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Irs Amendment

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Irs Amendment

Irs amendment Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. Irs amendment General RulesFiguring Installment Sale Income Reporting Installment Sale Income Other RulesElecting Out of the Installment Method Payments Received or Considered Received Escrow Account Depreciation Recapture Income Sale to a Related Person Like-Kind Exchange Contingent Payment Sale Single Sale of Several Assets Sale of a Business Unstated Interest and Original Issue Discount (OID) Disposition of an Installment Obligation Repossession Interest on Deferred Tax Reporting an Installment SaleRelated person. Irs amendment Several assets. Irs amendment Special situations. Irs amendment Schedule D (Form 1040). Irs amendment Form 4797. Irs amendment How To Get Tax Help What Is an Installment Sale? An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. Irs amendment The rules for installment sales do not apply if you elect not to use the installment method (see Electing Out of the Installment Method under Other Rules, later) or the transaction is one for which the installment method may not apply. Irs amendment The installment sales method cannot be used for the following. Irs amendment Sale of inventory. Irs amendment   The regular sale of inventory of personal property does not qualify as an installment sale even if you receive a payment after the year of sale. Irs amendment See Sale of a Business under Other Rules, later. Irs amendment Dealer sales. Irs amendment   Sales of personal property by a person who regularly sells or otherwise disposes of the same type of personal property on the installment plan are not installment sales. Irs amendment This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. Irs amendment However, the rule does not apply to an installment sale of property used or produced in farming. Irs amendment Special rule. Irs amendment   Dealers of time-shares and residential lots can treat certain sales as installment sales and report them under the installment method if they elect to pay a special interest charge. Irs amendment For more information, see section 453(l). Irs amendment Stock or securities. Irs amendment   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. Irs amendment You must report the entire gain on the sale in the year in which the trade date falls. Irs amendment Installment obligation. Irs amendment   The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you. Irs amendment General Rules If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method. Irs amendment See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. Irs amendment Sale at a loss. Irs amendment   If your sale results in a loss, you cannot use the installment method. Irs amendment If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. Irs amendment Unstated interest. Irs amendment   If your sale calls for payments in a later year and the sales contract provides for little or no interest, you may have to figure unstated interest, even if you have a loss. Irs amendment See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Irs amendment Figuring Installment Sale Income You can use the following discussions or Form 6252 to help you determine gross profit, contract price, gross profit percentage, and installment sale income. Irs amendment Each payment on an installment sale usually consists of the following three parts. Irs amendment Interest income. Irs amendment Return of your adjusted basis in the property. Irs amendment Gain on the sale. Irs amendment In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. Irs amendment You do not include in income the part that is the return of your basis in the property. Irs amendment Basis is the amount of your investment in the property for installment sale purposes. Irs amendment Interest Income You must report interest as ordinary income. Irs amendment Interest is generally not included in a down payment. Irs amendment However, you may have to treat part of each later payment as interest, even if it is not called interest in your agreement with the buyer. Irs amendment Interest provided in the agreement is called stated interest. Irs amendment If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Irs amendment See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Irs amendment Adjusted Basis and Installment Sale Income (Gain on Sale) After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if it were made up of two parts. Irs amendment A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). Irs amendment Figuring adjusted basis for installment sale purposes. Irs amendment   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. Irs amendment When you have completed the worksheet, you will also have determined the gross profit percentage necessary to figure your installment sale income (gain) for this year. Irs amendment Worksheet A. Irs amendment Figuring Adjusted Basis and Gross Profit Percentage 1. Irs amendment Enter the selling price for the property   2. Irs amendment Enter your adjusted basis for the property     3. Irs amendment Enter your selling expenses     4. Irs amendment Enter any depreciation recapture     5. Irs amendment Add lines 2, 3, and 4. Irs amendment  This is your adjusted basis for installment sale purposes   6. Irs amendment Subtract line 5 from line 1. Irs amendment If zero or less, enter -0-. Irs amendment  This is your gross profit     If the amount entered on line 6 is zero, stop here. Irs amendment You cannot use the installment method. Irs amendment   7. Irs amendment Enter the contract price for the property   8. Irs amendment Divide line 6 by line 7. Irs amendment This is your gross profit percentage   Selling price. Irs amendment   The selling price is the total cost of the property to the buyer and includes any of the following. Irs amendment Any money you are to receive. Irs amendment The fair market value (FMV) of any property