you meet all the tests under Exception , earlier, except that the points paid were more than are generally charged in your area (test 3), you can deduct in the year paid only the points that are generally charged. Copy 2011 taxes You must spread any additional points over the life of the mortgage. Copy 2011 taxes Mortgage ending early. Copy 2011 taxes   If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. Copy 2011 taxes A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event. Copy 2011 taxes Example. Copy 2011 taxes Dan paid $3,000 in points in 2006 that he had to spread out over the 15-year life of the mortgage. Copy 2011 taxes He had deducted $1,400 of these points through 2012. Copy 2011 taxes Dan prepaid his mortgage in full in 2013. Copy 2011 taxes He can deduct the remaining $1,600 of points in 2013. Copy 2011 taxes Exception. Copy 2011 taxes   If you refinance the mortgage with the same lender, you cannot deduct any remaining points for the year. Copy 2011 taxes Instead, deduct them over the term of the new loan. Copy 2011 taxes Form 1098. Copy 2011 taxes   The mortgage interest statement you receive should show not only the total interest paid during the year, but also your deductible points paid during the year. Copy 2011 taxes See Mortgage Interest Statement , later. Copy 2011 taxes Where To Deduct Home Mortgage Interest Enter on Schedule A (Form 1040), line 10, the home mortgage interest and points reported to you on Form 1098 (discussed next). Copy 2011 taxes If you did not receive a Form 1098, enter your deductible interest on line 11, and any deductible points on line 12. Copy 2011 taxes See Table 1 below for a summary of where to deduct home mortgage interest and real estate taxes. Copy 2011 taxes If you paid home mortgage interest to the person from whom you bought your home, show that person's name, address, and social security number (SSN) or employer identification number (EIN) on the dotted lines next to line 11. Copy 2011 taxes The seller must give you this number and you must give the seller your SSN. Copy 2011 taxes Form W-9, Request for Taxpayer Identification Number and Certification, can be used for this purpose. Copy 2011 taxes Failure to meet either of these requirements may result in a $50 penalty for each failure. Copy 2011 taxes Table 1. Copy 2011 taxes Where To Deduct Interest and Taxes Paid on Your Home See the text for information on what expenses are eligible. Copy 2011 taxes IF you are eligible to deduct . Copy 2011 taxes . Copy 2011 taxes . Copy 2011 taxes THEN report the amount  on Schedule A (Form 1040) . Copy 2011 taxes . Copy 2011 taxes . Copy 2011 taxes real estate taxes line 6. Copy 2011 taxes home mortgage interest and points reported on Form 1098 line 10. Copy 2011 taxes home mortgage interest not reported on  Form 1098 line 11. Copy 2011 taxes points not reported on Form 1098 line 12. Copy 2011 taxes qualified mortgage insurance premiums line 13. Copy 2011 taxes Mortgage Interest Statement If you paid $600 or more of mortgage interest (including certain points and mortgage insurance premiums) during the year on any one mortgage to a mortgage holder in the course of that holder's trade or business, you should receive a Form 1098 or similar statement from the mortgage holder. Copy 2011 taxes The statement will show the total interest paid on your mortgage during the year. Copy 2011 taxes If you bought a main home during the year, it also will show the deductible points you paid and any points you can deduct that were paid by the person who sold you your home. Copy 2011 taxes See Points , earlier. Copy 2011 taxes The interest you paid at settlement should be included on the statement. Copy 2011 taxes If it is not, add the interest from the settlement sheet that qualifies as home mortgage interest to the total shown on Form 1098 or similar statement. Copy 2011 taxes Put the total on Schedule A (Form 1040), line 10, and attach a statement to your return explaining the difference. Copy 2011 taxes Write “See attached” to the right of line 10. Copy 2011 taxes A mortgage holder can be a financial institution, a governmental unit, or a cooperative housing corporation. Copy 2011 taxes If a statement comes from a cooperative housing corporation, it generally will show your share of interest. Copy 2011 taxes Your mortgage interest statement for 2013 should be provided or sent to you by January 31, 2014. Copy 2011 taxes If it is mailed, you should allow adequate time to receive it before contacting the mortgage holder. Copy 2011 taxes A copy of this form will be sent to the IRS also. Copy 2011 taxes Example. Copy 2011 taxes You bought a new home on May 3. Copy 2011 taxes You paid no points on the purchase. Copy 2011 taxes During the year, you made mortgage payments which included $4,480 deductible interest on your new home. Copy 2011 taxes The settlement sheet for the purchase of the home included interest of $620 for 29 days in May. Copy 2011 taxes The mortgage statement you receive from the lender includes total interest of $5,100 ($4,480 + $620). Copy 2011 taxes You can deduct the $5,100 if you itemize your deductions. Copy 2011 taxes Refund of overpaid interest. Copy 2011 taxes   If you receive a refund of mortgage interest you overpaid in a prior year, you generally will receive a Form 1098 showing the refund in box 3. Copy 2011 taxes Generally, you must include the refund in income in the year you receive it. Copy 2011 taxes See Refund of home mortgage interest , earlier, under Home Mortgage Interest. Copy 2011 taxes More than one borrower. Copy 2011 taxes   If you and at least one other person (other than your spouse if you file a joint return) were