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File taxes for 2012 free 7. File taxes for 2012 free   Coverdell Education Savings Account (ESA) Table of Contents Introduction What Is a Coverdell ESAQualified Education Expenses ContributionsContribution Limits Additional Tax on Excess Contributions Rollovers and Other TransfersRollovers Changing the Designated Beneficiary Transfer Because of Divorce DistributionsTax-Free Distributions Taxable Distributions When Assets Must Be Distributed Introduction If your modified adjusted gross income (MAGI) is less than $110,000 ($220,000 if filing a joint return), you may be able to establish a Coverdell ESA to finance the qualified education expenses of a designated beneficiary. File taxes for 2012 free For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return. File taxes for 2012 free There is no limit on the number of separate Coverdell ESAs that can be established for a designated beneficiary. File taxes for 2012 free However, total contributions for the beneficiary in any year cannot be more than $2,000, no matter how many accounts have been established. File taxes for 2012 free See Contributions , later. File taxes for 2012 free This benefit applies not only to higher education expenses, but also to elementary and secondary education expenses. File taxes for 2012 free What is the tax benefit of the Coverdell ESA. File taxes for 2012 free   Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed. File taxes for 2012 free   If, for a year, distributions from an account are not more than a designated beneficiary's qualified education expenses at an eligible educational institution, the beneficiary will not owe tax on the distributions. File taxes for 2012 free See Tax-Free Distributions , later. File taxes for 2012 free    Table 7-1 summarizes the main features of the Coverdell ESA. File taxes for 2012 free Table 7-1. File taxes for 2012 free Coverdell ESA at a Glance Do not rely on this table alone. File taxes for 2012 free It provides only general highlights. File taxes for 2012 free See the text for definitions of terms in bold type and for more complete explanations. File taxes for 2012 free Question Answer What is a Coverdell ESA? A savings account that is set up to pay the qualified education expenses of a designated beneficiary. File taxes for 2012 free Where can it be established? It can be opened in the United States at any bank or other IRS-approved entity that offers Coverdell ESAs. File taxes for 2012 free Who can have a Coverdell ESA? Any beneficiary who is under age 18 or is a special needs beneficiary. File taxes for 2012 free Who can contribute to a Coverdell ESA? Generally, any individual (including the beneficiary) whose modified adjusted gross income for the year is less than $110,000 ($220,000 in the case of a joint return). File taxes for 2012 free Are distributions tax free? Yes, if the distributions are not more than the beneficiary's adjusted qualified education expenses for the year. File taxes for 2012 free What Is a Coverdell ESA A Coverdell ESA is a trust or custodial account created or organized in the United States only for the purpose of paying the qualified education expenses of the Designated beneficiary (defined later) of the account. File taxes for 2012 free When the account is established, the designated beneficiary must be under age 18 or a special needs beneficiary. File taxes for 2012 free To be treated as a Coverdell ESA, the account must be designated as a Coverdell ESA when it is created. File taxes for 2012 free The document creating and governing the account must be in writing and must satisfy the following requirements. File taxes for 2012 free The trustee or custodian must be a bank or an entity approved by the IRS. File taxes for 2012 free The document must provide that the trustee or custodian can only accept a contribution that meets all of the following conditions. File taxes for 2012 free The contribution is in cash. File taxes for 2012 free The contribution is made before the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary. File taxes for 2012 free The contribution would not result in total contributions for the year (not including rollover contributions) being more than $2,000. File taxes for 2012 free Money in the account cannot be invested in life insurance contracts. File taxes for 2012 free Money in the account cannot be combined with other property except in a common trust fund or common investment fund. File taxes for 2012 free The balance in the account generally must be distributed within 30 days after the earlier of the following events. File taxes for 2012 free The beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary. File taxes for 2012 free The beneficiary's death. File taxes for 2012 free Qualified Education Expenses Generally, these are expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution. File taxes for 2012 free For purposes of Coverdell ESAs, the expenses can be either qualified higher education expenses or qualified elementary and secondary education expenses. File taxes for 2012 free Designated beneficiary. File taxes for 2012 free   This is the individual named in the document creating the trust or custodial account to receive the benefit of the funds in the account. File taxes for 2012 free Contributions to a qualified tuition program (QTP). File taxes for 2012 free   A contribution to a QTP is a qualified education expense if the contribution is on behalf of the designated beneficiary of the Coverdell ESA. File taxes for 2012 free In the case of a change in beneficiary, this is a qualified expense only if the new beneficiary is a family member of that designated beneficiary. File taxes for 2012 free See chapter 8, Qualified Tuition Program . File taxes for 2012 free Eligible Educational Institution For purposes of Coverdell ESAs, an eligible educational institution can be either an eligible postsecondary school or an eligible elementary or secondary school. File taxes for 2012 free Eligible postsecondary school. File taxes for 2012 free   This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U. File taxes for 2012 free S. File taxes for 2012 free Department of Education. File taxes for 2012 free It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. File taxes for 2012 free The educational institution should be able to tell you if it is an eligible educational institution. File taxes for 2012 free   Certain educational institutions located outside the United States also participate in the U. File taxes for 2012 free S. File taxes for 2012 free Department of Education's Federal Student Aid (FSA) programs. File taxes for 2012 free Eligible elementary or secondary school. File taxes for 2012 free   This is any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12), as determined under state law. File taxes for 2012 free Qualified Higher Education Expenses These are expenses related to enrollment or attendance at an eligible postsecondary school. File taxes for 2012 free As shown in the following list, to be qualified, some of the expenses must be required by the school and some must be incurred by students who are enrolled at least half-time. File taxes for 2012 free The following expenses must be required for enrollment or attendance of a designated beneficiary at an eligible postsecondary school. File taxes for 2012 free Tuition and fees. File taxes for 2012 free Books, supplies, and equipment. File taxes for 2012 free Expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible postsecondary school. File taxes for 2012 free Expenses for room and board must be incurred by students who are enrolled at least half-time (defined below). File taxes for 2012 free The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts. File taxes for 2012 free The allowance for room and board, as determined by the school, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student. File taxes for 2012 free The actual amount charged if the student is residing in housing owned or operated by the school. File taxes for 2012 free Half-time student. File taxes for 2012 free   A student is enrolled “at least half-time” if he or she is enrolled for at least half the full-time academic work load for the course of study the student is pursuing, as determined under the standards of the school where the student is enrolled. File taxes for 2012 free Qualified Elementary and Secondary Education Expenses These are expenses related to enrollment or attendance at an eligible elementary or secondary school. File taxes for 2012 free As shown in the following list, to be qualified, some of the expenses must be required or provided by the school. File taxes for 2012 free There are special rules for computer-related expenses. File taxes for 2012 free The following expenses must be incurred by a designated beneficiary in connection with enrollment or attendance at an eligible elementary or secondary school. File taxes for 2012 free Tuition and fees. File taxes for 2012 free Books, supplies, and equipment. File taxes for 2012 free Academic tutoring. File taxes for 2012 free Special needs services for a special needs beneficiary. File taxes for 2012 free The following expenses must be required or provided by an eligible elementary or secondary school in connection with attendance or enrollment at the school. File taxes for 2012 free Room and board. File taxes for 2012 free Uniforms. File taxes for 2012 free Transportation. File taxes for 2012 free Supplementary items and services (including extended day programs). File taxes for 2012 free The purchase of computer technology, equipment, or Internet access and related services is a qualified elementary and secondary education expense if it is to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in elementary or secondary school. File taxes for 2012 free (This does not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature. File taxes for 2012 free ) Contributions Any individual (including the designated beneficiary) can contribute to a Coverdell ESA if the individual's MAGI (defined later under Contribution Limits ) for the year is less than $110,000. File taxes for 2012 free For individuals filing joint returns, that amount is $220,000. File taxes for 2012 free Organizations, such as corporations and trusts, can also contribute to Coverdell ESAs. File taxes for 2012 free There is no requirement that an organization's income be below a certain level. File taxes for 2012 free Contributions must meet all of the following requirements. File taxes for 2012 free They must be in cash. File taxes for 2012 free They cannot be made after the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary. File taxes for 2012 free They must be made by the due date of the contributor's tax return (not including extensions). File taxes for 2012 free Contributions can be made to one or several Coverdell ESAs for the same designated beneficiary provided that the total contributions are not more than the contribution limits (defined later) for a year. File taxes for 2012 free Contributions can be made, without penalty, to both a Coverdell ESA and a QTP in the same year for the same beneficiary. File taxes for 2012 free Table 7-2 summarizes many of the features of contributing to a Coverdell ESA. File taxes for 2012 free When contributions considered made. File taxes for 2012 free   Contributions made to a Coverdell ESA for the preceding tax year are considered to have been made on the last day of the preceding year. File taxes for 2012 free They must be made by the due date (not including extensions) for filing your return for the preceding year. File taxes for 2012 free   For example, if you make a contribution to a Coverdell ESA in February 2014, and you designate it as a contribution for 2013, you are considered to have made that contribution on December 31, 2013. File taxes for 2012 free Contribution Limits There are two yearly limits: One on the total amount that can be contributed for each designated beneficiary in any year, and One on the amount that any individual can contribute for any one designated beneficiary for a year. File taxes for 2012 free Limit for each designated beneficiary. File taxes for 2012 free   For 2013, the total of all contributions to all Coverdell ESAs set up for the benefit of any one designated beneficiary cannot be more than $2,000. File taxes for 2012 free This includes contributions (other than rollovers) to all the beneficiary's Coverdell ESAs from all sources. File taxes for 2012 free Rollovers are discussed under Rollovers and Other Transfers , later. File taxes for 2012 free Example. File taxes for 2012 free When Maria Luna was born in 2012, three separate Coverdell ESAs were set up for her, one by her parents, one by her grandfather, and one by her aunt. File taxes for 2012 free In 2013, the total of all contributions to Maria's three Coverdell ESAs cannot be more than $2,000. File taxes for 2012 free For example, if her grandfather contributed $2,000 to one of her Coverdell ESAs, no one else could contribute to any of her three accounts. File taxes for 2012 free Or, if her parents contributed $1,000 and her aunt $600, her grandfather or someone else could contribute no more than $400. File taxes for 2012 free These contributions could be put into any of Maria's Coverdell ESA accounts. File taxes for 2012 free Limit for each contributor. File taxes for 2012 free   Generally, you can contribute up to $2,000 for each designated beneficiary for 2013. File taxes