you are to receive (FMV is discussed in Property Used As a Payment under Other Rules, later). Irs amendment Any existing mortgage or other debt the buyer pays, assumes, or takes (a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property). Irs amendment Any of your selling expenses the buyer pays. Irs amendment   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Irs amendment Adjusted basis for installment sale purposes. Irs amendment   Your adjusted basis is the total of the following three items. Irs amendment Adjusted basis. Irs amendment Selling expenses. Irs amendment Depreciation recapture. Irs amendment Adjusted basis. Irs amendment   Basis is your investment in the property for installment sale purposes. Irs amendment The way you figure basis depends on how you acquire the property. Irs amendment The basis of property you buy is generally its cost. Irs amendment The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Irs amendment   While you own property, various events may change your original basis. Irs amendment Some events, such as adding rooms or making permanent improvements, increase basis. Irs amendment Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Irs amendment The result is adjusted basis. Irs amendment   For more information on how to figure basis and adjusted basis, see Publication 551. Irs amendment For more information regarding your basis in property you inherited from someone who died in 2010 and whose executor filed Form 8939, Allocation of Increase In Basis for Property Acquired From a Decedent, see Publication 4895. Irs amendment Selling expenses. Irs amendment   Selling expenses relate to the sale of the property. Irs amendment They include commissions, attorney fees, and any other expenses paid on the sale. Irs amendment Selling expenses are added to the basis of the sold property. Irs amendment Depreciation recapture. Irs amendment   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Irs amendment See Depreciation Recapture Income under Other Rules, later. Irs amendment Gross profit. Irs amendment   Gross profit is the total gain you report on the installment method. Irs amendment   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Irs amendment If the property you sold was your home, subtract from the gross profit any gain you can exclude. Irs amendment See Sale of Your Home , later, under Reporting Installment Sale Income. Irs amendment Contract price. Irs amendment   Contract price equals: The selling price, minus The mortgages, debts, and other liabilities assumed or taken by the buyer, plus The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes. Irs amendment Gross profit percentage. Irs amendment   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Irs amendment This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Irs amendment   The gross profit percentage generally remains the same for each payment you receive. Irs amendment However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. Irs amendment Example. Irs amendment You sell property at a contract price of $6,000 and your gross profit is $1,500. Irs amendment Your gross profit percentage is 25% ($1,500 ÷ $6,000). Irs amendment After subtracting interest, you report 25% of each payment, including the down payment, as installment sale income from the sale for the tax year you receive the payment. Irs amendment The remainder (balance) of each payment is the tax-free return of your adjusted basis. Irs amendment Amount to report as installment sale income. Irs amendment   Multiply the payments you receive each year (less interest) by the gross profit percentage. Irs amendment The result is your installment sale income for the tax year. Irs amendment In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Irs amendment A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Irs amendment For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. Irs amendment Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. Irs amendment You then must refigure the gross profit percentage for the remaining payments. Irs amendment Refigure your gross profit using Worksheet B. Irs amendment You will spread any remaining gain over future installments. Irs amendment Worksheet B. Irs amendment New Gross Profit Percentage — Selling Price Reduced 1. Irs amendment Enter the reduced selling  price for the property   2. Irs amendment Enter your adjusted  basis for the  property     3. Irs amendment Enter your selling  expenses     4. Irs amendment Enter any depreciation  recapture     5. Irs amendment Add lines 2, 3, and 4. Irs amendment   6. Irs amendment Subtract line 5 from line 1. Irs amendment  This is your adjusted  gross profit   7. Irs amendment Enter any installment sale  income reported in  prior year(s)   8. Irs amendment Subtract line 7 from line 6   9. Irs amendment Future installments   10. Irs amendment Divide line 8 by line 9. Irs amendment  This is your new gross profit percentage*   * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Irs amendment Example. Irs amendment In 2011, you sold land with a basis of $40,000 for $100,000. Irs amendment Your gross profit was $60,000. Irs amendment You received a $20,000 down payment and the buyer's note for $80,000. Irs amendment The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. Irs amendment Your gross profit percentage is 60%. Irs amendment You reported a gain of $12,000 on each payment received in 2011 and 2012. Irs amendment In 2013, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2013, 2014, and 2015 are reduced to $15,000 for each year. Irs amendment The new gross profit percentage, 46. Irs amendment 67%, is figured on Example—Worksheet B. Irs amendment You will report a gain of $7,000 (46. Irs amendment 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. Irs amendment Example — Worksheet B. Irs amendment New Gross Profit Percentage — Selling Price Reduced 1. Irs amendment Enter the reduced selling  price for the property 85,000 2. Irs amendment Enter your adjusted  