liable for and paid interest on a mortgage that was for your home, and the other person received a Form 1098 showing the interest that was paid during the year, attach a statement to your return explaining this. Copy 2011 taxes Show how much of the interest each of you paid, and give the name and address of the person who received the form. Copy 2011 taxes Deduct your share of the interest on Schedule A (Form 1040), line 11, and write “See attached” to the right of that line. Copy 2011 taxes Mortgage Insurance Premiums You may be able to take an itemized deduction on Schedule A (Form 1040), line 13, for premiums you pay or accrue during 2013 for qualified mortgage insurance in connection with home acquisition debt on your qualified home. Copy 2011 taxes Mortgage insurance premiums you paid or accrued on any mortgage insurance contract issued before January 1, 2007, are not deductible as an itemized deduction. Copy 2011 taxes Qualified Mortgage Insurance Qualified mortgage insurance is mortgage insurance provided by the Veterans Administration, the Federal Housing Administration, or the Rural Housing Administration, and private mortgage insurance (as defined in section 2 of the Homeowners Protection Act of 1998 as in effect on December 20, 2006). Copy 2011 taxes Prepaid mortgage insurance premiums. Copy 2011 taxes   If you paid premiums that are allocable to periods after 2013, you must allocate them over the shorter of: The stated term of the mortgage, or 84 months, beginning with the month the insurance was obtained. Copy 2011 taxes The premiums are treated as paid in the year to which they were allocated. Copy 2011 taxes If the mortgage is satisfied before its term, no deduction is allowed for the unamortized balance. Copy 2011 taxes See Publication 936 for details. Copy 2011 taxes Exception for certain mortgage insurance. Copy 2011 taxes   The allocation rules, explained above, do not apply to qualified mortgage insurance provided by the Department of Veterans Affairs or Rural Housing Service. Copy 2011 taxes Home Acquisition Debt Home acquisition debt is a mortgage you took out after October 13, 1987, to buy, build, or substantially improve a qualified home. Copy 2011 taxes It also must be secured by that home. Copy 2011 taxes If the amount of your mortgage is more than the cost of the home plus the cost of any substantial improvements, only the debt that is not more than the cost of the home plus improvements qualifies as home acquisition debt. Copy 2011 taxes Home acquisition debt limit. Copy 2011 taxes   The total amount you can treat as home acquisition debt at any time on your home cannot be more than $1 million ($500,000 if married filing separately). Copy 2011 taxes Discharges of qualified principal residence indebtedness. Copy 2011 taxes   You can exclude from gross income any discharges of qualified principal residence indebtedness made after 2006 and before 2014. Copy 2011 taxes You must reduce the basis of your principal residence (but not below zero) by the amount you exclude. Copy 2011 taxes Principal residence. Copy 2011 taxes   Your principal residence is the home where you ordinarily live most of the time. Copy 2011 taxes You can have only one principal residence at any one time. Copy 2011 taxes Qualified principal residence indebtedness. Copy 2011 taxes   This is a mortgage that you took out to buy, build, or substantially improve your principal residence and that is secured by that residence. Copy 2011 taxes If the amount of your original mortgage is more than the cost of your principal residence plus the cost of substantial improvements, qualified principal residence indebtedness cannot be more than the cost of your principal residence plus improvements. Copy 2011 taxes   Any debt secured by your principal residence that you use to refinance qualified principal residence indebtedness is qualified principal residence indebtedness up to the amount of your old mortgage principal just before the refinancing. Copy 2011 taxes Additional debt incurred to substantially improve your principal residence is also qualified principal residence indebtedness. Copy 2011 taxes Amount you can exclude. Copy 2011 taxes   You can only exclude debt discharged after 2006 and before 2014. Copy 2011 taxes The most you can exclude is $2 million ($1 million if married filing separately). Copy 2011 taxes You cannot exclude any amount that was discharged because of services performed for the lender or on account of any other factor not directly related either to a decline in the value of your residence or to your financial condition. Copy 2011 taxes Ordering rule. Copy 2011 taxes   If only a part of a loan is qualified principal residence indebtedness, you can exclude only the amount of the discharge that is more than the amount of the loan (immediately before the discharge) that is not qualified principal residence indebtedness. Copy 2011 taxes Qualified Home This means your main home or your second home. Copy 2011 taxes A home includes a house, condominium, cooperative, mobile home, house trailer, boat, or similar property that has sleeping, cooking, and toilet facilities. Copy 2011 taxes Main home. Copy 2011 taxes   You can have only one main home at any one time. Copy 2011 taxes This is the home where you ordinarily live most of the time. Copy 2011 taxes Second home and other special situations. Copy 2011 taxes   If you have a second home, use part of your home for other than residential living (such as a home office), rent out part of your home, or are having your home constructed, see Qualified Home in Publication 936. Copy 2011 taxes Limit on Deduction If your adjusted gross income (AGI) on Form 1040, line 38, is more than $100,000 ($50,000 if your filing status is married filing separately), the amount of your mortgage insurance premiums that are deductible is reduced and may be eliminated. Copy 2011 taxes See Line 13 in the instructions for Schedule A (Form 1040) and complete the Mortgage Insurance Premiums Deduction Worksheet to figure the amount you can deduct. Copy 2011 taxes If your AGI is more than $109,000 ($54,500 if married filing separately), you cannot deduct your mortgage insurance premiums. Copy 2011 taxes Form 1098. Copy 2011 taxes   The amount of mortgage insurance premiums you paid during 2013 should be reported in box 4. Copy 2011 taxes See Form 1098, Mortgage Interest Statement in Publication 936. Copy 2011 taxes Mortgage Interest Credit The mortgage interest credit is intended to help lower-income individuals afford home ownership. Copy 2011 taxes If you qualify, you can claim the credit on Form 8396 each year for part of the home mortgage interest you pay. Copy 2011 taxes Who qualifies. Copy 2011 taxes   You may be eligible for the credit if you were issued a qualified Mortgage Credit Certificate (MCC) from your state or local government. Copy 2011 taxes Generally, an MCC is issued only in connection with a new mortgage for the purchase of your main home. Copy 2011 taxes The MCC will show the certificate credit rate you will use to figure your credit. Copy 2011 taxes It also will show the certified indebtedness amount. Copy 2011 taxes Only the interest on that amount qualifies for the credit. Copy 2011 taxes See Figuring the Credit , later. Copy 2011 taxes You must contact the appropriate government agency about getting an MCC before you get a mortgage and buy your home. Copy 2011 taxes Contact your state or local housing finance agency for information about the availability of MCCs in your area. Copy 2011 taxes How to claim the credit. Copy 2011 taxes   To claim the credit, complete Form 8396 and attach it to your Form 1040 or Form 1040NR, U. Copy 2011 taxes S. Copy 2011 taxes Nonresident Alien Income Tax Return. Copy 2011 taxes Include the credit in your total for Form 1040, line 53, or Form 1040NR, line 50; be sure to check box c and write “Form 8396” on that line. Copy 2011 taxes Reducing your home mortgage interest deduction. Copy 2011 taxes   If you itemize your deductions on Schedule A (Form 1040), you must reduce your home mortgage interest deduction by the amount of the mortgage interest credit shown on Form 8396, line 3. Copy 2011 taxes You must do this even if part of that amount is to be carried forward to 2014. Copy 2011 taxes Selling your home. Copy 2011 taxes   If you purchase a home after 1990 using an MCC, and you sell that home within 9 years, you may have to recapture (repay) all or part of the benefit you received from the MCC program. Copy 2011 taxes For additional information, see Recapturing (Paying Back) a Federal Mortgage Subsidy, in Publication 523. Copy 2011 taxes Figuring the Credit Figure your credit on Form 8396. Copy 2011 taxes Mortgage not more than certified indebtedness. Copy 2011 taxes   If your mortgage loan amount is equal to (or smaller than) the certified indebtedness amount shown on your MCC, enter on Form 8396, line 1, all the interest you paid on your mortgage during the year. Copy 2011 taxes Mortgage more than certified indebtedness. Copy 2011 taxes   If your mortgage loan amount is larger than the certified indebtedness amount shown on your MCC, you can figure the credit on only part of the interest you paid. Copy 2011 taxes To find the amount to enter on line 1, multiply the total interest you paid during the year on your mortgage by the following fraction. Copy 2011 taxes Certified indebtedness amount on your MCC Original amount of your mortgage   The fraction will not change as long as you are entitled to take the mortgage interest credit. Copy 2011 taxes Example. Copy 2011 taxes Emily bought a home this year. Copy 2011 taxes Her mortgage loan is $125,000. Copy 2011 taxes The certified indebtedness amount on her MCC is $100,000. Copy 2011 taxes She paid $7,500 interest this year. Copy 2011 taxes Emily figures the interest to enter on Form 8396, line 1, as follows:   $100,000 = 80% (. Copy 2011 taxes 80)       $125,000       $7,500 x . Copy 2011 taxes 80 = $6,000   Emily enters $6,000 on Form 8396, line 1. Copy 2011 taxes In each later year, she will figure her credit using only 80% of the interest she pays for that year. Copy 2011 taxes Limits Two limits may apply to your credit. Copy 2011 taxes A limit based on the credit rate, and A limit based on your tax. Copy 2011 taxes Limit based on credit rate. Copy 2011 taxes   If the certificate credit rate is higher than 20%, the credit you are allowed cannot be more than $2,000. Copy 2011 taxes Limit based on tax. Copy 2011 taxes   After applying the limit based on the credit rate, your credit generally cannot be more than your tax liability. Copy 2011 taxes See the Credit Limit Worksheet in the Form 8396 instructions to calculate the limit based on tax. Copy 2011 taxes Dividing the Credit If two or more persons (other than a married couple filing a joint return) hold an interest in the home to which the MCC relates, the credit must be divided based on the interest held by each person. Copy 2011 taxes Example. Copy 2011 taxes John and his brother, George, were issued an MCC. Copy 2011 taxes They used it to get a mortgage on their main home. Copy 2011 taxes John has a 60% ownership interest in the home, and George has a 40% ownership interest in the home. Copy 2011 taxes John paid $5,400 mortgage interest this year and George paid $3,600. Copy 2011 taxes The MCC