for 2012 free This is the most you can contribute for the benefit of any one beneficiary for the year, regardless of the number of Coverdell ESAs set up for the beneficiary. File taxes for 2012 free Example. File taxes for 2012 free The facts are the same as in the previous example except that Maria Luna's older brother, Edgar, also has a Coverdell ESA. File taxes for 2012 free If their grandfather contributed $2,000 to Maria's Coverdell ESA in 2013, he could also contribute $2,000 to Edgar's Coverdell ESA. File taxes for 2012 free Reduced limit. File taxes for 2012 free   Your contribution limit may be reduced. File taxes for 2012 free If your MAGI (defined on this page) is between $95,000 and $110,000 (between $190,000 and $220,000 if filing a joint return), the $2,000 limit for each designated beneficiary is gradually reduced (see Figuring the limit , later). File taxes for 2012 free If your MAGI is $110,000 or more ($220,000 or more if filing a joint return), you cannot contribute to anyone's Coverdell ESA. File taxes for 2012 free Table 7-2. File taxes for 2012 free Coverdell ESA Contributions at a Glance Do not rely on this table alone. File taxes for 2012 free It provides only general highlights. File taxes for 2012 free See the text for more complete explanations. File taxes for 2012 free Question Answer Are contributions deductible? No. File taxes for 2012 free What is the annual contribution limit per designated beneficiary? $2,000 for each designated beneficiary. File taxes for 2012 free What if more than one Coverdell ESA has been opened for the same designated beneficiary? The annual contribution limit is $2,000 for each beneficiary, no matter how many Coverdell ESAs are set up for that beneficiary. File taxes for 2012 free What if more than one individual makes contributions for the same designated beneficiary? The annual contribution limit is $2,000 per beneficiary, no matter how many individuals contribute. File taxes for 2012 free Can contributions other than cash be made to a Coverdell ESA? No. File taxes for 2012 free When must contributions stop? No contributions can be made to a beneficiary's Coverdell ESA after he or she reaches age 18, unless the beneficiary is a special needs beneficiary. File taxes for 2012 free Modified adjusted gross income (MAGI). File taxes for 2012 free   For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return. File taxes for 2012 free MAGI when using Form 1040A. File taxes for 2012 free   If you file Form 1040A, your MAGI is the AGI on line 22 of that form. File taxes for 2012 free MAGI when using Form 1040. File taxes for 2012 free   If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any: Foreign earned income exclusion, Foreign housing exclusion, Foreign housing deduction, Exclusion of income by bona fide residents of American Samoa, and Exclusion of income by bona fide residents of Puerto Rico. File taxes for 2012 free MAGI when using Form 1040NR. File taxes for 2012 free   If you file Form 1040NR, your MAGI is the AGI on line 36 of that form. File taxes for 2012 free MAGI when using Form 1040NR-EZ. File taxes for 2012 free   If you file Form 1040NR-EZ, your MAGI is the AGI on line 10 of that form. File taxes for 2012 free   If you have any of these adjustments, you can use Worksheet 7-1. File taxes for 2012 free MAGI for a Coverdell ESA , later, to figure your MAGI for Form 1040. File taxes for 2012 free Worksheet 7-1. File taxes for 2012 free MAGI for a Coverdell ESA 1. File taxes for 2012 free Enter your adjusted gross income  (Form 1040, line 38)   1. File taxes for 2012 free   2. File taxes for 2012 free Enter your foreign earned income exclusion and/or housing exclusion (Form 2555, line 45, or Form 2555-EZ, line 18)   2. File taxes for 2012 free       3. File taxes for 2012 free Enter your foreign housing deduction (Form 2555, line 50)   3. File taxes for 2012 free         4. File taxes for 2012 free Enter the amount of income from Puerto Rico you are excluding   4. File taxes for 2012 free       5. File taxes for 2012 free Enter the amount of income from American Samoa you are excluding (Form 4563, line 15)   5. File taxes for 2012 free       6. File taxes for 2012 free Add lines 2, 3, 4, and 5   6. File taxes for 2012 free   7. File taxes for 2012 free Add lines 1 and 6. File taxes for 2012 free This is your  modified adjusted gross income   7. File taxes for 2012 free   Figuring the limit. File taxes for 2012 free    To figure the limit on the amount you can contribute for each designated beneficiary, multiply $2,000 by a fraction. File taxes for 2012 free The numerator (top number) is your MAGI minus $95,000 ($190,000 if filing a joint return). File taxes for 2012 free The denominator (bottom number) is $15,000 ($30,000 if filing a joint return). File taxes for 2012 free Subtract the result from $2,000. File taxes for 2012 free This is the amount you can contribute for each beneficiary. File taxes for 2012 free You can use Worksheet 7-2. File taxes for 2012 free Coverdell ESA Contribution Limit to figure the limit on contributions. File taxes for 2012 free    Worksheet 7-2. File taxes for 2012 free Coverdell ESA Contribution Limit 1. File taxes for 2012 free Maximum contribution   1. File taxes for 2012 free $2,000 2. File taxes for 2012 free Enter your modified adjusted gross income (MAGI) for purposes of figuring the contribution limit to a Coverdell ESA (see definition or Worksheet 7-1, earlier)   2. File taxes for 2012 free   3. File taxes for 2012 free Enter $190,000 if married filing jointly; $95,000 for all other filers   3. File taxes for 2012 free   4. File taxes for 2012 free Subtract line 3 from line 2. File taxes for 2012 free If zero or less, enter -0- on line 4, skip lines 5 through 7, and enter $2,000 on line 8   4. File taxes for 2012 free   5. File taxes for 2012 free Enter $30,000 if married filing jointly; $15,000 for all other filers   5. File taxes for 2012 free     Note. File taxes for 2012 free If the amount on line 4 is greater than or equal to the amount on line 5, stop here. File taxes for 2012 free You are not allowed to contribute to a Coverdell ESA for 2013. File taxes for 2012 free       6. File taxes for 2012 free Divide line 4 by line 5 and enter the result as a decimal (rounded to at least 3 places)   6. File taxes for 2012 free . File taxes for 2012 free 7. File taxes for 2012 free Multiply line 1 by line 6   7. File taxes for 2012 free   8. File taxes for 2012 free Subtract line 7 from line 1   8. File taxes for 2012 free   Note: The total Coverdell ESA contributions from all sources for the designated beneficiary during the tax year may not exceed $2,000. File taxes for 2012 free Example. File taxes for 2012 free Paul, who is single, had a MAGI of $96,500 for 2013. File taxes for 2012 free Paul can contribute up to $1,800 in 2013 for each beneficiary, as shown in the illustrated Worksheet 7-2, Coverdell ESA Contribution Limit–Illustrated. File taxes for 2012 free Worksheet 7-2. File taxes for 2012 free Coverdell ESA Contribution Limit—Illustrated 1. File taxes for 2012 free Maximum contribution   1. File taxes for 2012 free $2,000 2. File taxes for 2012 free Enter your modified adjusted gross  income (MAGI) for purposes of figuring the contribution limit to a Coverdell ESA (see definition or Worksheet 7-1, earlier)   2. File taxes for 2012 free 96,500 3. File taxes for 2012 free Enter $190,000 if married filing jointly; $95,000 for all other filers   3. File taxes for 2012 free 95,000 4. File taxes for 2012 free Subtract line 3 from line 2. File taxes for 2012 free If zero or less, enter -0- on line 4, skip lines 5 through 7, and enter $2,000 on line 8   4. File taxes for 2012 free 1,500 5. File taxes for 2012 free Enter $30,000 if married filing jointly; $15,000 for all other filers   5. File taxes for 2012 free 15,000   Note. File taxes for 2012 free If the amount on line 4 is greater than or equal to the amount on line 5,  stop here. File taxes for 2012 free You are not allowed to  contribute to a Coverdell ESA for 2013. File taxes for 2012 free       6. File taxes for 2012 free Divide line 4 by line 5 and enter the result as a decimal (rounded to at least 3 places)   6. File taxes for 2012 free . File taxes for 2012 free 100 7. File taxes for 2012 free Multiply line 1 by line 6   7. File taxes for 2012 free 200 8. File taxes for 2012 free Subtract line 7 from line 1   8. File taxes for 2012 free 1,800 Note: The total Coverdell ESA contributions from all sources for the designated beneficiary during the tax year may not exceed $2,000. File taxes for 2012 free Additional Tax on Excess Contributions The beneficiary must pay a 6% excise tax each year on excess contributions that are in a Coverdell ESA at the end of the year. File taxes for 2012 free Excess contributions are the total of the following two amounts. File taxes for 2012 free Contributions to any designated beneficiary's Coverdell ESA for the year that are more than $2,000 (or, if less, the total of each contributor's limit for the year, as discussed earlier). File taxes for 2012 free Excess contributions for the preceding year, reduced by the total of the following two amounts: Distributions (other than those rolled over as discussed later) during the year, and The contribution limit for the current year minus the amount contributed for the current year. File taxes for 2012 free Exceptions. File taxes for 2012 free   The excise tax does not apply if excess contributions made during 2013 (and any earnings on them) are distributed before the first day of the sixth month of the following tax year (June 1, 2014, for a calendar year taxpayer). File taxes for 2012 free   However, you must include the distributed earnings in gross income for the year in which the excess contribution was made. File taxes for 2012 free You should receive Form 1099-Q, Payments From Qualified Education Programs, from each institution from which excess contributions were distributed. File taxes for 2012 free Box 2 of that form will show the amount of earnings on your excess contributions. File taxes for 2012 free Code “2” or “3” entered in the blank box below boxes 5 and 6 indicate the year in which the earnings are taxable. File taxes for 2012 free See Instructions for Recipient on the back of copy B of your Form 1099-Q. File taxes for 2012 free Enter the amount of earnings on line 21 of Form 1040 (or Form 1040NR) for the applicable tax year. File taxes for 2012 free For more information, see Taxable Distributions , later. File taxes for 2012 free   The excise tax does not apply to any rollover contribution. File taxes for 2012 free Note. File taxes for 2012 free Contributions made in one year for the preceding tax year are considered to have been made on the last day of the preceding year. File taxes for 2012 free Example. File taxes for 2012 free In 2012, Greta's parents and grandparents contributed a total of $2,300 to Greta's Coverdell ESA— an excess contribution of $300. File taxes for 2012 free Because Greta did not withdraw the excess before June 1, 2013, she had to pay an additional tax of $18 (6% × $300) when she filed her 2012 tax return. File taxes for 2012 free In 2013, excess contributions of $500 were made to Greta's account, however, she withdrew $250 from that account to use for qualified education expenses. File taxes for 2012 free Using the steps shown earlier under Additional Tax on Excess Contributions , Greta figures the excess contribution in her account at the end of 2013 as follows. File taxes for 2012 free (1)   $500 excess contributions made in 2013     + (2)   $300 excess contributions in ESA at end of 2012     − (2a)   $250 distribution during 2013         $550 excess at end of 2013   × 6%=$33           If Greta limits 2014 contributions to $1,450 ($2,000 maximum allowed − $550 excess contributions from 2013), she will not owe any additional tax in 2014 for excess contributions. File taxes for 2012 free Figuring and reporting the additional tax. File taxes for 2012 free   You figure this excise tax in Part V of Form 5329. File taxes for 2012 free Report the additional tax on Form 1040, line 58 (or Form 1040NR, line 56). File taxes for 2012 free Rollovers and Other Transfers Assets can be rolled over from one Coverdell ESA to another or the designated beneficiary can be changed. File taxes for 2012 free The beneficiary's interest can be transferred to a spouse or former spouse because of divorce. File taxes for 2012 free Rollovers Any amount distributed from a Coverdell ESA is not taxable if it is rolled over to another Coverdell ESA for the benefit of the same beneficiary or a member of the beneficiary's family (including the beneficiary's spouse) who is under age 30. File taxes for 2012 free This age limitation does not apply if the new beneficiary is a special needs beneficiary. File taxes for 2012 free An amount is rolled over if it is paid to another Coverdell ESA within 60 days after the date of the distribution. File taxes for 2012 free Do not report qualifying rollovers (those that meet the above criteria) anywhere on Form 1040 or 1040NR. File taxes for 2012 free These are not taxable distributions. File taxes for 2012 free Members of the beneficiary's family. File taxes for 2012 free   For these purposes, the beneficiary's family includes the beneficiary's spouse and the following other relatives of the beneficiary. File taxes for 2012 free Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them. File taxes for 2012 free Brother, sister, stepbrother, or stepsister. File