basis for the  property 40,000   3. Irs amendment Enter your selling  expenses -0-   4. Irs amendment Enter any depreciation  recapture -0-   5. Irs amendment Add lines 2, 3, and 4. Irs amendment 40,000 6. Irs amendment Subtract line 5 from line 1. Irs amendment  This is your adjusted  gross profit 45,000 7. Irs amendment Enter any installment sale  income reported in  prior year(s) 24,000 8. Irs amendment Subtract line 7 from line 6 21,000 9. Irs amendment Future installments 45,000 10. Irs amendment Divide line 8 by line 9. Irs amendment  This is your new gross profit percentage* 46. Irs amendment 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Irs amendment Reporting Installment Sale Income Generally, you will use Form 6252 to report installment sale income from casual sales of real or personal property during the tax year. Irs amendment You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. Irs amendment See Schedule D (Form 1040) and Form 4797 , later. Irs amendment If the property was your main home, you may be able to exclude part or all of the gain. Irs amendment See Sale of Your Home , later. Irs amendment Form 6252 Use Form 6252 to report an installment sale in the year it takes place and to report payments received, or considered received because of related party resales, in later years. Irs amendment Attach it to your tax return for each year. Irs amendment Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. Irs amendment Which parts to complete. Irs amendment   Which part to complete depends on whether you are filing the form for the year of sale or a later year. Irs amendment Year of sale. Irs amendment   Complete lines 1 through 4, Part I, and Part II. Irs amendment If you sold property to a related party during the year, also complete Part III. Irs amendment Later years. Irs amendment   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. Irs amendment   If you sold a marketable security to a related party after May 14, 1980, and before January 1, 1987, complete Form 6252 for each year of the installment agreement, even if you did not receive a payment. Irs amendment (After December 31, 1986, the installment method is not available for the sale of marketable securities. Irs amendment ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Irs amendment Complete Part III unless you received the final payment during the tax year. Irs amendment   If you sold property other than a marketable security to a related party after May 14, 1980, complete Form 6252 for the year of sale and for 2 years after the year of sale, even if you did not receive a payment. Irs amendment Complete lines 1 through 4 and Part II for any year during this 2-year period in which you receive a payment from the sale. Irs amendment Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. Irs amendment Schedule D (Form 1040) Enter the gain figured on Form 6252 (line 26) for personal-use property (capital assets) on Schedule D (Form 1040), as a short-term gain (line 4) or long-term gain (line 11). Irs amendment If your gain from the installment sale qualifies for long-term capital gain treatment in the year of sale, it will continue to qualify in later tax years. Irs amendment Your gain is long-term if you owned the property for more than 1 year when you sold it. Irs amendment Form 4797 An installment sale of property used in your business or that earns rent or royalty income may result in a capital gain, an ordinary gain, or both. Irs amendment All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. Irs amendment For trade or business property held for more than 1 year, enter the amount from line 26 of Form 6252 on Form 4797, line 4. Irs amendment If the property was held 1 year or less or you have an ordinary gain from the sale of a noncapital asset (even if the holding period is more than 1 year), enter this amount on Form 4797, line 10, and write “From Form 6252. Irs amendment ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. Irs amendment See Publication 523 for information about excluding the gain. Irs amendment If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. Irs amendment Seller-financed mortgage. Irs amendment   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. Irs amendment   When you report interest income received from a buyer who uses the property as a personal residence, write the buyer's name, address, and social security number (SSN) on line 1 of Schedule B (Form 1040A or 1040), Interest and Ordinary Dividends. Irs amendment   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. Irs amendment   If either person fails to include the other person's SSN, a $50 penalty will be assessed. Irs amendment Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. Irs amendment The following topics are discussed. Irs amendment Electing out of the installment method. Irs amendment Payments received or considered received. Irs amendment Escrow account. Irs amendment Depreciation recapture income. Irs amendment Sale to a related person. Irs amendment Like-kind exchange. Irs amendment Contingent payment sale. Irs amendment Single sale of several assets. Irs amendment Sale of a business. Irs amendment Unstated interest and original issue discount. Irs amendment Disposition of an installment obligation. Irs amendment Repossession. Irs amendment Interest on deferred tax. Irs amendment Electing Out of the Installment Method If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you do not receive all the sale proceeds in that year. Irs amendment To figure the amount of gain to report, use the fair market value (FMV) of the buyer's installment obligation that represents the buyer's debt to you. Irs amendment Notes, mortgages, and land contracts are examples of obligations that are included at FMV. Irs amendment You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. Irs amendment If you use the cash method of accounting, the FMV of the obligation will never be considered to be less than the FMV of the property sold (minus any other