shows a credit rate of 25% and a certified indebtedness amount of $130,000. Copy 2011 taxes The loan amount (mortgage) on their home is $120,000. Copy 2011 taxes The credit is limited to $2,000 because the credit rate is more than 20%. Copy 2011 taxes John figures the credit by multiplying the mortgage interest he paid this year ($5,400) by the certificate credit rate (25%) for a total of $1,350. Copy 2011 taxes His credit is limited to $1,200 ($2,000 × 60%). Copy 2011 taxes George figures the credit by multiplying the mortgage interest he paid this year ($3,600) by the certificate credit rate (25%) for a total of $900. Copy 2011 taxes His credit is limited to $800 ($2,000 × 40%). Copy 2011 taxes Carryforward If your allowable credit is reduced because of the limit based on your tax, you can carry forward the unused portion of the credit to the next 3 years or until used, whichever comes first. Copy 2011 taxes Example. Copy 2011 taxes You receive a mortgage credit certificate from State X. Copy 2011 taxes This year, your regular tax liability is $1,100, you owe no alternative minimum tax, and your mortgage interest credit is $1,700. Copy 2011 taxes You claim no other credits. Copy 2011 taxes Your unused mortgage interest credit for this year is $600 ($1,700 − $1,100). Copy 2011 taxes You can carry forward this amount to the next 3 years or until used, whichever comes first. Copy 2011 taxes Credit rate more than 20%. Copy 2011 taxes   If you are subject to the $2,000 limit because your certificate credit rate is more than 20%, you cannot carry forward any amount more than $2,000 (or your share of the $2,000 if you must divide the credit). Copy 2011 taxes Example. Copy 2011 taxes In the earlier example under Dividing the Credit , John and George used the entire $2,000 credit. Copy 2011 taxes The excess   John $1,350 − $1,200 = $150     George $900 − $800 = $100   $150 for John ($1,350 − $1,200) and $100 for George ($900 − $800) cannot be carried forward to future years, despite the respective tax liabilities for John and George. Copy 2011 taxes Refinancing If you refinance your original mortgage loan on which you had been given an MCC, you must get a new MCC to be able to claim the credit on the new loan. Copy 2011 taxes The amount of credit you can claim on the new loan may change. Copy 2011 taxes Table 2 below summarizes how to figure your credit if you refinance your original mortgage loan. Copy 2011 taxes Table 2. Copy 2011 taxes Effect of Refinancing on Your Credit IF you get a new (reissued) MCC and the amount of your new mortgage is . Copy 2011 taxes . Copy 2011 taxes . Copy 2011 taxes THEN the interest you claim on Form 8396, line 1, is* . Copy 2011 taxes . Copy 2011 taxes . Copy 2011 taxes smaller than or equal to the certified indebtedness amount on the new MCC all the interest paid during the year on your new mortgage. Copy 2011 taxes larger than the certified indebtedness amount on the new MCC interest paid during the year on your new mortgage multiplied by the following fraction. Copy 2011 taxes         certified indebtedness  amount on your new MCC       original amount of your  mortgage   *The credit using the new MCC cannot be more than the credit using the old MCC. Copy 2011 taxes  See New MCC cannot increase your credit above. Copy 2011 taxes An issuer may reissue an MCC after you refinance your mortgage. Copy 2011 taxes If you did not get a new MCC, you may want to contact the state or local housing finance agency that issued your original MCC for information about whether you can get a reissued MCC. Copy 2011 taxes Year of refinancing. Copy 2011 taxes   In the year of refinancing, add the applicable amount of interest paid on the old mortgage and the applicable amount of interest paid on the new mortgage, and enter the total on Form 8396, line 1. Copy 2011 taxes   If your new MCC has a credit rate different from the rate on the old MCC, you must attach a statement to Form 8396. Copy 2011 taxes The statement must show the calculation for lines 1, 2, and 3 for the part of the year when the old MCC was in effect. Copy 2011 taxes It must show a separate calculation for the part of the year when the new MCC was in effect. Copy 2011 taxes Combine the amounts from both calculations for line 3, enter the total on line 3 of the form, and write “See attached” on the dotted line next to line 2. Copy 2011 taxes New MCC cannot increase your credit. Copy 2011 taxes   The credit that you claim with your new MCC cannot be more than the credit that you could have claimed with your old MCC. Copy 2011 taxes   In most cases, the agency that issues your new MCC will make sure that it does not increase your credit. Copy 2011 taxes However, if either your old loan or your new loan has a variable (adjustable) interest rate, you will need to check this yourself. Copy 2011 taxes In that case, you will need to know the amount of the credit you could have claimed using the old MCC. Copy 2011 taxes   There are two methods for figuring the credit you could have claimed. Copy 2011 taxes Under one method, you figure the actual credit that would have been allowed. Copy 2011 taxes This means you use the credit rate on the old MCC and the interest you would have paid on the old loan. Copy 2011 taxes   If your old loan was a variable rate mortgage, you can use another method to determine the credit that you could have claimed. Copy 2011 taxes Under this method, you figure the credit using a payment schedule of a hypothetical self-amortizing mortgage with level payments projected to the final maturity date of the old mortgage. Copy 2011 taxes The interest rate of the hypothetical mortgage is the annual