taxes for 2012 free Father or mother or ancestor of either. File taxes for 2012 free Stepfather or stepmother. File taxes for 2012 free Son or daughter of a brother or sister. File taxes for 2012 free Brother or sister of father or mother. File taxes for 2012 free Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. File taxes for 2012 free The spouse of any individual listed above. File taxes for 2012 free First cousin. File taxes for 2012 free Example. File taxes for 2012 free When Aaron graduated from college last year he had $5,000 left in his Coverdell ESA. File taxes for 2012 free He wanted to give this money to his younger sister, who was still in high school. File taxes for 2012 free In order to avoid paying tax on the distribution of the amount remaining in his account, Aaron contributed the same amount to his sister's Coverdell ESA within 60 days of the distribution. File taxes for 2012 free Only one rollover per Coverdell ESA is allowed during the 12-month period ending on the date of the payment or distribution. File taxes for 2012 free This rule does not apply to the rollover of a military death gratuity or payment from Servicemembers' Group Life Insurance (SGLI). File taxes for 2012 free Military death gratuity. File taxes for 2012 free   If you received a military death gratuity or a payment from Servicemembers' Group Life Insurance (SGLI), you may roll over all or part of the amount received to one or more Coverdell ESAs for the benefit of members of the beneficiary's family (see Members of the beneficiary's family , earlier). File taxes for 2012 free Such payments are made to an eligible survivor upon the death of a member of the armed forces. File taxes for 2012 free The contribution to a Coverdell ESA from survivor benefits received cannot be made later than 1 year after the date on which you receive the gratuity or SGLI payment. File taxes for 2012 free   This rollover contribution is not subject to (but is in addition to) the contribution limits discussed earlier under Contribution Limits . File taxes for 2012 free The amount you roll over cannot exceed the total survivor benefits you received, reduced by contributions from these benefits to a Roth IRA or other Coverdell ESAs. File taxes for 2012 free   The amount contributed from the survivor benefits is treated as part of your basis (cost) in the Coverdell ESA, and will not be taxed when distributed. File taxes for 2012 free See Distributions , later. File taxes for 2012 free The limit of one rollover per Coverdell ESA during a 12-month period does not apply to a military death gratuity or SGLI payment. File taxes for 2012 free Changing the Designated Beneficiary The designated beneficiary can be changed. File taxes for 2012 free See Members of the beneficiary's family , earlier. File taxes for 2012 free There are no tax consequences if, at the time of the change, the new beneficiary is under age 30 or is a special needs beneficiary. File taxes for 2012 free Example. File taxes for 2012 free Assume the same situation for Aaron as in the last example (see Rollovers , earlier). File taxes for 2012 free Instead of closing his Coverdell ESA and paying the distribution into his sister's Coverdell ESA, Aaron could have instructed the trustee of his account to simply change the name of the beneficiary on his account to that of his sister. File taxes for 2012 free Transfer Because of Divorce If a spouse or former spouse receives a Coverdell ESA under a divorce or separation instrument, it is not a taxable transfer. File taxes for 2012 free After the transfer, the spouse or former spouse treats the Coverdell ESA as his or her own. File taxes for 2012 free Example. File taxes for 2012 free In their divorce settlement, Peg received her ex-husband's Coverdell ESA. File taxes for 2012 free In this process, the account was transferred into her name. File taxes for 2012 free Peg now treats the funds in this Coverdell ESA as if she were the original owner. File taxes for 2012 free Distributions The designated beneficiary of a Coverdell ESA can take a distribution at any time. File taxes for 2012 free Whether the distributions are tax free depends, in part, on whether the distributions are equal to or less than the amount of Adjusted qualified education expenses (defined later) that the beneficiary has in the same tax year. File taxes for 2012 free See Table 7-3, Coverdell ESA Distributions at a Glance, for highlights. File taxes for 2012 free Table 7-3. File taxes for 2012 free Coverdell ESA Distributions at a Glance Do not rely on this table alone. File taxes for 2012 free It provides only general highlights. File taxes for 2012 free See the text for definitions of terms in bold type and for more complete explanations. File taxes for 2012 free Question Answer Is a distribution from a Coverdell ESA to pay for a designated beneficiary's qualified education expenses tax free? Generally, yes, to the extent the amount of the distribution is not more than the designated beneficiary's adjusted qualified education expenses. File taxes for 2012 free After the designated beneficiary completes his or her education at an eligible educational institution, can amounts remaining in the Coverdell ESA be distributed? Yes. File taxes for 2012 free Amounts must be distributed when the designated beneficiary reaches age 30, unless he or she is a special needs beneficiary. File taxes for 2012 free Also, certain transfers to members of the beneficiary's family are permitted. File taxes for 2012 free Does the designated beneficiary need to be enrolled for a minimum number of courses to take a tax-free distribution? No. File taxes for 2012 free Adjusted qualified education expenses. File taxes for 2012 free   To determine if total distributions for the year are more than the amount of qualified education expenses, reduce total qualified education expenses by any tax-free educational assistance. File taxes for 2012 free Tax-free educational assistance includes: The tax-free part of scholarships and fellowships (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), and Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. File taxes for 2012 free The amount you get by subtracting tax-free educational assistance from your total qualified education expenses is your adjusted qualified education expenses. File taxes for 2012 free Tax-Free Distributions Generally, distributions are tax free if they are not more than the beneficiary's adjusted qualified education expenses for the year. File taxes for 2012 free Do not report tax-free distributions (including qualifying rollovers) on your tax return. File taxes for 2012 free Taxable Distributions A portion of the distributions is generally taxable to the beneficiary if the total distributions are more than the beneficiary's adjusted qualified education expenses for the year. File taxes for 2012 free Excess distribution. File taxes for 2012 free   This is the part of the total distribution that is more than the beneficiary's adjusted qualified education expenses for the year. File taxes for 2012 free Earnings and basis. File taxes for 2012 free   You will receive a Form 1099-Q for each of the Coverdell ESAs from which money was distributed in 2013. File taxes for 2012 free The amount of your gross distribution will be shown in box 1. File taxes for 2012 free For 2013, instead of dividing the gross distribution between your earnings (box 2) and your basis (already-taxed amount) (box 3), the payer or trustee may report the fair market value (account balance) of the Coverdell ESA as of December 31, 2013. File taxes for 2012 free This will be shown in the blank box below boxes 5 and 6. File taxes for 2012 free   The amount contributed from survivor benefits (see Military death gratuity , earlier) is treated as part of your basis and will not be taxed when distributed. File taxes for 2012 free Figuring the Taxable Portion of a Distribution The taxable portion is the amount of the excess distribution that represents earnings that have accumulated tax free in the account. File taxes for 2012 free Figure the taxable portion for 2013 as shown in the following steps. File taxes for 2012 free Multiply the total amount distributed by a fraction. File taxes for 2012 free The numerator is the basis (contributions not previously distributed) at the end of 2012 plus total contributions for 2013 and the denominator is the value (balance) of the account at the end of 2013 plus the amount distributed during 2013. File taxes for 2012 free Subtract the amount figured in (1) from the total amount distributed during 2013. File taxes for 2012 free The result is the amount of earnings included in the distribution(s). File taxes for 2012 free Multiply the amount of earnings figured in (2) by a fraction. File taxes for 2012 free The numerator is the adjusted qualified education expenses paid during 2013 and the denominator is the total amount distributed during 2013. File taxes for 2012 free Subtract the amount figured in (3) from the amount figured in (2). File taxes for 2012 free The result is the amount the beneficiary must include in income. File taxes for 2012 free The taxable amount must be reported on Form 1040 or Form 1040NR, line 21. File taxes for 2012 free Example. File taxes for 2012 free You received an $850 distribution from your Coverdell ESA, to which $1,500 had been contributed before 2013. File taxes for 2012 free There were no contributions in 2013. File taxes for 2012 free This is your first distribution from the account, so your basis in the account on December 31, 2012, was $1,500. File taxes for 2012 free The value (balance) of your account on December 31, 2013, was $950. File taxes for 2012 free You had $700 of adjusted qualified education expenses (AQEE) for the year. File taxes for 2012 free Using the steps in Figuring the Taxable Portion of a Distribution , earlier, figure the taxable portion of your distribution as follows. File taxes for 2012 free   1. File taxes for 2012 free $850 (distribution) × $1,500 basis + $0 contributions  $950 value + $850 distribution       =$708 (basis portion of distribution)     2. File taxes for 2012 free $850 (distribution)−$708 (basis portion of distribution)     =$142 (earnings included in distribution)   3. File taxes for 2012 free $142 (earnings) × $700 AQEE  $850 distribution           =$117 (tax-free earnings)     4. File taxes for 2012 free $142 (earnings)−$117 (tax-free earnings)=$25 (taxable earnings)                 You must include $25 in income as distributed earnings not used for qualified education expenses. File taxes for 2012 free Report this amount on Form 1040, line 21, listing the type and amount of income on the dotted line. File taxes for 2012 free Worksheet 7-3, Coverdell ESA–Taxable Distributions and Basis , at the end of this chapter, can help you figure your adjusted qualified education expenses, how much of your distribution must be included in income, and the remaining basis in your Coverdell ESA(s). File taxes for 2012 free Coordination With American Opportunity and Lifetime Learning Credits The American opportunity or lifetime learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits. File taxes for 2012 free This means the beneficiary must reduce qualified higher education expenses by tax-free educational assistance, and then further reduce them by any expenses taken into account in determining an American opportunity or lifetime learning credit. File taxes for 2012 free Example. File taxes for 2012 free Derek Green had $5,800 of qualified higher education expenses for 2013, his first year in college. File taxes for 2012 free He paid his college expenses from the following sources. File taxes for 2012 free     Partial tuition scholarship (tax free) $1,500     Coverdell ESA distribution 1,000     Gift from parents 2,100     Earnings from part-time job 1,200           Of his $5,800 of qualified higher education expenses, $4,000 was tuition and related expenses that also qualified for an American opportunity credit. File taxes for 2012 free Derek's parents claimed a $2,500 American opportunity credit (based on $4,000 expenses) on their tax return. File taxes for 2012 free Before Derek can determine the taxable portion of his Coverdell ESA distribution, he must reduce his total qualified higher education expenses. File taxes for 2012 free     Total qualified higher education expenses $5,800     Minus: Tax-free educational assistance −1,500     Minus: Expenses taken into account in  figuring American opportunity credit − 4,000     Equals: Adjusted qualified higher education  expenses (AQHEE) $ 300           Since the adjusted qualified higher education expenses ($300) are less than the Coverdell ESA distribution ($1,000), part of the distribution will be taxable. File taxes for 2012 free The balance in Derek's account was $1,800 on December 31, 2013. File taxes for 2012 free Prior to 2013, $2,100 had been contributed to this account. File taxes for 2012 free Contributions for 2013 totaled $400. File taxes for 2012 free Using the four steps outlined earlier, Derek figures the taxable portion of his distribution as shown below. File taxes for 2012 free   1. File taxes for 2012 free $1,000 (distribution) × $2,100 basis + $400 contributions  $1,800 value + $1,000 distribution           =$893 (basis portion of distribution)     2. File taxes for 2012 free $1,000 (distribution)−$893 (basis portion of distribution)     = $107 (earnings included in distribution)   3. File taxes for 2012 free $107 (earnings) × $300 