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Free tax returns 6. Free tax returns   Dual-Status Tax Year Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Tax Year Income Subject to Tax Restrictions for Dual-Status Taxpayers Exemptions How To Figure TaxIncome Tax Credits and Payments Forms To File When and Where To File Introduction You have a dual-status tax year when you have been both a resident alien and a nonresident alien in the same year. Free tax returns Dual status does not refer to your citizenship; it refers only to your resident status in the United States. Free tax returns In determining your U. Free tax returns S. Free tax returns income tax liability for a dual-status tax year, different rules apply for the part of the year you are a resident of the United States and the part of the year you are a nonresident. Free tax returns The most common dual-status tax years are the years of arrival and departure. Free tax returns See Dual-Status Aliens in chapter 1. Free tax returns If you are married and choose to be treated as a U. Free tax returns S. Free tax returns resident for the entire year, as explained in chapter 1, the rules of this chapter do not apply to you for that year. Free tax returns Topics - This chapter discusses: Income subject to tax, Restrictions for dual-status taxpayers, Exemptions, How to figure the tax, Forms to file, When and where to file, and How to fill out a dual-status return. Free tax returns Useful Items - You may want to see: Publication 503 Child and Dependent Care Expenses 514 Foreign Tax Credit for Individuals 575 Pension and Annuity Income Form (and Instructions) 1040 U. Free tax returns S. Free tax returns Individual Income Tax Return 1040-C U. Free tax returns S. Free tax returns Departing Alien Income Tax Return 1040-ES Estimated Tax for Individuals 1040-ES (NR) U. Free tax returns S. Free tax returns Estimated Tax for Nonresident Alien Individuals 1040NR U. Free tax returns S. Free tax returns Nonresident Alien Income Tax Return 1116 Foreign Tax Credit See chapter 12 for information about getting these publications and forms. Free tax returns Tax Year You must file your tax return on the basis of an annual accounting period called a tax year. Free tax returns If you have not previously established a fiscal tax year, your tax year is the calendar year. Free tax returns A calendar year is 12 consecutive months ending on December 31. Free tax returns If you have previously established a regular fiscal year (12 consecutive months ending on the last day of a month other than December, or a 52–53 week year) and are considered to be a U. Free tax returns S. Free tax returns resident for any calendar year, you will be treated as a U. Free tax returns S. Free tax returns resident for any part of your fiscal year that falls within that calendar year. Free tax returns Income Subject to Tax For the part of the year you are a resident alien, you are taxed on income from all sources. Free tax returns Income from sources outside the United States is taxable if you receive it while you are a resident alien. Free tax returns The income is taxable even if you earned it while you were a nonresident alien or if you became a nonresident alien after receiving it and before the end of the year. Free tax returns For the part of the year you are a nonresident alien, you are taxed on income from U. Free tax returns S. Free tax returns sources and on certain foreign source income treated as effectively connected with a U. Free tax returns S. Free tax returns trade or business. Free tax returns (The rules for treating foreign source income as effectively connected are discussed in chapter 4 under Foreign Income. Free tax returns ) Income from sources outside the United States that is not effectively connected with a trade or business in the United States is not taxable if you receive it while you are a nonresident alien. Free tax returns The income is not taxable even if you earned it while you were a resident alien or if you became a resident alien or a U. Free tax returns S. Free tax returns citizen after receiving it and before the end of the year. Free tax returns Income from U. Free tax returns S. Free tax returns sources is taxable whether you receive it while a nonresident alien or a resident alien unless specifically exempt under the Internal Revenue Code or a tax treaty provision. Free tax returns Generally, tax treaty provisions apply only to the part of the year you were a nonresident. Free tax returns In certain cases, however, treaty provisions may apply while you were a resident alien. Free tax returns See chapter 9 for more information. Free tax returns When determining what income is taxed in the United States, you must consider exemptions under U. Free tax returns S. Free tax returns tax law as well as the reduced tax rates and exemptions provided by tax treaties between the United States and certain foreign countries. Free tax returns For a further discussion of tax treaties, see chapter 9. Free tax returns Restrictions for Dual-Status Taxpayers The following