percentage rate (APR) of the new mortgage for purposes of the Federal Truth in Lending Act. Copy 2011 taxes The principal of the hypothetical mortgage is the remaining outstanding balance of the certified mortgage indebtedness shown on the old MCC. Copy 2011 taxes    You must choose one method and use it consistently beginning with the first tax year for which you claim the credit based on the new MCC. Copy 2011 taxes    As part of your tax records, you should keep your old MCC and the schedule of payments for your old mortgage. Copy 2011 taxes Basis Basis is your starting point for figuring a gain or loss if you later sell your home, or for figuring depreciation if you later use part of your home for business purposes or for rent. Copy 2011 taxes While you own your home, you may add certain items to your basis. Copy 2011 taxes You may subtract certain other items from your basis. Copy 2011 taxes These items are called adjustments to basis and are explained later under Adjusted Basis . Copy 2011 taxes It is important that you understand these terms when you first acquire your home because you must keep track of your basis and adjusted basis during the period you own your home. Copy 2011 taxes You also must keep records of the events that affect basis or adjusted basis. Copy 2011 taxes See Keeping Records , below. Copy 2011 taxes Figuring Your Basis How you figure your basis depends on how you acquire your home. Copy 2011 taxes If you buy or build your home, your cost is your basis. Copy 2011 taxes If you receive your home as a gift, your basis is usually the same as the adjusted basis of the person who gave you the property. Copy 2011 taxes If you inherit your home from a decedent, different rules apply depending on the date of the decedent's death. Copy 2011 taxes Each of these topics is discussed later. Copy 2011 taxes Property transferred from a spouse. Copy 2011 taxes   If your home is transferred to you from your spouse, or from your former spouse as a result of a divorce, your basis is the same as your spouse's (or former spouse's) adjusted basis just before the transfer. Copy 2011 taxes Publication 504, Divorced or Separated Individuals, fully discusses transfers between spouses. Copy 2011 taxes Cost as Basis The cost of your home, whether you purchased it or constructed it, is the amount you paid for it, including any debt you assumed. Copy 2011 taxes The cost of your home includes most settlement or closing costs you paid when you bought the home. Copy 2011 taxes If you built your home, your cost includes most closing costs paid when you bought the land or settled on your mortgage. Copy 2011 taxes See Settlement or closing costs , later. Copy 2011 taxes If you elect to deduct the sales taxes on the purchase or construction of your home as an itemized deduction on Schedule A (Form 1040), you cannot include the sales taxes as part of your cost basis in the home. Copy 2011 taxes Purchase. Copy 2011 taxes   The basis of a home you bought is the amount you paid for it. Copy 2011 taxes This usually includes your down payment and any debt you assumed. Copy 2011 taxes The basis of a cooperative apartment is the amount you paid for your shares in the corporation that owns or controls the property. Copy 2011 taxes This amount includes any purchase commissions or other costs of acquiring the shares. Copy 2011 taxes Construction. Copy 2011 taxes   If you contracted to have your home built on land that you own, your basis in the home is your basis in the land plus the amount you paid to have the home built. Copy 2011 taxes This includes the cost of labor and materials, the amount you paid the contractor, any architect's fees, building permit charges, utility meter and connection charges, and legal fees that are directly connected with building your home. Copy 2011 taxes If you built all or part of your home yourself, your basis is the total amount it cost you to build it. Copy 2011 taxes You cannot include in basis the value of your own labor or any other labor for which you did not pay. Copy 2011 taxes Real estate taxes. Copy 2011 taxes   Real estate taxes are usually divided so that you and the seller each pay taxes for the part of the property tax year that each owned the home. Copy 2011 taxes See the earlier discussion of Real estate taxes paid at settlement or closing , under Real Estate Taxes, earlier, to figure the real estate taxes you paid or are considered to have paid. Copy 2011 taxes   If you pay any part of the seller's share of the real estate taxes (the taxes up to the date of sale), and the seller did not reimburse you, add those taxes to your basis in the home. Copy 2011 taxes You cannot deduct them as taxes paid. Copy 2011 taxes   If the seller paid any of your share of the real estate taxes (the taxes beginning with the date of sale), you can still deduct those taxes. Copy 2011 taxes Do not include those taxes in your basis. Copy 2011 taxes If you did not reimburse the seller, you must reduce your basis by the amount of those taxes. Copy 2011 taxes Example 1. Copy 2011 taxes You bought your home on September 1. Copy 2011 taxes The property tax year in your area is the calendar year, and the tax is due on August 15. Copy 2011 taxes The real estate taxes on the home you bought were $1,275 for the year and had been paid by the seller on August 15. Copy 2011 taxes You did not reimburse the seller for your share of the real estate taxes from September 1 through December 31. Copy 2011 taxes You must reduce the basis of your home by the $426 [(122 ÷ 365) × $1,275] the seller paid for you. Copy 2011 taxes You can deduct your $426 share of real estate taxes on your return for the year you