AQHEE  $1,000 distribution       =$32 (tax-free earnings)     4. File taxes for 2012 free $107 (earnings)−$32 (tax-free earnings)=$75 (taxable earnings)                 Derek must include $75 in income (Form 1040, line 21). File taxes for 2012 free This is the amount of distributed earnings not used for adjusted qualified higher education expenses. File taxes for 2012 free Coordination With Qualified Tuition Program (QTP) Distributions If a designated beneficiary receives distributions from both a Coverdell ESA and a QTP in the same year, and the total distribution is more than the beneficiary's adjusted qualified higher education expenses, those expenses must be allocated between the distribution from the Coverdell ESA and the distribution from the QTP before figuring how much of each distribution is taxable. File taxes for 2012 free The following two examples illustrate possible allocations. File taxes for 2012 free Example 1. File taxes for 2012 free In 2013, Beatrice graduated from high school and began her first semester of college. File taxes for 2012 free That year, she had $1,000 of qualified elementary and secondary education expenses (QESEE) for high school and $3,000 of qualified higher education expenses (QHEE) for college. File taxes for 2012 free To pay these expenses, Beatrice withdrew $800 from her Coverdell ESA and $4,200 from her QTP. File taxes for 2012 free No one claimed Beatrice as a dependent, nor was she eligible for an education credit. File taxes for 2012 free She did not receive any tax-free educational assistance in 2013. File taxes for 2012 free Beatrice must allocate her total qualified education expenses between the two distributions. File taxes for 2012 free Beatrice knows that tax-free treatment will be available if she applies her $800 Coverdell ESA distribution toward her $1,000 of qualified education expenses for high school. File taxes for 2012 free The qualified expenses are greater than the distribution, making the $800 Coverdell ESA distribution tax free. File taxes for 2012 free Next, Beatrice matches her $4,200 QTP distribution to her $3,000 of QHEE, and finds she has an excess QTP distribution of $1,200 ($4,200 QTP − $3,000 QHEE). File taxes for 2012 free She cannot use the extra $200 of high school expenses (from (1) above) against the QTP distribution because those expenses do not qualify a QTP for tax-free treatment. File taxes for 2012 free Finally, Beatrice figures the taxable and tax-free portions of her QTP distribution based on her $3,000 of QHEE. File taxes for 2012 free (See Figuring the Taxable Portion of a Distribution in chapter 8, Qualified Tuition Program for more information. File taxes for 2012 free ) Example 2. File taxes for 2012 free Assume the same facts as in Example 1 , except that Beatrice withdrew $1,800 from her Coverdell ESA and $3,200 from her QTP. File taxes for 2012 free In this case, she allocates her qualified education expenses as follows. File taxes for 2012 free Using the same reasoning as in Example 1, Beatrice matches $1,000 of her Coverdell ESA distribution to her $1,000 of QESEE—she has $800 of her distribution remaining. File taxes for 2012 free Because higher education expenses can also qualify a Coverdell ESA distribution for tax-free treatment, Beatrice allocates her $3,000 of QHEE between the remaining $800 Coverdell ESA and the $3,200 QTP distributions ($4,000 total). File taxes for 2012 free   $3,000 QHEE × $800 ESA distribution  $4,000 total distribution = $600 QHEE (ESA)     $3,000 QHEE × $3,200 QTP distribution  $4,000 total distribution = $2,400 QHEE (QTP)   Beatrice then figures the taxable part of her: Coverdell ESA distribution based on qualified education expenses of $1,600 ($1,000 QESEE + $600 QHEE). File taxes for 2012 free See Figuring the Taxable Portion of a Distribution , earlier, in this chapter. File taxes for 2012 free   QTP distribution based on her $2,400 of QHEE (see Figuring the Taxable Portion of a Distribution in chapter 8, Qualified Tuition Program). File taxes for 2012 free The above examples show two types of allocation between distributions from a Coverdell ESA and a QTP. File taxes for 2012 free However, you do not have to allocate your expenses in the same way. File taxes for 2012 free You can use any reasonable method. File taxes for 2012 free Losses on Coverdell ESA Investments If you have a loss on your investment in a Coverdell ESA, you may be able to deduct the loss on your income tax return. File taxes for 2012 free You can deduct the loss only when all amounts from that account have been distributed and the total distributions are less than your unrecovered basis. File taxes for 2012 free Your basis is the total amount of contributions to that Coverdell ESA. File taxes for 2012 free You claim the loss as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23 (Schedule A (Form 1040NR), line 9), subject to the 2%-of-adjusted-gross-income limit. File taxes for 2012 free If you have distributions from more than one Coverdell ESA account during a year, you must combine the information (amount of distribution, basis, etc. File taxes for 2012 free ) from all such accounts in order to determine your taxable earnings for the year. File taxes for 2012 free By doing this, the loss from one ESA account reduces the distributed earnings (if any) from any other ESA account. File taxes for 2012 free For examples of the calculation, see Losses on QTP Investments in chapter 8, Qualified Tuition Program. File taxes for 2012 free Additional Tax on Taxable Distributions Generally, if you receive a taxable distribution, you also must pay a 10% additional tax on the amount included in income. File taxes for 2012 free Exceptions. File taxes for 2012 free   The 10% additional tax does not apply to distributions: Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary. File taxes for 2012 free Made because the designated beneficiary is disabled. File taxes for 2012 free A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. File taxes for 2012 free A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration. File taxes for 2012 free Included in income because the designated beneficiary received: A tax-free scholarship or fellowship (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), or Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. File taxes for 2012 free Made on account of the attendance of the designated beneficiary at a U. File taxes for 2012 free S. File taxes for 2012 free military academy (such as the USMA at West Point). File taxes for 2012 free This exception applies only to the extent that the amount of the distribution does not exceed the costs of advanced education (as defined in section 2005(d)(3) of title 10 of the U. File taxes for 2012 free S. File taxes for 2012 free Code) attributable to such attendance. File taxes for 2012 free Included in income only because the qualified education expenses were taken into account in determining the American opportunity or lifetime learning credit (see Coordination With American Opportunity and Lifetime Learning Credits , earlier). File taxes for 2012 free Made before June 1, 2014, of an excess 2013 contribution (and any earnings on it). File taxes for 2012 free The distributed earnings must be included in gross income for the year in which the excess contribution was made. File taxes for 2012 free Exception (3) applies only to the extent the distribution is not more than the scholarship, allowance, or payment. File taxes for 2012 free Figuring the additional tax. File taxes for 2012 free    Use Part II of Form 5329, to figure any additional tax. File taxes for 2012 free Report the amount on Form 1040, line 58, or Form 1040NR, line 56. File taxes for 2012 free When Assets Must Be Distributed Any assets remaining in a Coverdell ESA must be distributed when either one of the following two events occurs. File taxes for 2012 free The designated beneficiary reaches age 30. File taxes for 2012 free In this case, the remaining assets must be distributed within 30 days after the beneficiary reaches age 30. File taxes for 2012 free However, this rule does not apply if the beneficiary is a special needs beneficiary. File taxes for 2012 free The designated beneficiary dies before reaching age 30. File taxes for 2012 free In this case, the remaining assets must generally be distributed within 30 days after the date of death. File taxes for 2012 free Exception for Transfer to Surviving Spouse or Family Member If a Coverdell ESA is transferred to a surviving spouse or other family member as the result of the death of the designated beneficiary, the Coverdell ESA retains its status. File taxes for 2012 free (“Family member” was defined earlier under Rollovers . File taxes for 2012 free ) This means the spouse or other family member can treat the Coverdell ESA as his or her own and does not need to withdraw the assets until he or she reaches age 30. File taxes for 2012 free This age limitation does not apply if the new beneficiary is a special needs beneficiary. File taxes for 2012 free There are no tax consequences as a result of the transfer. File taxes for 2012 free How To Figure the Taxable Earnings When a total distribution is made because the designated beneficiary either reached age 30 or died, the earnings that accumulated tax free in the account must be included in taxable income. File taxes for 2012 free You determine these earnings as shown in the following two steps. File taxes for 2012 free Multiply the amount distributed by a fraction. File taxes for 2012 free The numerator is the basis (contributions not previously distributed) at the end of 2012 plus total contributions for 2013 and the denominator is the balance in the account at the end of 2013 plus the amount distributed during 2013. File taxes for 2012 free Subtract the amount figured in (1) from the total amount distributed during 2013. File taxes for 2012 free The result is the amount of earnings included in the distribution. File taxes for 2012 free For an example, see steps (1) and (2) of the Example under Figuring the Taxable Portion of a Distribution, earlier. File taxes for 2012 free The beneficiary or other person receiving the distribution must report this amount on Form 1040, line 21, or Form 1040NR, line 21, listing the type and amount of income on the dotted line. File taxes for 2012 free Worksheet 7-3 Instructions. File taxes for 2012 free Coverdell ESA—Taxable Distributions and Basis Line G. File taxes for 2012 free Enter the total distributions received from all Coverdell ESAs during 2013. File taxes for 2012 free Do not include amounts rolled over to another ESA within 60 days (only one rollover is allowed during any 12-month period). File taxes for 2012 free Also, do not include excess contributions that were distributed with the related earnings (or less any loss) before the first day of the sixth month of the tax year following the year for which the contributions were made. File taxes for 2012 free Line 2. File taxes for 2012 free Your basis (amount already taxed) in this Coverdell ESA as of December 31, 2012, is the total of:   •All contributions to this Coverdell ESA before 2013 •Minus the tax-free portion of any distributions from this Coverdell ESA before 2013. File taxes for 2012 free   If your last distribution from this Coverdell ESA was before 2013, you must start with the basis in your account as of the end of the last year in which you took a distribution. File taxes for 2012 free For years before 2002, you can find that amount on the last line of the worksheet in the Instructions for Form 8606, Nondeductible IRAs, that you completed for that year. File taxes for 2012 free For years after 2001, you can find that amount by using the ending basis from the worksheet in Publication 970 for that year. File taxes for 2012 free You can determine your basis in this Coverdell ESA as of December 31, 2012, by adding to the basis as of the end of that year any contributions made to that account after the year of the distribution and before 2013. File taxes for 2012 free Line 4. File taxes for 2012 free Enter the total distributions received from this Coverdell ESA in 2013. File taxes for 2012 free Do not include amounts rolled over to another Coverdell ESA within 60 days (only one rollover is allowed during any 12-month period). File taxes for 2012 free   Also, do not include excess contributions that were distributed with the related earnings (or less any loss) before the first day of the sixth month of the tax year following the year of the contributions. File taxes for 2012 free Line 7. File taxes for 2012 free Enter the total value of this Coverdell ESA as of December 31, 2013, plus any outstanding rollovers contributed to the account after 2012, but before the end of the 60-day rollover period. File taxes for 2012 free A statement should be sent to you by January 31, 2014, for this Coverdell ESA showing the value on December 31, 2013. File taxes for 2012 free   A rollover is a tax-free withdrawal from one Coverdell ESA that is contributed to another Coverdell ESA. File taxes for 2012 free An outstanding rollover is any amount withdrawn within 60 days before the end of 2013 (November 2 through December 31) that was rolled over after December 31, 2013, but within the 60-day rollover period. File taxes for 2012 free Worksheet 7-3. File taxes for 2012 free Coverdell ESA—Taxable Distributions and Basis How to complete this worksheet. File taxes for 2012 free • • • Complete Part I, lines A through H, on