consideration received). Irs amendment Example. Irs amendment You sold a parcel of land for $50,000. Irs amendment You received a $10,000 down payment and will receive the balance over the next 10 years at $4,000 a year, plus 8% interest. Irs amendment The buyer gave you a note for $40,000. Irs amendment The note had an FMV of $40,000. Irs amendment You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. Irs amendment The land cost $25,000, and you owned it for more than one year. Irs amendment You decide to elect out of the installment method and report the entire gain in the year of sale. Irs amendment Gain realized:     Selling price $50,000 Minus: Property's adj. Irs amendment basis $25,000     Commission 3,000 28,000 Gain realized $22,000 Gain recognized in year of sale:   Cash $10,000 Market value of note 40,000 Total realized in year of sale $50,000 Minus: Property's adj. Irs amendment basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. Irs amendment You include the entire gain in income in the year of sale, so you do not include in income any principal payments you receive in later tax years. Irs amendment The interest on the note is ordinary income and is reported as interest income each year. Irs amendment How to elect out. Irs amendment   To make this election, do not report your sale on Form 6252. Irs amendment Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. Irs amendment When to elect out. Irs amendment   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Irs amendment Automatic six-month extension. Irs amendment   If you timely file your tax return without making the election, you still can make the election by filing an amended return within 6 months of the due date of your return (excluding extensions). Irs amendment Write “Filed pursuant to section 301. Irs amendment 9100-2” at the top of the amended return and file it where the original return was filed. Irs amendment Revoking the election. Irs amendment   Once made, the election can be revoked only with IRS approval. Irs amendment A revocation is retroactive. Irs amendment You will not be allowed to revoke the election if either of the following applies. Irs amendment One of the purposes is to avoid federal income tax. Irs amendment The tax year in which any payment was received has closed. Irs amendment Payments Received or Considered Received You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale. Irs amendment In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Irs amendment These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. Irs amendment However, as discussed later, the buyer's assumption of your debt is treated as a recovery of your basis rather than as a payment in many cases. Irs amendment Buyer Pays Seller's Expenses If the buyer pays any of your expenses related to the sale of your property, it is considered a payment to you in the year of sale. Irs amendment Include these expenses in the selling and contract prices when figuring the gross profit percentage. Irs amendment Buyer Assumes Mortgage If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply. Irs amendment Mortgage not more than basis. Irs amendment   If the buyer assumes a mortgage that is not more than your installment sale basis in the property, it is not considered a payment to you. Irs amendment It is considered a recovery of your basis. Irs amendment The contract price is the selling price minus the mortgage. Irs amendment Example. Irs amendment You sell property with an adjusted basis of $19,000. Irs amendment You have selling expenses of $1,000. Irs amendment The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 12% interest) in each of the next 4 years). Irs amendment The selling price is $25,000 ($15,000 + $10,000). Irs amendment Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Irs amendment The contract price is $10,000 ($25,000 − $15,000 mortgage). Irs amendment Your gross profit percentage is 50% ($5,000 ÷ $10,000). Irs amendment You report half of each $2,000 payment received as gain from the sale. Irs amendment You also report all interest you receive as ordinary income. Irs amendment Mortgage more than basis. Irs amendment   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Irs amendment The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Irs amendment   To figure the contract price, subtract the mortgage from the selling price. Irs amendment This is the total amount (other than interest) you will receive directly from the buyer. Irs amendment Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Irs amendment The contract price is then the same as your gross profit from the sale. Irs amendment    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. Irs amendment Example. Irs amendment The selling price for your property is $9,000. Irs amendment The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Irs amendment Your adjusted basis in the property is $4,400. Irs amendment You have selling expenses of $600, for a total installment sale basis of $5,000. Irs amendment The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Irs amendment This amount is included in the contract price and treated as a payment received in the year of sale. Irs amendment The contract price is $4,000: Selling price $9,000 Minus: Mortgage (6,000) Amount actually received $3,000 Add difference:   Mortgage $6,000   Minus: Installment sale basis 5,000 1,000 Contract price $4,000       Your gross profit on the sale is also $4,000: Selling price $9,000 Minus: Installment sale basis (5,000) Gross profit $4,000 Your gross profit percentage is 100%. Irs amendment Report 100% of each payment (less interest) as gain from the sale. Irs amendment Treat the $1,000 difference between the mortgage and your installment sale basis as a payment and report 100% of it as gain in the year of sale. Irs amendment Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. Irs amendment You are considered to receive a payment equal to the outstanding canceled debt. Irs amendment Example. Irs