restrictions apply if you are filing a tax return for a dual-status tax year. Free tax returns 1) Standard deduction. Free tax returns   You cannot use the standard deduction allowed on Form 1040. Free tax returns However, you can itemize any allowable deductions. Free tax returns 2) Exemptions. Free tax returns   Your total deduction for the exemptions for your spouse and allowable dependents cannot be more than your taxable income (figured without deducting personal exemptions) for the period you are a resident alien. Free tax returns 3) Head of household. Free tax returns   You cannot use the head of household Tax Table column or Tax Computation Worksheet. Free tax returns 4) Joint return. Free tax returns   You cannot file a joint return. Free tax returns However, see Choosing Resident Alien Status under Dual-Status Aliens in chapter 1. Free tax returns 5) Tax rates. Free tax returns   If you are married and a nonresident of the United States for all or part of the tax year and you do not choose to file jointly as discussed in chapter 1, you must use the Tax Table column or Tax Computation Worksheet for married filing separately to figure your tax on income effectively connected with a U. Free tax returns S. Free tax returns trade or business. Free tax returns You cannot use the Tax Table column or Tax Computation Worksheet for married filing jointly or single. Free tax returns However, you may be able to file as single if you lived apart from your spouse during the last 6 months of the year and you are a: Married resident of Canada, Mexico, or South Korea, or Married U. Free tax returns S. Free tax returns national. Free tax returns  See the instructions for Form 1040NR to see if you qualify. Free tax returns    A U. Free tax returns S. Free tax returns national is an individual who, although not a U. Free tax returns S. Free tax returns citizen, owes his or her allegiance to the United States. Free tax returns U. Free tax returns S. Free tax returns nationals include American Samoans and Northern Mariana Islanders who chose to become U. Free tax returns S. Free tax returns nationals instead of U. Free tax returns S. Free tax returns citizens. Free tax returns 6) Tax credits. Free tax returns   You cannot claim the education credits, the earned income credit, or the credit for the elderly or the disabled unless: You are married, and You choose to be treated as a resident for all of 2013 by filing a joint return with your spouse who is a U. Free tax returns S. Free tax returns citizen or resident, as discussed in chapter 1. Free tax returns Exemptions As a dual-status taxpayer, you usually will be able to claim your own personal exemption. Free tax returns Subject to the general rules for qualification, you can claim exemptions for your spouse and dependents when you figure taxable income for the part of the year you are a resident alien. Free tax returns The amount you can claim for these exemptions is limited to your taxable income (figured before subtracting exemptions) for the part of the year you are a resident alien. Free tax returns You cannot use exemptions (other than your own) to reduce taxable income to less than zero for that period. Free tax returns Special rules apply to exemptions for the part of the tax year you are a nonresident alien if you are a: Resident of Canada, Mexico, or South Korea, U. Free tax returns S. Free tax returns national, or Student or business apprentice from India. Free tax returns For more information, see Exemptions in chapter 5. Free tax returns How To Figure Tax When you figure your U. Free tax returns S. Free tax returns tax for a dual-status year, you are subject to different rules for the part of the year you are a resident and the part of the year you are a nonresident. Free tax returns Income All income for your period of residence and all income that is effectively connected with a trade or business in the United States for your period of nonresidence, after allowable deductions, is added and taxed at the rates that apply to U. Free tax returns S. Free tax returns citizens and residents. Free tax returns Income that is not connected with a trade or business in the United States for your period of nonresidence is subject to the flat 30% rate or lower treaty rate. Free tax returns You cannot take any deductions against this income. Free tax returns Social security and railroad retirement benefits. Free tax returns   During the part of the year you are a nonresident alien, 85% of any U. Free tax returns S. Free tax returns social security benefits (and the equivalent portion of tier 1 railroad retirement benefits) you receive is subject to the flat 30% tax, unless exempt, or subject to a lower treaty rate. Free tax returns (See The 30% Tax in chapter 4. Free tax returns )   During the part of the year you are a resident alien, part of the social security and the equivalent portion of tier 1 railroad retirement benefits will be taxed at graduated rates if your modified adjusted gross income plus half of these benefits is more than a certain base amount. Free