purchased your home. Copy 2011 taxes Example 2. Copy 2011 taxes You bought your home on May 3, 2013. Copy 2011 taxes The property tax year in your area is the calendar year. Copy 2011 taxes The taxes for the previous year are assessed on January 2 and are due on May 31 and November 30. Copy 2011 taxes Under state law, the taxes become a lien on May 31. Copy 2011 taxes You agreed to pay all taxes due after the date of sale. Copy 2011 taxes The taxes due in 2013 for 2012 were $1,375. Copy 2011 taxes The taxes due in 2014 for 2013 will be $1,425. Copy 2011 taxes You cannot deduct any of the taxes paid in 2013 because they relate to the 2012 property tax year and you did not own the home until 2013. Copy 2011 taxes Instead, you add the $1,375 to the cost (basis) of your home. Copy 2011 taxes You owned the home in 2013 for 243 days (May 3 to December 31), so you can take a tax deduction on your 2014 return of $949 [(243 ÷ 365) × $1,425] paid in 2014 for 2013. Copy 2011 taxes You add the remaining $476 ($1,425 − $949) of taxes paid in 2014 to the cost (basis) of your home. Copy 2011 taxes Settlement or closing costs. Copy 2011 taxes   If you bought your home, you probably paid settlement or closing costs in addition to the contract price. Copy 2011 taxes These costs are divided between you and the seller according to the sales contract, local custom, or understanding of the parties. Copy 2011 taxes If you built your home, you probably paid these costs when you bought the land or settled on your mortgage. Copy 2011 taxes   The only settlement or closing costs you can deduct are home mortgage interest and certain real estate taxes. Copy 2011 taxes You deduct them in the year you buy your home if you itemize your deductions. Copy 2011 taxes You can add certain other settlement or closing costs to the basis of your home. Copy 2011 taxes Items added to basis. Copy 2011 taxes   You can include in your basis the settlement fees and closing costs you paid for buying your home. Copy 2011 taxes A fee is for buying the home if you would have had to pay it even if you paid cash for the home. Copy 2011 taxes   The following are some of the settlement fees and closing costs that you can include in the original basis of your home. Copy 2011 taxes Abstract fees (abstract of title fees). Copy 2011 taxes Charges for installing utility services. Copy 2011 taxes Legal fees (including fees for the title search and preparation of the sales contract and deed). Copy 2011 taxes Recording fees. Copy 2011 taxes Surveys. Copy 2011 taxes Transfer or stamp taxes. Copy 2011 taxes Owner's title insurance. Copy 2011 taxes Any amount the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, cost for improvements or repairs, and sales commissions. Copy 2011 taxes   If the seller actually paid for any item for which you are liable and for which you can take a deduction (such as your share of the real estate taxes for the year of sale), you must reduce your basis by that amount unless you are charged for it in the settlement. Copy 2011 taxes Items not added to basis and not deductible. Copy 2011 taxes   Here are some settlement and closing costs that you cannot deduct or add to your basis. Copy 2011 taxes Fire insurance premiums. Copy 2011 taxes Charges for using utilities or other services related to occupancy of the home before closing. Copy 2011 taxes Rent for occupying the home before closing. Copy 2011 taxes Charges connected with getting or refinancing a mortgage loan, such as: Loan assumption fees, Cost of a credit report, and Fee for an appraisal required by a lender. Copy 2011 taxes Points paid by seller. Copy 2011 taxes   If you bought your home after April 3, 1994, you must reduce your basis by any points paid for your mortgage by the person who sold you your home. Copy 2011 taxes   If you bought your home after 1990 but before April 4, 1994, you must reduce your basis by seller-paid points only if you deducted them. Copy 2011 taxes See Points , earlier, for the rules on deducting points. Copy 2011 taxes Gift To figure the basis of property you receive as a gift, you must know its adjusted basis (defined later) to the donor just before it was given to you, its fair market value (FMV) at the time it was given to you, and any gift tax paid on it. Copy 2011 taxes Fair market value. Copy 2011 taxes   Fair market value (FMV) 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 who both have a reasonable knowledge of all the necessary facts. Copy 2011 taxes Donor's adjusted basis is more than FMV. Copy 2011 taxes   If someone gave you your home and the donor's adjusted basis, when it was given to you, was more than the FMV, your basis at the time of receipt is the same as the donor's adjusted basis. Copy 2011 taxes Disposition basis. Copy 2011 taxes   If the donor's adjusted basis at the time of the gift is more than the FMV, your basis (plus or minus any required adjustments, see Adjusted Basis , later) when you dispose of the property will depend on whether you have a gain or a loss. Copy 2011 taxes Your basis for figuring a gain is the same as the donor's adjusted basis. Copy 2011 taxes Your basis for figuring a loss is the FMV when you received the gift. Copy 2011 taxes If you use the donor's adjusted basis to figure a gain and it results in a loss, then you must use the FMV (at the time of the gift) to refigure the loss. Copy 2011 taxes However, if using the FMV results in a gain, then you neither have a gain nor a loss. Copy 2011 taxes Example 1. Copy 2011 taxes Andrew received a house as a gift from Ishmael (the donor). Copy 2011 taxes At the time of the gift, the home had an FMV of $80,000. Copy 2011 taxes Ishmael's adjusted