amendment Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. Irs amendment On April 4, 2013, she bought the land for $70,000. Irs amendment At that time, $30,000 of her loan to you was outstanding. Irs amendment She agreed to forgive this $30,000 debt and to pay you $20,000 (plus interest) on August 1, 2013, and $20,000 on August 1, 2014. Irs amendment She did not assume an existing mortgage. Irs amendment She canceled the $30,000 debt you owed her. Irs amendment You are considered to have received a $30,000 payment at the time of the sale. Irs amendment Buyer Assumes Other Debts If the buyer assumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of sale. Irs amendment If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Irs amendment Compare the debt to your installment sale basis in the property being sold. Irs amendment If the debt is less than your installment sale basis, none of it is treated as a payment. Irs amendment If it is more, only the difference is treated as a payment. Irs amendment If the buyer assumes more than one debt, any part of the total that is more than your installment sale basis is considered a payment. Irs amendment These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . Irs amendment However, they apply only to the following types of debt the buyer assumes. Irs amendment Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Irs amendment Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Irs amendment If the buyer assumes any other type of debt, such as a personal loan or your legal fees relating to the sale, it is treated as if the buyer had paid off the debt at the time of the sale. Irs amendment The value of the assumed debt is then considered a payment to you in the year of sale. Irs amendment Property Used As a Payment If you receive property other than money from the buyer, it is still considered a payment in the year received. Irs amendment However, see Like-Kind Exchange , later. Irs amendment Generally, the amount of the payment is the property's FMV on the date you receive it. Irs amendment Exception. Irs amendment   If the property the buyer gives you is payable on demand or readily tradable, the amount you should consider as payment in the year received is: The FMV of the property on the date you receive it if you use the cash method of accounting, The face amount of the obligation on the date you receive it if you use the accrual method of accounting, or The stated redemption price at maturity less any original issue discount (OID) or, if there is no OID, the stated redemption price at maturity appropriately discounted to reflect total unstated interest. Irs amendment See Unstated Interest and Original Issue Discount (OID) , later. Irs amendment Debt not payable on demand. Irs amendment   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. Irs amendment This is true even if the debt is guaranteed by a third party, including a government agency. Irs amendment Fair market value (FMV). Irs amendment   This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of all the necessary facts. Irs amendment Third-party note. Irs amendment   If the property the buyer gives you is a third-party note (or other obligation of a third party), you are considered to have received a payment equal to the note's FMV. Irs amendment Because the FMV of the note is itself a payment on your installment sale, any payments you later receive from the third party are not considered payments on the sale. Irs amendment The excess of the note's face value over its FMV is interest. Irs amendment Exclude this interest in determining the selling price of the property. Irs amendment However, see Exception under Property Used As a Payment, earlier. Irs amendment Example. Irs amendment You sold real estate in an installment sale. Irs amendment As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. Irs amendment The FMV of the third-party note at the time of the sale was $30,000. Irs amendment This amount, not $50,000, is a payment to you in the year of sale. Irs amendment The third-party note had an FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable return of capital. Irs amendment The remaining 40% is interest taxed as ordinary income. Irs amendment Bond. Irs amendment   A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. Irs amendment For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. Irs amendment    If you receive a government or corporate bond for a sale before October 22, 2004, and the bond has interest coupons attached or can be readily traded in an established securities market, you are considered to have received payment equal to the bond's FMV. Irs amendment However, see Exception under Property Used As a Payment, earlier. Irs amendment Buyer's note. Irs amendment   The buyer's note (unless payable on demand) is not considered payment on the sale. Irs amendment However, its full face value is included when figuring the selling price and the contract price. Irs amendment Payments you receive on the note are used to figure your gain in the year received. Irs amendment Installment Obligation Used as Security (Pledge Rule) If you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation. Irs amendment This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. Irs amendment It does not apply to the following dispositions. Irs amendment Sales of property used or produced in farming. Irs amendment Sales of personal-use property. Irs amendment Qualifying sales of time-shares and residential lots. Irs amendment The net debt proceeds are the gross debt minus the direct expenses of getting the debt. Irs amendment The amount treated as a payment is considered received on the later of the following dates. Irs amendment The date the debt becomes secured. Irs amendment The date you receive the debt proceeds. Irs amendment A debt is secured by an installment obligation to the extent that payment of principal or interest on the debt is directly secured (under the terms of the loan or any underlying