tax returns Use the Social Security Benefits Worksheet in the Form 1040 instructions to help you figure the taxable part of your social security and equivalent tier 1 railroad retirement benefits for the part of the year you were a resident alien. Free tax returns If you received U. Free tax returns S. Free tax returns social security benefits while you were a nonresident alien, the Social Security Administration will send you Form SSA-1042S showing your combined benefits for the entire year and the amount of tax withheld. Free tax returns You will not receive separate statements for the benefits received during your periods of U. Free tax returns S. Free tax returns residence and nonresidence. Free tax returns Therefore, it is important for you to keep careful records of these amounts. Free tax returns You will need this information to properly complete your return and determine your tax liability. Free tax returns If you received railroad retirement benefits while you were a nonresident alien, the U. Free tax returns S. Free tax returns Railroad Retirement Board (RRB) will send you Form RRB-1042S, Statement for Nonresident Alien Recipients of Payments by the Railroad Retirement Board, and/or Form RRB-1099-R, Annuities or Pensions by the Railroad Retirement Board. Free tax returns If your country of legal residence changed or your rate of tax changed during the tax year, you may receive more than one form. Free tax returns Tax Credits and Payments This discussion covers tax credits and payments for dual-status aliens. Free tax returns Credits As a dual-status alien, you generally can claim tax credits using the same rules that apply to resident aliens. Free tax returns There are certain restrictions that may apply. Free tax returns These restrictions are discussed here, along with a brief explanation of credits often claimed by individuals. Free tax returns Foreign tax credit. Free tax returns   If you have paid or are liable for the payment of income tax to a foreign country on income from foreign sources, you may be able to claim a credit for the foreign taxes. Free tax returns   If you claim the foreign tax credit, you generally must file Form 1116 with your income tax return. Free tax returns For more information, see the Instructions for Form 1116 and Publication 514. Free tax returns Child and dependent care credit. Free tax returns   You may qualify for this credit if you pay someone to care for your qualifying child who is under age 13, or your disabled dependent or disabled spouse so that you can work or look for work. Free tax returns Generally, you must be able to claim an exemption for your dependent. Free tax returns   Married dual-status aliens can claim the credit only if they choose to file a joint return as discussed in chapter 1, or if they qualify as certain married individuals living apart. Free tax returns   The amount of your child and dependent care expense that qualifies for the credit in any tax year cannot be more than your earned income for that tax year. Free tax returns   For more information, get Publication 503 and Form 2441. Free tax returns Retirement savings contributions credit. Free tax returns   You may qualify for this credit (also known as the saver's credit) if you made eligible contributions to an employer-sponsored retirement plan or to an individual retirement arrangement (IRA) in 2013. Free tax returns You cannot claim this credit if: You were born after January 1, 1996, You were a full-time student, Your exemption is claimed by someone else on his or her 2013 tax return, or Your adjusted gross income is more than $29,500. Free tax returns Use Form 8880 to figure the credit. Free tax returns For more information, see Publication 590. Free tax returns Child tax credit. Free tax returns   You may be able to take this credit if you have a qualifying child. Free tax returns   A qualifying child for purposes of the child tax credit is a child who: Was under age 17 at the end of 2013. Free tax returns Is your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, half brother, half sister, or a descendant of any of them (for example, your grandchild, niece, or nephew). Free tax returns Is a U. Free tax returns S. Free tax returns citizen, a U. Free tax returns S. Free tax returns national, or a resident alien. Free tax returns Did not provide over half of his or her own support for 2013. Free tax returns Lived with you more than half of 2013. Free tax returns Temporary absences, such as for school, vacation, or medical care, count as time lived in the home. Free tax returns Is claimed as a dependent on your return. Free tax returns An adopted child is always treated as your own child. Free tax returns An adopted child includes a child lawfully placed with you for legal adoption. Free tax returns   See your form instructions for additional details. Free tax returns Adoption credit. Free tax returns   You may qualify to take a tax credit of up to $12,970 for qualifying expenses paid to adopt an eligible child. Free tax returns This amount may be allowed for the adoption