basis was $100,000. Copy 2011 taxes After he received the house, no events occurred to increase or decrease the basis. Copy 2011 taxes If Andrew sells the house for $120,000, he will have a $20,000 gain because he must use the donor's adjusted basis ($100,000) at the time of the gift as his basis to figure the gain. Copy 2011 taxes Example 2. Copy 2011 taxes Same facts as Example 1 , except this time Andrew sells the house for $70,000. Copy 2011 taxes He will have a loss of $10,000 because he must use the FMV ($80,000) at the time of the gift as his basis to figure the loss. Copy 2011 taxes Example 3. Copy 2011 taxes Same facts as Example 1 , except this time Andrew sells the house for $90,000. Copy 2011 taxes Initially, he figures the gain using Ishmael's adjusted basis ($100,000), which results in a loss of $10,000. Copy 2011 taxes Since it is a loss, Andrew must now recalculate the loss using the FMV ($80,000), which results in a gain of $10,000. Copy 2011 taxes So in this situation, Andrew will neither have a gain nor a loss. Copy 2011 taxes Donor's adjusted basis equal to or less than the FMV. Copy 2011 taxes   If someone gave you your home after 1976 and the donor's adjusted basis, when it was given to you, was equal to or less than the FMV, your basis at the time of receipt is the same as the donor's adjusted basis, plus the part of any federal gift tax paid that is due to the net increase in value of the home. Copy 2011 taxes Part of federal gift tax due to net increase in value. Copy 2011 taxes   Figure the part of the federal gift tax paid that is due to the net increase in value of the home by multiplying the total federal gift tax paid by a fraction. Copy 2011 taxes The numerator (top part) of the fraction is the net increase in the value of the home, and the denominator (bottom part) is the value of the home for gift tax purposes after reduction for any annual exclusion and marital or charitable deduction that applies to the gift. Copy 2011 taxes The net increase in the value of the home is its FMV minus the adjusted basis of the donor. Copy 2011 taxes Publication 551 gives more information, including examples, on figuring your basis when you receive property as a gift. Copy 2011 taxes Inheritance Your basis in a home you inherited is generally the fair market value of the home on the date of the decedent's death or on the alternative valuation date if the personal representative for the estate chooses to use alternative valuation. Copy 2011 taxes If an estate tax return was filed, your basis is generally the value of the home listed on the estate tax return. Copy 2011 taxes If an estate tax return was not filed, your basis is the appraised value of the home at the decedent's date of death for state inheritance or transmission taxes. Copy 2011 taxes Publication 551 and Publication 559, Survivors, Executors, and Administrators, have more information on the basis of inherited property. Copy 2011 taxes If you inherited your home from someone who died in 2010, and the executor of the decedent's estate made the election to file Form 8939, Allocation of Increase in Basis for Property Acquired From a Decedent, refer to the information provided by the executor or see Publication 4895, Tax Treatment of Property Acquired From a Decedent Dying in 2010. Copy 2011 taxes Adjusted Basis While you own your home, various events may take place that can change the original basis of your home. Copy 2011 taxes These events can increase or decrease your original basis. Copy 2011 taxes The result is called adjusted basis. Copy 2011 taxes See Table 3, on this page, for a list of some of the items that can adjust your basis. Copy 2011 taxes Table 3. Copy 2011 taxes Adjusted Basis This table lists examples of some items that generally will increase or decrease your basis in your home. Copy 2011 taxes It is not intended to be all-inclusive. Copy 2011 taxes Increases to Basis Decreases to Basis Improvements: Putting an addition on your home Replacing an entire roof Paving your driveway Installing central air conditioning Rewiring your home Assessments for local improvements (see Assessments for local benefits , under What You Can and Cannot Deduct, earlier) Amounts spent to restore damaged property Insurance or other reimbursement for casualty losses Deductible casualty loss not covered by insurance Payments received for easement or right-of-way granted Depreciation allowed or allowable if home is used for business or rental purposes Value of subsidy for energy conservation measure excluded from income Improvements. Copy 2011 taxes   An improvement materially adds to the value of your home, considerably prolongs its useful life, or adapts it to new uses. Copy 2011 taxes You must add the cost of any improvements to the basis of your home. Copy 2011 taxes You cannot deduct these costs. Copy 2011 taxes   Improvements include putting a recreation room in your unfinished basement, adding another bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, installing a new roof, and paving your driveway. Copy 2011 taxes Amount added to basis. Copy 2011 taxes   The amount you add to your basis for improvements is your actual cost. Copy 2011 taxes This includes all costs for material and labor, except your own labor, and all expenses related to the improvement. Copy 2011 taxes For example, if you had your lot surveyed to put up a fence, the cost of the survey is a part of the cost of the fence. Copy 2011 taxes   You also must add to your basis state and local assessments for improvements such as streets and sidewalks if they increase the value of the property. Copy 2011 taxes These assessments are discussed earlier