arrangement) by any interest in the installment obligation. Irs amendment For sales after December 16, 1999, payment on a debt is treated as directly secured by an interest in an installment obligation to the extent an arrangement allows you to satisfy all or part of the debt with the installment obligation. Irs amendment Limit. Irs amendment   The net debt proceeds treated as a payment on the pledged installment obligation cannot be more than the excess of item (1) over item (2), below. Irs amendment The total contract price on the installment sale. Irs amendment Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. Irs amendment Installment payments. Irs amendment   The pledge rule accelerates the reporting of the installment obligation payments. Irs amendment Do not report payments received on the obligation after it has been pledged until the payments received exceed the amount reported under the pledge rule. Irs amendment Exception. Irs amendment   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. Irs amendment The debt was outstanding on December 17, 1987. Irs amendment The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. Irs amendment   A refinancing as a result of the creditor's calling of the debt is treated as a continuation of the original debt so long as a person other than the creditor or a person related to the creditor provides the refinancing. Irs amendment   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Irs amendment Any excess is treated as a payment on the installment obligation. Irs amendment Escrow Account In some cases, the sales agreement or a later agreement may call for the buyer to establish an irrevocable escrow account from which the remaining installment payments (including interest) are to be made. Irs amendment These sales cannot be reported on the installment method. Irs amendment The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. Irs amendment When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. Irs amendment Example. Irs amendment You sell property for $100,000. Irs amendment The sales agreement calls for a down payment of $10,000 and payment of $15,000 in each of the next 6 years to be made from an irrevocable escrow account containing the balance of the purchase price plus interest. Irs amendment You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. Irs amendment You report the entire gain in the year of sale. Irs amendment Escrow established in a later year. Irs amendment   If you make an installment sale and in a later year an irrevocable escrow account is established to pay the remaining installments plus interest, the amount placed in the escrow account represents payment of the balance of the installment obligation. Irs amendment Substantial restriction. Irs amendment   If an escrow arrangement imposes a substantial restriction on your right to receive the sale proceeds, the sale can be reported on the installment method, provided it otherwise qualifies. Irs amendment For an escrow arrangement to impose a substantial restriction, it must serve a bona fide purpose of the buyer, that is, a real and definite restriction placed on the seller or a specific economic benefit conferred on the buyer. Irs amendment Depreciation Recapture Income If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Irs amendment Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Irs amendment Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. Irs amendment The recapture income is also included in Part I of Form 6252. Irs amendment However, the gain equal to the recapture income is reported in full in the year of the sale. Irs amendment Only the gain greater than the recapture income is reported on the installment method. Irs amendment For more information on depreciation recapture, see chapter 3 in Publication 544. Irs amendment The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. Irs amendment Determining gross profit is discussed under General Rules , earlier. Irs amendment Sale to a Related Person If you sell depreciable property to a related person and the sale is an installment sale, you may not be able to report the sale using the installment method. Irs amendment If you sell property to a related person and the related person disposes of the property before you receive all payments with respect to the sale, you may have to treat the amount realized by the related person as received by you when the related person disposes of the property. Irs amendment These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. Irs amendment Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Irs amendment Instead, all payments to be received are considered received in the year of sale. Irs amendment However, see Exception , below. Irs amendment Depreciable property for this rule is any property the purchaser can depreciate. Irs amendment Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. Irs amendment In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. Irs amendment The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. Irs amendment Exception. Irs amendment   You can use the installment method to report a sale of depreciable property to a related person if no significant tax deferral benefit will be derived from the sale. Irs amendment You must show to the satisfaction of the IRS that avoidance of federal income tax was not one of the principal purposes of the sale. Irs amendment Related person. Irs amendment   Related persons include the following. Irs amendment A person and all controlled entities with respect to that person. Irs amendment A taxpayer and any trust in which such taxpayer (or his spouse) is a beneficiary, unless that beneficiary's interest in the trust is a remote contingent interest. Irs amendment Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of that estate. Irs amendment Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. Irs amendment   For information about which entities are controlled entities, see section 1239(c). Irs amendment Sale and Later Disposition