of a child with special needs regardless of whether you have qualifying expenses. Free tax returns To claim the adoption credit, file Form 8839 with the U. Free tax returns S. Free tax returns income tax return that you file. Free tax returns   Married dual-status aliens can claim the credit only if they choose to file a joint return with a U. Free tax returns S. Free tax returns citizen or resident spouse as discussed in chapter 1, or if they qualify as certain married individuals living apart (see Married Persons Not Filing Jointly in the Form 8839 instructions). Free tax returns Payments You can report as payments against your U. Free tax returns S. Free tax returns income tax liability certain taxes you paid, are considered to have paid, or that were withheld from your income. Free tax returns These include: Tax withheld from wages earned in the United States, Taxes withheld at the source from various items of income from U. Free tax returns S. Free tax returns sources other than wages, Estimated tax paid with Form 1040-ES or Form 1040-ES (NR), and Tax paid with Form 1040-C, at the time of departure from the United States. Free tax returns Forms To File The U. Free tax returns S. Free tax returns income tax return you must file as a dual-status alien depends on whether you are a resident alien or a nonresident alien at the end of the tax year. Free tax returns Resident at end of year. Free tax returns   You must file Form 1040 if you are a dual-status taxpayer who becomes a resident during the year and who is a U. Free tax returns S. Free tax returns resident on the last day of the tax year. Free tax returns Write “Dual-Status Return” across the top of the return. Free tax returns Attach a statement to your return to show the income for the part of the year you are a nonresident. Free tax returns You can use Form 1040NR or Form 1040NR-EZ as the statement, but be sure to mark “Dual-Status Statement” across the top. Free tax returns Nonresident at end of year. Free tax returns   You must file Form 1040NR or Form 1040NR-EZ if you are a dual-status taxpayer who gives up residence in the United States during the year and who is not a U. Free tax returns S. Free tax returns resident on the last day of the tax year. Free tax returns Write “Dual-Status Return” across the top of the return. Free tax returns Attach a statement to your return to show the income for the part of the year you are a resident. Free tax returns You can use Form 1040 as the statement, but be sure to mark “Dual-Status Statement” across the top. Free tax returns   If you expatriated or terminated your residency in 2013, you may be required to file an expatriation statement (Form 8854) with your tax return. Free tax returns For more information, see Expatriation Tax in chapter 4. Free tax returns Statement. Free tax returns   Any statement must have your name, address, and taxpayer identification number on it. Free tax returns You do not need to sign a separate statement or schedule accompanying your return, because your signature on the return also applies to the supporting statements and schedules. Free tax returns When and Where To File If you are a resident alien on the last day of your tax year and report your income on a calendar year basis, you must file no later than April 15 of the year following the close of your tax year. Free tax returns If you report your income on other than a calendar year basis, file your return no later than the 15th day of the 4th month following the close of your tax year. Free tax returns In either case, file your return with the address for dual-status aliens shown on the back page of the Form 1040 instructions. Free tax returns If you are a nonresident alien on the last day of your tax year and you report your income on a calendar year basis, you must file no later than April 15 of the year following the close of your tax year if you receive wages subject to withholding. Free tax returns If you report your income on other than a calendar year basis, file your return no later than the 15th day of the 4th month following the close of your tax year. Free tax returns If you did not receive wages subject to withholding and you report your income on a calendar year basis, you must file no later than June 15 of the year following the close of your tax year. Free tax returns If you report your income on other than a calendar year basis, file your return no later than the 15th day of the 6th month following the close of your tax year. Free tax returns In any case, mail your return to:  Department of the Treasury Internal Revenue Service  Austin, TX 73301-0215 If enclosing a payment, mail your return to:  Internal Revenue Service  P. Free tax returns O. Free tax returns Box 1303 Charlotte, NC 28201-1303 If the regular due date for filing falls on a Saturday, Sunday, or legal holiday, the due date is the next day that is not a Saturday, Sunday, or legal holiday. Free tax returns Prev  Up  Next   Home   More Online Publications
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Understanding Your CP2000 Notice