under Real Estate Taxes . Copy 2011 taxes Improvements no longer part of home. Copy 2011 taxes    Your home's adjusted basis does not include the cost of any improvements that are replaced and are no longer part of the home. Copy 2011 taxes Example. Copy 2011 taxes You put wall-to-wall carpeting in your home 15 years ago. Copy 2011 taxes Later, you replaced that carpeting with new wall-to-wall carpeting. Copy 2011 taxes The cost of the old carpeting you replaced is no longer part of your home's adjusted basis. Copy 2011 taxes Repairs versus improvements. Copy 2011 taxes   A repair keeps your home in an ordinary, efficient operating condition. Copy 2011 taxes It does not add to the value of your home or prolong its life. Copy 2011 taxes Repairs include repainting your home inside or outside, fixing your gutters or floors, fixing leaks or plastering, and replacing broken window panes. Copy 2011 taxes You cannot deduct repair costs and generally cannot add them to the basis of your home. Copy 2011 taxes   However, repairs that are done as part of an extensive remodeling or restoration of your home are considered improvements. Copy 2011 taxes You add them to the basis of your home. Copy 2011 taxes Records to keep. Copy 2011 taxes   You can use Table 4 (at the end of the publication) as a guide to help you keep track of improvements to your home. Copy 2011 taxes Also see Keeping Records , below. Copy 2011 taxes Energy conservation subsidy. Copy 2011 taxes   If a public utility gives you (directly or indirectly) a subsidy for the purchase or installation of an energy conservation measure for your home, do not include the value of that subsidy in your income. Copy 2011 taxes You must reduce the basis of your home by that value. Copy 2011 taxes   An energy conservation measure is an installation or modification primarily designed to reduce consumption of electricity or natural gas or to improve the management of energy demand. Copy 2011 taxes Keeping Records Keeping full and accurate records is vital to properly report your income and expenses, to support your deductions and credits, and to know the basis or adjusted basis of your home. Copy 2011 taxes These records include your purchase contract and settlement papers if you bought the property, or other objective evidence if you acquired it by gift, inheritance, or similar means. Copy 2011 taxes You should keep any receipts, canceled checks, and similar evidence for improvements or other additions to the basis. Copy 2011 taxes In addition, you should keep track of any decreases to the basis such as those listed in Table 3, earlier. Copy 2011 taxes How to keep records. Copy 2011 taxes   How you keep records is up to you, but they must be clear and accurate and must be available to the IRS. Copy 2011 taxes How long to keep records. Copy 2011 taxes   You must keep your records for as long as they are important for meeting any provision of the federal tax law. Copy 2011 taxes   Keep records that support an item of income, a deduction, or a credit appearing on a return until the period of limitations for the return runs out. Copy 2011 taxes (A period of limitations is the period of time after which no legal action can be brought. Copy 2011 taxes ) For assessment of tax you owe, this is generally 3 years from the date you filed the return. Copy 2011 taxes For filing a claim for credit or refund, this is generally 3 years from the date you filed the original return, or 2 years from the date you paid the tax, whichever is later. Copy 2011 taxes Returns filed before the due date are treated as filed on the due date. Copy 2011 taxes   You may need to keep records relating to the basis of property (discussed earlier) for longer than the period of limitations. Copy 2011 taxes Keep those records as long as they are important in figuring the basis of the original or replacement property. Copy 2011 taxes Generally, this means for as long as you own the property and, after you dispose of it, for the period of limitations that applies to you. Copy 2011 taxes Table 4. Copy 2011 taxes Record of Home Improvements Keep this for your records. Copy 2011 taxes Also, keep receipts or other proof of improvements. Copy 2011 taxes Remove from this record any improvements that are no longer part of your main home. Copy 2011 taxes For example, if you put wall-to-wall carpeting in your home and later replace it with new wall-to-wall carpeting, remove the cost of the first carpeting. Copy 2011 taxes (a) Type of Improvement (b) Date (c) Amount   (a) Type of Improvement (b) Date (c) Amount Additions:       Heating & Air  Conditioning:     Bedroom       Heating system     Bathroom       Central air conditioning     Deck       Furnace     Garage       Duct work     Porch       Central humidifier     Patio       Filtration system     Storage shed       Other     Fireplace       Electrical:     Other           Lawn & Grounds:       Lighting fixtures           Wiring upgrades     Landscaping       Other     Driveway       Plumbing:     Walkway           Fences       Water heater     Retaining wall       Soft water system     Sprinkler system       Filtration system     Swimming pool       Other     Exterior lighting       Insulation:     Other           Communications:       Attic           Walls     Satellite dish       Floors     Intercom       Pipes and duct work     Security system       Other     Other             Miscellaneous:       Interior  Improvements:     Storm windows and doors       Built-in appliances     Roof       Kitchen modernization     Central vacuum       Bathroom modernization     Other       Flooring             Wall-to-wall carpeting             Other     How To