only one worksheet. File taxes for 2012 free  Complete a separate Part II, lines 1 through 15, for each of your Coverdell ESAs. File taxes for 2012 free  Complete Part III, the Summary (line 16), on only one worksheet. File taxes for 2012 free Part I. File taxes for 2012 free Qualified Education Expenses (Complete for total expenses)       A. File taxes for 2012 free Enter your total qualified education expenses for 2013   A. File taxes for 2012 free   B. File taxes for 2012 free Enter those qualified education expenses paid for with tax-free educational assistance (for example, tax-free scholarships, veterans' educational benefits, Pell grants, employer-provided educational assistance)   B. File taxes for 2012 free         C. File taxes for 2012 free Enter those qualified higher education expenses deducted on Schedule C or C-EZ (Form 1040). File taxes for 2012 free Schedule F (Form 1040), or as a miscellaneous itemized deduction on Schedule A (Form 1040 or 1040NR)   C. File taxes for 2012 free         D. File taxes for 2012 free Enter those qualified higher education expenses on which  an American opportunity or lifetime learning credit was based   D. File taxes for 2012 free         E. File taxes for 2012 free Add lines B, C, and D   D. File taxes for 2012 free   F. File taxes for 2012 free Subtract line E from line A. File taxes for 2012 free This is your adjusted qualified education expense for 2013   E. File taxes for 2012 free   G. File taxes for 2012 free Enter your total distributions from all Coverdell ESAs during 2013. File taxes for 2012 free Do not include rollovers  or the return of excess contributions (see instructions)   F. File taxes for 2012 free   H. File taxes for 2012 free Divide line F by line G. File taxes for 2012 free Enter the result as a decimal (rounded to at least 3 places). File taxes for 2012 free If the  result is 1. File taxes for 2012 free 000 or more, enter 1. File taxes for 2012 free 000   G. File taxes for 2012 free . File taxes for 2012 free Part II. File taxes for 2012 free Taxable Distributions and Basis (Complete separately for each account) 1. File taxes for 2012 free Enter the amount contributed to this Coverdell ESA for 2013, including contributions made for 2013 from January 1, 2014, through April 15, 2014. File taxes for 2012 free Do not include rollovers or the return of excess contributions   1. File taxes for 2012 free   2. File taxes for 2012 free Enter your basis in this Coverdell ESA as of December 31, 2012 (see instructions)   2. File taxes for 2012 free   3. File taxes for 2012 free Add lines 1 and 2   3. File taxes for 2012 free   4. File taxes for 2012 free Enter the total distributions from this Coverdell ESA during 2013. File taxes for 2012 free Do not include rollovers  or the return of excess contributions (see instructions)   4. File taxes for 2012 free   5. File taxes for 2012 free Multiply line 4 by line H. File taxes for 2012 free This is the amount of adjusted qualified  education expense attributable to this Coverdell ESA   5. File taxes for 2012 free         6. File taxes for 2012 free Subtract line 5 from line 4   6. File taxes for 2012 free         7. File taxes for 2012 free Enter the total value of this Coverdell ESA as of December 31, 2013,  plus any outstanding rollovers (see instructions)   7. File taxes for 2012 free         8. File taxes for 2012 free Add lines 4 and 7   8. File taxes for 2012 free         9. File taxes for 2012 free Divide line 3 by line 8. File taxes for 2012 free Enter the result as a decimal (rounded to  at least 3 places). File taxes for 2012 free If the result is 1. File taxes for 2012 free 000 or more, enter 1. File taxes for 2012 free 000   9. File taxes for 2012 free . File taxes for 2012 free       10. File taxes for 2012 free Multiply line 4 by line 9. File taxes for 2012 free This is the amount of basis allocated to your  distributions, and is tax free   10. File taxes for 2012 free     Note. File taxes for 2012 free If line 6 is zero, skip lines 11 through 13, enter -0- on line 14, and go to line 15. File taxes for 2012 free       11. File taxes for 2012 free Subtract line 10 from line 4   11. File taxes for 2012 free   12. File taxes for 2012 free Divide line 5 by line 4. File taxes for 2012 free Enter the result as a decimal (rounded to  at least 3 places). File taxes for 2012 free If the result is 1. File taxes for 2012 free 000 or more, enter 1. File taxes for 2012 free 000   12. File taxes for 2012 free . File taxes for 2012 free       13. File taxes for 2012 free Multiply line 11 by line 12. File taxes for 2012 free This is the amount of qualified education  expenses allocated to your distributions, and is tax free   13. File taxes for 2012 free   14. File taxes for 2012 free Subtract line 13 from line 11. File taxes for 2012 free This is the portion of the distributions from this  Coverdell ESA in 2013 that you must include in income   14. File taxes for 2012 free   15. File taxes for 2012 free Subtract line 10 from line 3. File taxes for 2012 free This is your basis in this Coverdell ESA as of December 31, 2013   15. File taxes for 2012 free   Part III. File taxes for 2012 free Summary (Complete only once)       16. File taxes for 2012 free Taxable amount. File taxes for 2012 free Add together all amounts on line 14 for all your Coverdell ESAs. File taxes for 2012 free Enter here  and include on Form 1040, line 21, or Form 1040NR, line 21, listing the type and amount of income on the dotted line   16. 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File taxes for 2012 free Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. File taxes for 2012 free 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. File taxes for 2012 free Several assets. File taxes for 2012 free Special situations. File taxes for 2012 free Schedule D (Form 1040). File taxes for 2012 free Form 4797. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free The installment sales method cannot be used for the following. File taxes for 2012 free Sale of inventory. File taxes for 2012 free   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. File taxes for 2012 free See Sale of a Business under Other Rules, later. File taxes for 2012 free Dealer sales. File taxes for 2012 free   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. File taxes for 2012 free This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. File taxes for 2012 free However, the rule does not apply to an installment sale of property used or produced in farming. File taxes for 2012 free Special rule. File taxes for 2012 free   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. File taxes for 2012 free For more information, see section 453(l). File taxes for 2012 free Stock or securities. File taxes for 2012 free   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. File taxes for 2012 free You must report the entire gain on the sale in the year in which the trade date falls. File taxes for 2012 free Installment obligation. File taxes for 2012 free   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. File taxes for 2012 free 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. File taxes for 2012 free See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. File taxes for 2012 free Sale at a loss. File taxes for 2012 free   If your sale results in a loss, you cannot use the installment method. File taxes for 2012 free If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. File taxes for 2012 free Unstated interest. File taxes for 2012 free   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. File taxes for 2012 free See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. File taxes for 2012 free 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. File taxes for 2012 free Each payment on an installment sale usually consists of the following three parts. File taxes for 2012 free Interest income. File taxes for 2012 free Return of your adjusted basis in the property. File taxes for 2012 free Gain on the sale. File taxes for 2012 free 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. File taxes for 2012 free You do not include in income the part that is the return of your basis in the property. File taxes for 2012 free Basis is the amount of your investment in the property for installment sale purposes. File taxes for 2012 free Interest Income You must report interest as ordinary income. File taxes for 2012 free Interest is generally not included in a down payment. File taxes for 2012 free 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. File taxes for 2012 free Interest provided in the agreement is called stated interest. File taxes for 2012 free If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. File taxes for 2012 free See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. File taxes for 2012 free 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. File taxes for 2012 free A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). File taxes for 2012 free Figuring adjusted basis for installment sale purposes. File taxes for 2012 free   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. File taxes for 2012 free 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. File taxes for 2012 free Worksheet A. File taxes for 2012 free Figuring Adjusted Basis and Gross Profit Percentage 1. File taxes for 2012 free Enter the selling price for the property   2. File taxes for 2012 free Enter your adjusted basis for the property     3. File taxes for 2012 free Enter your selling expenses     4. File taxes for 2012 free Enter any depreciation recapture     5. File taxes for 2012 free Add lines 2, 3, and 4. File taxes for 2012 free  This is your adjusted basis for installment sale purposes   6. File taxes for 2012 free Subtract line 5 from line 1. File taxes for 2012 free If zero or less, enter -0-. File taxes for 2012 free  This is your gross profit     If the amount entered on line 6 is zero, stop here. File taxes for 2012 free You cannot use the installment method. File taxes for 2012 free   7. File taxes for 2012 free Enter the contract price for the property   8. File taxes for 2012 free Divide line 6 by line 7. File taxes for 2012 free This is your gross profit percentage   Selling price. File taxes for 2012 free   The selling price is the total cost of the property to the buyer and includes any of the following. File taxes for 2012 free Any money you are to receive. File taxes for 2012 free 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). File taxes for 2012 free 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). File taxes for 2012 free Any of your selling expenses the buyer pays. File taxes for 2012 free   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. File taxes for 2012 free Adjusted basis for installment sale purposes. File taxes for 2012 free   Your adjusted basis is the total of the following three items. File taxes for 2012 free Adjusted basis. File taxes for 2012 free Selling expenses. File taxes for 2012 free Depreciation recapture. File taxes for 2012 free Adjusted basis. File taxes for 2012 free   Basis is your investment in the property for installment sale purposes. File taxes for 2012 free The way you figure basis depends on how you acquire the property. File taxes for 2012 free The basis of property you buy is generally its cost. File taxes for 2012 free The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. File taxes for 2012 free   While you own property, various events may change your original basis. File taxes for 2012 free Some events, such as adding rooms or making permanent improvements, increase basis. File taxes for 2012 free Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. File taxes for 2012 free The result is adjusted basis. File taxes for 2012 free   For more information on how to figure basis and adjusted basis, see Publication 551. File taxes for 2012 free 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. File taxes for 2012 free Selling expenses. File taxes for 2012 free   Selling expenses relate to the sale of the property. File taxes for 2012 free They include commissions, attorney fees, and any other expenses paid on the sale. File taxes for 2012 free Selling expenses are added to the basis of the sold property. File taxes for 2012 free Depreciation recapture. File taxes for 2012 free   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. File taxes for 2012 free See Depreciation Recapture Income under Other Rules, later. File taxes for 2012 free Gross profit. File taxes for 2012 free   Gross profit is the total gain you report on the installment method. File taxes for 2012 free   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. File taxes for 2012 free If the property you sold was your home, subtract from the gross profit any gain you can exclude. File taxes for 2012 free See Sale of Your Home , later, under Reporting Installment Sale Income. File taxes for 2012 free Contract price. File taxes for 2012 free   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. File taxes for 2012 free Gross profit percentage. File taxes for 2012 free   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. File taxes for 2012 free This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. File taxes for 2012 free   The gross profit percentage generally remains the same for each payment you receive. File taxes for 2012 free However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. File taxes for 2012 free Example. File taxes for 2012 free You sell property at a contract price