The income and/or payment information we have on file doesn’t match the information you reported on your tax return. This could affect your tax return; it may cause an increase or decrease in your tax, or may not change it at all.


What you need to do

  • Read your notice carefully—it explains the information we received and how it affects your tax return.
  • Complete the notice response form whether or not you agree or disagree with the notice, the response form explains what actions to take. (Your specific notice may not have a response form. In that case, the notice will have instructions on what to do).
  • Contact the business or person reporting the information, if it is wrong. Ask them to correct it, and then provide the corrected information to us.

You may want to…


Answers to Common Questions

Why did I receive the notice?

We received information from a third party that doesn’t match the information you reported on your tax return.

Is the notice a bill?

No. It informs you about the information we’ve received and how it affects your tax.

What do I need to do?

Complete the notice response form. (Follow the notice instructions if your notice doesn’t have a response form.)

What do I do if the information is wrong or if I disagree?

The notice response form has instructions on what to do if the new information is wrong. You also may want to contact whoever reported the information and ask them to correct it.

The information is wrong because someone else is using my name and social security number. What can I do?

Call us and let us know. You also can use this link to go to our Identity theft information webpage to find out more about what you can do.

I reported the information but I reported it incorrectly. Can I call you to correct my return?

We can accept your information over the phone for incorrectly reported information as long as the mistake didn't increase or decrease your tax.

Do I need to amend my return?

If the information displayed in the CP2000 notice is correct, you don't need to amend your return unless you have additional income, credits or expenses to report. If you agree with our notice, follow the instructions to sign the response page and return it to us in the envelope provided.

If you have additional income, credits or expenses to report, you may want to complete and submit a Form 1040-X, Amended U.S. Individual Income Tax Return. You can receive help at an IRS Taxpayer Assistance Center.

I want to check a copy of my original return. I don’t have one. How can I get one?

You can get a transcript of your return on our ”Order a Transcript” webpage at irs.gov. You also can get one by completing and sending us a Form 4506-T, Request for Transcript of Tax Return.

I don’t want a transcript of my return. I want a copy. How can I get one?

Did an accountant or some other person prepare your return? You could ask them for a copy.

I can’t get a copy of my return from a tax preparer. How else can I get a copy of it?

You can get a copy of your return by completing and sending us a Form 4506, Request for Copy of Tax Return. We charge a fee for tax return requests.

How can I find an IRS Taxpayer Assistance Center?

We have centers located throughout the country. Our website has directions on how to find the center nearest to you.

Why did it take you so long to contact me about this matter?

Our computer systems match the information you report on your tax return with information reported by employers, banks, businesses, and others. This matching takes several months to complete.

The notice says my taxes will increase. Will I be charged interest on the money I owe?

Yes, interest accrues on your unpaid balance until you pay it in full.

What happens if I can’t pay the full amount I owe?

You can make a payment plan with us when you can’t pay the full amount you owe.

How can I make a payment plan?

Call us at the toll free number on the top right corner of your notice to talk about payment plans or learn more about them at this web page.


Tips for next year

You can avoid future problems by:

  • keeping accurate and full records
  • waiting until you get all of your income statements before filing your tax return
  • checking the records you get from your employer, mortgage company, bank, or other sources of income (W-2s, 1098s, 1099s, etc.) to make sure they're correct
  • including all your income on your tax return
  • following the instructions on how to report income, expenses and deductions
  • filing an amended tax return for any information you receive after you’ve filed your return

Consider filing your taxes electronically. Filing online can help you avoid mistakes and find credits and deductions you may qualify for. In many cases, you can file for free. Learn more about how to file electronically here.

Page Last Reviewed or Updated: 28-Feb-2014

The Free Tax Returns

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