Generally, a special rule applies if you sell or exchange property to a related person on the installment method (first disposition) who then sells, exchanges, or gives away the property (second disposition) under the following circumstances. Irs amendment The related person makes the second disposition before making all payments on the first disposition. Irs amendment The related person disposes of the property within 2 years of the first disposition. Irs amendment This rule does not apply if the property involved is marketable securities. Irs amendment Under this rule, you treat part or all of the amount the related person realizes (or the FMV if the disposed property is not sold or exchanged) from the second disposition as if you received it at the time of the second disposition. Irs amendment See Exception , later. Irs amendment Related person. Irs amendment   Related persons include the following. Irs amendment Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. Irs amendment A partnership or estate and a partner or beneficiary. Irs amendment A trust (other than a section 401(a) employees trust) and a beneficiary. Irs amendment A trust and an owner of the trust. Irs amendment Two corporations that are members of the same controlled group as defined in section 267(f). Irs amendment The fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts. Irs amendment A tax-exempt educational or charitable organization and a person (if an individual, including members of the individual's family) who directly or indirectly controls such an organization. Irs amendment An individual and a corporation when the individual owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation. Irs amendment A fiduciary of a trust and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation. Irs amendment The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Irs amendment Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. Irs amendment An S corporation and a corporation that is not an S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation. Irs amendment A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership. Irs amendment An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. Irs amendment Example 1. Irs amendment In 2012, Harvey Green sold farm land to his son Bob for $500,000, which was to be paid in five equal payments over 5 years, plus adequate stated interest on the balance due. Irs amendment His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. Irs amendment His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). Irs amendment He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. Irs amendment 50). Irs amendment Bob made no improvements to the property and sold it to Alfalfa Inc. Irs amendment , in 2013 for $600,000 after making the payment for that year. Irs amendment The amount realized from the second disposition is $600,000. Irs amendment Harvey figures his installment sale income for 2013 as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $500,000 Subtract: Sum of payments from Bob in 2012 and 2013 - 200,000 Amount treated as received because of second disposition $300,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $400,000 Multiply by gross profit % × . Irs amendment 50 Installment sale income for 2013 $200,000 Harvey will not include in his installment sale income any principal payments he receives on the installment obligation for 2014, 2015, and 2016 because he has already reported the total payments of $500,000 from the first disposition ($100,000 in 2012 and $400,000 in 2013). Irs amendment Example 2. Irs amendment Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. Irs amendment The gain for 2013 is figured as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $400,000 Subtract: Sum of payments from Bob in 2012 and 2013 − 200,000 Amount treated as received because of second disposition $200,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $300,000 Multiply by gross profit % × . Irs amendment 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. Irs amendment They are not taxed because he treated the $200,000 from the disposition in 2013 as a payment received and paid tax on the installment sale income. Irs amendment In 2016, he receives the final $100,000 payment. Irs amendment He figures the installment sale income he must recognize in 2016 as follows: Total payments from the first disposition received by the end of 2016 $500,000 Minus the sum of:     Payment from 2012 $100,000   Payment from 2013 100,000   Amount treated as received in 2013 200,000   Total on which gain was previously recognized  − 400,000 Payment on which gain is recognized for 2016  $100,000 Multiply by gross profit % × . Irs amendment 50 Installment sale income for 2016 $ 50,000 Exception. Irs amendment   This rule does not apply to a second disposition, and any later transfer, if you can show to the satisfaction of the IRS that neither the first disposition (to the related person) nor the second disposition had as one of its principal purposes the avoidance of federal income tax. Irs amendment Generally, an involuntary second disposition will qualify under the nontax avoidance exception, such as when a creditor of the related person forecloses on the property or the related person declares bankruptcy. Irs amendment   The nontax avoidance exception also applies to a second disposition that is also an installment sale if the terms of payment under the installment resale are substantially equal to or longer than those for the first installment sale. Irs amendment However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. Irs amendment   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. Irs amendment An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. Irs amendment A transfer after the death of the person making the first disposition or the related person's death, whichever is earlier, is not treated as a second disposition. Irs amendment Like-Kind Exchange If you trade business or investment property solely