of $6,000 and your gross profit is $1,500. File taxes for 2012 free Your gross profit percentage is 25% ($1,500 ÷ $6,000). File taxes for 2012 free 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. File taxes for 2012 free The remainder (balance) of each payment is the tax-free return of your adjusted basis. File taxes for 2012 free Amount to report as installment sale income. File taxes for 2012 free   Multiply the payments you receive each year (less interest) by the gross profit percentage. File taxes for 2012 free The result is your installment sale income for the tax year. File taxes for 2012 free In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. File taxes for 2012 free A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. File taxes for 2012 free For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. File taxes for 2012 free Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. File taxes for 2012 free You then must refigure the gross profit percentage for the remaining payments. File taxes for 2012 free Refigure your gross profit using Worksheet B. File taxes for 2012 free You will spread any remaining gain over future installments. File taxes for 2012 free Worksheet B. File taxes for 2012 free New Gross Profit Percentage — Selling Price Reduced 1. File taxes for 2012 free Enter the reduced selling  price for the property   2. File taxes for 2012 free Enter your adjusted  basis for the  property     3. File taxes for 2012 free Enter your selling  expenses     4. File taxes for 2012 free Enter any depreciation  recapture     5. File taxes for 2012 free Add lines 2, 3, and 4. File taxes for 2012 free   6. File taxes for 2012 free Subtract line 5 from line 1. File taxes for 2012 free  This is your adjusted  gross profit   7. File taxes for 2012 free Enter any installment sale  income reported in  prior year(s)   8. File taxes for 2012 free Subtract line 7 from line 6   9. File taxes for 2012 free Future installments   10. File taxes for 2012 free Divide line 8 by line 9. File taxes for 2012 free  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. File taxes for 2012 free Example. File taxes for 2012 free In 2011, you sold land with a basis of $40,000 for $100,000. File taxes for 2012 free Your gross profit was $60,000. File taxes for 2012 free You received a $20,000 down payment and the buyer's note for $80,000. File taxes for 2012 free The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. File taxes for 2012 free Your gross profit percentage is 60%. File taxes for 2012 free You reported a gain of $12,000 on each payment received in 2011 and 2012. File taxes for 2012 free 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. File taxes for 2012 free The new gross profit percentage, 46. File taxes for 2012 free 67%, is figured on Example—Worksheet B. File taxes for 2012 free You will report a gain of $7,000 (46. File taxes for 2012 free 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. File taxes for 2012 free Example — Worksheet B. File taxes for 2012 free New Gross Profit Percentage — Selling Price Reduced 1. File taxes for 2012 free Enter the reduced selling  price for the property 85,000 2. File taxes for 2012 free Enter your adjusted  basis for the  property 40,000   3. File taxes for 2012 free Enter your selling  expenses -0-   4. File taxes for 2012 free Enter any depreciation  recapture -0-   5. File taxes for 2012 free Add lines 2, 3, and 4. File taxes for 2012 free 40,000 6. File taxes for 2012 free Subtract line 5 from line 1. File taxes for 2012 free  This is your adjusted  gross profit 45,000 7. File taxes for 2012 free Enter any installment sale  income reported in  prior year(s) 24,000 8. File taxes for 2012 free Subtract line 7 from line 6 21,000 9. File taxes for 2012 free Future installments 45,000 10. File taxes for 2012 free Divide line 8 by line 9. File taxes for 2012 free  This is your new gross profit percentage* 46. File taxes for 2012 free 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. File taxes for 2012 free 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. File taxes for 2012 free You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. File taxes for 2012 free See Schedule D (Form 1040) and Form 4797 , later. File taxes for 2012 free If the property was your main home, you may be able to exclude part or all of the gain. File taxes for 2012 free See Sale of Your Home , later. File taxes for 2012 free 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. File taxes for 2012 free Attach it to your tax return for each year. File taxes for 2012 free Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. File taxes for 2012 free Which parts to complete. File taxes for 2012 free   Which part to complete depends on whether you are filing the form for the year of sale or a later year. File taxes for 2012 free Year of sale. File taxes for 2012 free   Complete lines 1 through 4, Part I, and Part II. File taxes for 2012 free If you sold property to a related party during the year, also complete Part III. File taxes for 2012 free Later years. File taxes for 2012 free   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. File taxes for 2012 free   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. File taxes for 2012 free (After December 31, 1986, the installment method is not available for the sale of marketable securities. File taxes for 2012 free ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. File taxes for 2012 free Complete Part III unless you received the final payment during the tax year. File taxes for 2012 free   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. File taxes for 2012 free 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. File taxes for 2012 free Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. File taxes for 2012 free 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). File taxes for 2012 free 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. File taxes for 2012 free Your gain is long-term if you owned the property for more than 1 year when you sold it. File taxes for 2012 free 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. File taxes for 2012 free All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. File taxes for 2012 free See Publication 523 for information about excluding the gain. File taxes for 2012 free If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. File taxes for 2012 free Seller-financed mortgage. File taxes for 2012 free   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. File taxes for 2012 free   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. File taxes for 2012 free   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. File taxes for 2012 free   If either person fails to include the other person's SSN, a $50 penalty will be assessed. File taxes for 2012 free Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. File taxes for 2012 free The following topics are discussed. File taxes for 2012 free Electing out of the installment method. File taxes for 2012 free Payments received or considered received. File taxes for 2012 free Escrow account. File taxes for 2012 free Depreciation recapture income. File taxes for 2012 free Sale to a related person. File taxes for 2012 free Like-kind exchange. File taxes for 2012 free Contingent payment sale. File taxes for 2012 free Single sale of several assets. File taxes for 2012 free Sale of a business. File taxes for 2012 free Unstated interest and original issue discount. File taxes for 2012 free Disposition of an installment obligation. File taxes for 2012 free Repossession. File taxes for 2012 free Interest on deferred tax. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free Notes, mortgages, and land contracts are examples of obligations that are included at FMV. File taxes for 2012 free You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. File taxes for 2012 free 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). File taxes for 2012 free Example. File taxes for 2012 free You sold a parcel of land for $50,000. File taxes for 2012 free 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. File taxes for 2012 free The buyer gave you a note for $40,000. File taxes for 2012 free The note had an FMV of $40,000. File taxes for 2012 free You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. File taxes for 2012 free The land cost $25,000, and you owned it for more than one year. File taxes for 2012 free You decide to elect out of the installment method and report the entire gain in the year of sale. File taxes for 2012 free Gain realized:     Selling price $50,000 Minus: Property's adj. File taxes for 2012 free 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. File taxes for 2012 free basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. File taxes for 2012 free 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. File taxes for 2012 free The interest on the note is ordinary income and is reported as interest income each year. File taxes for 2012 free How to elect out. File taxes for 2012 free   To make this election, do not report your sale on Form 6252. File taxes for 2012 free Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. File taxes for 2012 free When to elect out. File taxes for 2012 free   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. File taxes for 2012 free Automatic six-month extension. File taxes for 2012 free   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). File taxes for 2012 free Write “Filed pursuant to section 301. File taxes for 2012 free 9100-2” at the top of the amended return and file it where the original return was filed. File taxes for 2012 free Revoking the election. File taxes for 2012 free   Once made, the election can be revoked only with IRS approval. File taxes for 2012 free A revocation is retroactive. File taxes for 2012 free You will not be allowed to revoke the election if either of the following applies. File taxes for 2012 free One of the purposes is to avoid federal income tax. File taxes for 2012 free The tax year in which any payment was received has closed. File taxes for 2012 free 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. File taxes for 2012 free In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free Include these expenses in the selling and contract prices when figuring the gross profit percentage. File taxes for 2012 free 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. File taxes for 2012 free Mortgage not more than basis. File taxes for 2012 free   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. File taxes for 2012 free It is considered a recovery of your basis. File taxes for 2012 free The contract price is the selling price minus the mortgage. File taxes for 2012 free Example. File taxes for 2012 free You sell property with an adjusted basis of $19,000. File taxes for 2012 free You have selling expenses of $1,000. File taxes for 2012 free 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). File taxes for 2012 free The selling price is $25,000 ($15,000 + $10,000). File taxes for 2012 free Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). File taxes for 2012 free The contract price is $10,000 ($25,000 − $15,000 mortgage). File taxes for 2012 free Your gross profit percentage is 50% ($5,000 ÷ $10,000). File taxes for 2012 free You report half of each $2,000 payment received as gain from the sale. File taxes for 2012 free You also report all interest you receive as ordinary income. File taxes for 2012 free Mortgage more than basis. File taxes for 2012 free   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. File taxes for 2012 free The part of the mortgage greater than your basis is treated as a payment received in the year of sale. File taxes for 2012 free   To figure the contract price, subtract the mortgage from the selling price. File taxes for 2012 free This is the total amount (other than interest) you will receive directly from the buyer. File taxes for 2012 free Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). File taxes for 2012 free The contract price is then the same as your gross profit from the sale. File taxes for 2012 free    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. File taxes for 2012 free Example. File taxes for 2012 free The selling price for your property is $9,000. File taxes for 2012 free The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. File taxes for 2012 free Your adjusted basis in the property is $4,400. File taxes for 2012 free You have selling expenses of $600, for a total installment sale basis of $5,000. File taxes for 2012 free The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). File taxes for 2012 free This amount is included in the contract price and treated as a payment received in the year of sale. File taxes for 2012 free 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%. File taxes for 2012 free Report 100% of each payment (less interest) as gain from the sale. File taxes for 2012 free 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. File taxes for 2012 free Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. File taxes for 2012 free You are considered to receive a payment equal to the outstanding canceled debt. File taxes for 2012 free Example. File taxes for 2012 free Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. File taxes for 2012 free On April 4, 2013, she bought the land for $70,000. File taxes for 2012 free At that time, $30,000 of her loan to you was outstanding. File taxes for 2012 free 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. File taxes for 2012 free She did not assume an existing mortgage. File taxes for 2012 free She canceled the $30,000 debt you owed her. File taxes for 2012 free You are considered to have received a $30,000 payment at the time of the sale. File taxes for 2012 free 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. File taxes for 2012 free If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. File taxes for 2012 free Compare the debt to your installment sale basis in the property being sold. File taxes for 2012 free If the debt is less than your installment sale basis, none of it is treated as a payment. File taxes for 2012 free If it is more, only the difference is treated as a payment. File taxes for 2012 free 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. File taxes for 2012 free These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . File taxes for 2012 free However, they apply only to the following types of debt the buyer assumes. File taxes for 2012 free Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. File taxes for 2012 free Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. File taxes for 2012 free 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. File taxes for 2012 free The value of the assumed debt is then considered a payment to you in the year of sale. File taxes for 2012 free 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. File taxes for 2012 free However, see Like-Kind Exchange , later. File taxes for 2012 free Generally, the amount of the payment is the property's FMV on the date you receive it. File taxes for 2012 free Exception. File taxes for 2012 free   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. File taxes for 2012 free See Unstated Interest and Original Issue Discount (OID) , later. File taxes for 2012 free Debt not payable on demand. File taxes for 2012 free   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. File taxes for 2012 free This is true even if the debt is guaranteed by a third party, including a government agency. File taxes for 2012 free Fair market value (FMV). File taxes for 2012 free   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. File taxes for 2012 free Third-party note. File taxes for 2012 free   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. File taxes for 2012 free 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. File taxes for 2012 free The excess of the note's face value over its FMV is interest. File taxes for 2012 free Exclude this interest in determining the selling price of the property. File taxes for 2012 free However, see Exception under Property Used As a Payment, earlier. File taxes for 2012 free Example. File taxes for 2012 free You sold real estate in an installment sale. File taxes for 2012 free As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. File taxes for 2012 free The FMV of the third-party note at the time of the sale was $30,000. File taxes for 2012 free This amount, not $50,000, is a payment to you in the year of sale. File taxes for 2012 free 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. File taxes for 2012 free The remaining 40% is interest taxed as ordinary income. File taxes for 2012 free Bond. File taxes for 2012 free   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. File taxes for 2012 free For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. File taxes for 2012 free    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. File taxes for 2012 free However, see Exception under Property Used As a Payment, earlier. File taxes for 2012 free Buyer's note. File taxes for 2012 free   The buyer's note (unless payable on demand) is not considered payment on the sale. File taxes for 2012 free However, its full face value is included when figuring the selling price and the contract price. File taxes for 2012 free Payments you receive on the note are used to figure your gain in the year received. File taxes for 2012 free 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. File taxes for 2012 free This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. File taxes for 2012 free It does not apply to the following dispositions. File taxes for 2012 free Sales of property used or produced in farming. File taxes for 2012 free Sales of personal-use property. File taxes for 2012 free Qualifying sales of time-shares and residential lots. File taxes for 2012 free The net debt proceeds are the gross debt minus the direct expenses of getting the debt. File taxes for 2012 free The amount treated as a payment is considered received on the later of the following dates. File taxes for 2012 free The date the debt becomes secured. File taxes for 2012 free The date you receive the debt proceeds. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free Limit. File taxes for 2012 free   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. File taxes for 2012 free The total contract price on the installment sale. File taxes for 2012 free Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. File taxes for 2012 free Installment payments. File taxes for 2012 free   The pledge rule accelerates the reporting of the installment obligation payments. File taxes for 2012 free 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. File taxes for 2012 free Exception. File taxes for 2012 free   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. File taxes for 2012 free The debt was outstanding on December 17, 1987. File taxes for 2012 free The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. File taxes for 2012 free   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. File taxes for 2012 free   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. File taxes for 2012 free Any excess is treated as a payment on the installment obligation. File taxes for 2012 free 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. File taxes for 2012 free These sales cannot be reported on the installment method. File taxes for 2012 free The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. File taxes for 2012 free When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. File taxes for 2012 free Example. File taxes for 2012 free You sell property for $100,000. File taxes for 2012 free 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. File taxes for 2012 free You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. File taxes for 2012 free You report the entire gain in the year of sale. File taxes for 2012 free Escrow established in a later year. File taxes for 2012 free   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. File taxes for 2012 free Substantial restriction. File taxes for 2012 free   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. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. File taxes for 2012 free Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. File taxes for 2012 free The recapture income is also included in Part I of Form 6252. File taxes for 2012 free However, the gain equal to the recapture income is reported in full in the year of the sale. File taxes for 2012 free Only the gain greater than the recapture income is reported on the installment method. File taxes for 2012 free For more information on depreciation recapture, see chapter 3 in Publication 544. File taxes for 2012 free 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. File taxes for 2012 free Determining gross profit is discussed under General Rules , earlier. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. File taxes for 2012 free Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. File taxes for 2012 free Instead, all payments to be received are considered received in the year of sale. File taxes for 2012 free However, see Exception , below. File taxes for 2012 free Depreciable property for this rule is any property the purchaser can depreciate. File taxes for 2012 free Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. File taxes for 2012 free In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. File taxes for 2012 free The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. File taxes for 2012 free Exception. File taxes for 2012 free   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. File taxes for 2012 free 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. File taxes for 2012 free Related person. File taxes for 2012 free   Related persons include the following. File taxes for 2012 free A person and all controlled entities with respect to that person. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. File taxes for 2012 free   For information about which entities are controlled entities, see section 1239(c). File taxes for 2012 free 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. File taxes for 2012 free The related person makes the second disposition before making all payments on the first disposition. File taxes for 2012 free The related person disposes of the property within 2 years of the first disposition. File taxes for 2012 free This rule does not apply if the property involved is marketable securities. File taxes for 2012 free 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. File taxes for 2012 free See Exception , later. File taxes for 2012 free Related person. File taxes for 2012 free   Related persons include the following. File taxes for 2012 free Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. File taxes for 2012 free A partnership or estate and a partner or beneficiary. File taxes for 2012 free A trust (other than a section 401(a) employees trust) and a beneficiary. File taxes for 2012 free A trust and an owner of the trust. File taxes for 2012 free Two corporations that are members of the same controlled group as defined in section 267(f). File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. File taxes for 2012 free Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. File taxes for 2012 free Example 1. File taxes for 2012 free 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. File taxes for 2012 free His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. File taxes for 2012 free His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). File taxes for 2012 free He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. File taxes for 2012 free 50). File taxes for 2012 free Bob made no improvements to the property and sold it to Alfalfa Inc. File taxes for 2012 free , in 2013 for $600,000 after making the payment for that year. File taxes for 2012 free The amount realized from the second disposition is $600,000. File taxes for 2012 free 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 % × . File taxes for 2012 free 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). File taxes for 2012 free Example 2. File taxes for 2012 free Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. File taxes for 2012 free 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 % × . File taxes for 2012 free 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. File taxes for 2012 free 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. File taxes for 2012 free In 2016, he receives the final $100,000 payment. File taxes for 2012 free 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 % × . File taxes for 2012 free 50 Installment sale income for 2016 $ 50,000 Exception. File taxes for 2012 free   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. File taxes for 2012 free 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. File taxes for 2012 free   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. File taxes for 2012 free However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. File taxes for 2012 free   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. File taxes for 2012 free An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free These trades are known as like-kind exchanges. File taxes for 2012 free The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. File taxes for 2012 free You do not have to report any part of your gain if you receive only like-kind property. File taxes for 2012 free 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. File taxes for 2012 free For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. File taxes for 2012 free Installment payments. File taxes for 2012 free   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. File taxes for 2012 free The contract price is reduced by the FMV of the like-kind property received in the trade. File taxes for 2012 free The gross profit is reduced by any gain on the trade that can be postponed. File taxes for 2012 free Like-kind property received in the trade is not considered payment on the installment obligation. File taxes for 2012 free Example. File taxes for 2012 free 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. File taxes for 2012 free He also receives an installment note for $800,000 in the trade. File taxes for 2012 free 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. File taxes for 2012 free George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). File taxes for 2012 free His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). File taxes for 2012 free The contract price is $800,000 ($1,000,000 − $200,000). File taxes for 2012 free The gross profit percentage is 75% ($600,000 ÷ $800,000). File taxes for 2012 free He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. File taxes for 2012 free 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). File taxes for 2012 free Deferred exchanges. File taxes for 2012 free   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. File taxes for 2012 free Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. File taxes for 2012 free 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. File taxes for 2012 free See Regulations section 1. File taxes for 2012 free 1031(k)-1(j)(2) for these rules. File taxes for 2012 free 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. File taxes for 2012 free This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. File taxes for 2012 free 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. File taxes for 2012 free For rules on using the installment method for a contingent payment sale, see Regulations section 15a. File taxes for 2012 free 453-1(c). File taxes for 2012 free 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. File taxes for 2012 free You also have to allocate part of the selling price to each asset. File taxes for 2012 free If you sell assets that constitute a trade or business, see Sale of a Business , later. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free This becomes the net FMV. File taxes for 2012 free A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. File taxes for 2012 free However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. File taxes for 2012 free It must be reported separately. File taxes for 2012 free The remaining assets sold at a gain are reported together. File taxes for 2012 free Example. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free Your installment sale basis for each parcel was $15,000. File taxes for 2012 free Your net gain was $85,000 ($130,000 − $45,000). File taxes for 2012 free You report the gain on the installment method. File taxes for 2012 free The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. File taxes for 2012 free The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. File taxes for 2012 free The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. File taxes for 2012 free You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. File taxes for 2012 free Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. File taxes for 2012 free However, if parcel C was held for personal use, the loss is not deductible. File taxes for 2012 free 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). File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free Assets sold at a loss. File taxes for 2012 free Real and personal property eligible for the installment method. File taxes for 2012 free Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. File taxes for 2012 free Inventory. File taxes for 2012 free   The sale of inventories of personal property cannot be reported on the installment method. File taxes for 2012 free All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. File taxes for 2012 free   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. File taxes for 2012 free If you do not, each payment must be allocated between the inventory and the other assets sold. File taxes for 2012 free   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. File taxes for 2012 free Use your basis in the inventory to figure the cost of goods sold. File taxes for 2012 free Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. File taxes for 2012 free Residual method. File taxes for 2012 free   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. File taxes for 2012 free This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. File taxes for 2012 free   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. File taxes for 2012 free 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). File taxes for 2012 free   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. File taxes for 2012 free   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). File taxes for 2012 free The consideration remaining after this reduction must be allocated among the various business assets in a certain order. File taxes for 2012 free   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. File taxes for 2012 free Certificates of deposit, U. File taxes for 2012 free S. File taxes for 2012 free Government securities, foreign currency, and actively traded personal property, including stock and securities. File taxes for 2012 free Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. File taxes for 2012 free However, see Regulations section 1. File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free All other assets except section 197 intangibles. File taxes for 2012 free Section 197 intangibles except goodwill and going concern value. File taxes for 2012 free Goodwill and going concern value (whether or not they qualify as section 197 intangibles). File taxes for 2012 free   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. File taxes for 2012 free For example, if an asset is described in both (4) and (6), include it in (4). File taxes for 2012 free Agreement. File taxes for 2012 free   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. File taxes for 2012 free This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. File taxes for 2012 free Reporting requirement. File taxes for 2012 free   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. File taxes for 2012 free Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. File taxes for 2012 free The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. File taxes for 2012 free 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. File taxes for 2012 free The sale of a partnership interest is treated as the sale of a single capital asset. File taxes for 2012 free The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. File taxes for 2012 free (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. File taxes for 2012 free ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. File taxes for 2012 free The gain allocated to the other assets can be reported under the installment method. File taxes for 2012 free For more information on the treatment of unrealized receivables and inventory, see Publication 541. File taxes for 2012 free Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. File taxes for 2012 free You received a $100,000 down payment and the buyer's note for $120,000. File taxes for 2012 free The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. File taxes for 2012 free The total selling price is $220,000. File taxes for 2012 free Your selling expenses are $11,000. File taxes for 2012 free The selling expenses are divided among all the assets sold, including inventory. File taxes for 2012 free Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). File taxes for 2012 free The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. File taxes for 2012 free 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). File taxes for 2012 free The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. File taxes for 2012 free 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. File taxes for 2012 free   Sale  Price Sale   Exp. File taxes for 2012 free Adj. File taxes for 2012 free   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. File taxes for 2012 free A 71,000 3,550 63,800 3,650 Mch. File taxes for 2012 free 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. File taxes for 2012 free There is no depreciation recapture income because the building was depreciated using the straight line method. File taxes for 2012 free 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. File taxes for 2012 free Figure depreciation recapture in Part III of Form 4797. File taxes for 2012 free The total depreciation recapture income reported in Part II of Form 4797 is $5,209. File taxes for 2012 free 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). File taxes for 2012 free These gains are reported in full in the year of sale and are not included in the installment sale computation. File taxes for 2012 free Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. File taxes for 2012 free 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. File taxes for 2012 free The selling price equals the contract price for the installment sale ($108,500). File taxes for 2012 free The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. File taxes for 2012 free   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). File taxes for 2012 free The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. File taxes for 2012 free 95 Building— $9,600 ÷ $108,500 8. File taxes for 2012 free 85 Goodwill— $17,575 ÷ $108,500 16. File taxes for 2012 free 20 Total 48. File taxes for 2012 free 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. File taxes for 2012 free The selling price for the installment sale is $108,500. File taxes for 2012 free This is 49. File taxes for 2012 free 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). File taxes for 2012 free The selling price of assets not reported on the installment method is $111,500. File taxes for 2012 free This is 50. File taxes for 2012 free 7% ($111,500 ÷ $220,000) of the total selling price. File taxes for 2012 free Multiply principal payments by 49. File taxes for 2012 free 3% to determine the part of the payment for the installment sale. File taxes for 2012 free The balance, 50. File taxes for 2012 free 7%, is for the part reported in the year of the sale. File taxes for 2012 free The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. File taxes for 2012 free When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. File taxes for 2012 free Only the part for the installment sale (49. File taxes for 2012 free 3%) is used in the installment sale computation. File taxes for 2012 free The only payment received in 2013 is the down payment of $100,000. File taxes for 2012 free The part of the payment for the installment sale is $49,300 ($100,000 × 49. File taxes for 2012 free 3%). File taxes for 2012 free This amount is used in the installment sale computation. File taxes for 2012 free Installment income for 2013. File taxes for 2012 free   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. File taxes for 2012 free Income Land—22. File taxes for 2012 free 95% of $49,300 $11,314 Building—8. File taxes for 2012 free 85% of $49,300 4,363 Goodwill—16. File taxes for 2012 free 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. File taxes for 2012 free   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. File taxes for 2012 free 3% of the total payments you receive on the buyer's note during the year. File taxes for 2012 free 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. File taxes for 2012 free Interest provided in the contract is called stated interest. File taxes for 2012 free 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. File taxes for 2012 free If section 483 applies to the contract, this interest is called unstated interest. File taxes for 2012 free If section 1274 applies to the contract, this interest is called original issue discount (OID). File taxes for 2012 free An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). File taxes for 2012 free Treatment of unstated interest and OID. File taxes for 2012 free   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. File taxes for 2012 free As a result, the buyer cannot deduct the unstated interest. File taxes for 2012 free The seller must report the unstated interest as income. File taxes for 2012 free   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. File taxes for 2012 free   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. File taxes for 2012 free Rules for the seller. File taxes for 2012 free   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. File taxes for 2012 free If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. File taxes for 2012 free   Include the unstated interest in income based on your regular method of accounting. File taxes for 2012 free Include OID in income over the term of the contract. File taxes for 2012 free   The OID includible in income each year is based on the constant yield method described in section 1272. File taxes for 2012 free (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. File taxes for 2012 free )   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. File taxes for 2012 free Reduce the selling price by any stated principal treated as interest to determine the gain. File taxes for 2012 free   Report unstated interest or OID on your tax return, in addition to stated interest. File taxes for 2012 free Rules for the buyer. File taxes for 2012 free   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. File taxes for 2012 free These rules do not apply to personal-use property (for example, property not used in a trade or business). File taxes for 2012 free Adequate stated interest. File taxes for 2012 free   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. File taxes for 2012 free The present value of a payment is determined based on the test rate of interest, defined next. File taxes for 2012 free (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. File taxes for 2012 free ) 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. File taxes for 2012 free Test rate of interest. File taxes for 2012 free   The test rate of interest for a contract is the 3-month rate. File taxes for 2012 free The 3-month rate is the lower of the following applicable federal rates (AFRs). File taxes for 2012 free 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. File taxes for 2012 free 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. File taxes for 2012 free Applicable federal rate (AFR). File taxes for 2012 free   The AFR depends on the month the binding