for the same kind of property to be held as business or investment property, you can postpone reporting the gain. Irs amendment These trades are known as like-kind exchanges. Irs amendment The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. Irs amendment You do not have to report any part of your gain if you receive only like-kind property. Irs amendment However, if you also receive money or other property (boot) in the exchange, you must report your gain to the extent of the money and the FMV of the other property received. Irs amendment For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. Irs amendment Installment payments. Irs amendment   If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine the installment sale income each year. Irs amendment The contract price is reduced by the FMV of the like-kind property received in the trade. Irs amendment The gross profit is reduced by any gain on the trade that can be postponed. Irs amendment Like-kind property received in the trade is not considered payment on the installment obligation. Irs amendment Example. Irs amendment In 2013, George Brown trades personal property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. Irs amendment He also receives an installment note for $800,000 in the trade. Irs amendment Under the terms of the note, he is to receive $100,000 (plus interest) in 2014 and the balance of $700,000 (plus interest) in 2015. Irs amendment George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Irs amendment His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). Irs amendment The contract price is $800,000 ($1,000,000 − $200,000). Irs amendment The gross profit percentage is 75% ($600,000 ÷ $800,000). Irs amendment He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. Irs amendment He reports $75,000 gain for 2014 (75% of $100,000 payment received) and $525,000 gain for 2015 (75% of $700,000 payment received). Irs amendment Deferred exchanges. Irs amendment   A deferred exchange is one in which you transfer property you use in business or hold for investment and receive like-kind property later that you will use in business or hold for investment. Irs amendment Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. Irs amendment If certain rules are met, these funds will not be considered a payment until you have the right to receive the funds or, if earlier, the end of the exchange period. Irs amendment See Regulations section 1. Irs amendment 1031(k)-1(j)(2) for these rules. Irs amendment Contingent Payment Sale A contingent payment sale is one in which the total selling price cannot be determined by the end of the tax year of sale. Irs amendment This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. Irs amendment If the selling price cannot be determined by the end of the tax year, you must use different rules to figure the contract price and the gross profit percentage than those you use for an installment sale with a fixed selling price. Irs amendment For rules on using the installment method for a contingent payment sale, see Regulations section 15a. Irs amendment 453-1(c). Irs amendment Single Sale of Several Assets If you sell different types of assets in a single sale, you must identify each asset to determine whether you can use the installment method to report the sale of that asset. Irs amendment You also have to allocate part of the selling price to each asset. Irs amendment If you sell assets that constitute a trade or business, see Sale of a Business , later. Irs amendment Unless an allocation of the selling price has been agreed to by both parties in an arm's-length transaction, you must allocate the selling price to an asset based on its FMV. Irs amendment If the buyer assumes a debt, or takes the property subject to a debt, you must reduce the FMV of the property by the debt. Irs amendment This becomes the net FMV. Irs amendment A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. Irs amendment However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. Irs amendment It must be reported separately. Irs amendment The remaining assets sold at a gain are reported together. Irs amendment Example. Irs amendment You sold three separate and unrelated parcels of real property (A, B, and C) under a single contract calling for a total selling price of $130,000. Irs amendment The total selling price consisted of a cash payment of $20,000, the buyer's assumption of a $30,000 mortgage on parcel B, and an installment obligation of $80,000 payable in eight annual installments, plus interest at 8% a year. Irs amendment Your installment sale basis for each parcel was $15,000. Irs amendment Your net gain was $85,000 ($130,000 − $45,000). Irs amendment You report the gain on the installment method. Irs amendment The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. Irs amendment The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. Irs amendment The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. Irs amendment You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Irs amendment Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. Irs amendment You should allocate the cash payment of $20,000 received in the year of sale and the note receivable on the basis of their proportionate net FMV. Irs amendment The allocation is figured as follows:   Parcels   A and B Parcel C FMV $120,000 $10,000 Minus: Mortgage assumed 30,000 -0- Net FMV $ 90,000 $10,000 Proportionate net FMV:     Percentage of total 90% 10% Payments in year of sale:     $20,000 × 90% $18,000   $20,000 × 10%   $2,000 Excess of parcel B mortgage over installment sale basis 15,000 -0- Allocation of payments  received (or considered  received) in year of sale $ 33,000 $ 2,000 You cannot report the sale of parcel C on the installment method because the sale results in a loss. Irs amendment You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. Irs amendment However, if parcel C was held for personal use, the loss is not deductible. Irs amendment You allocate the installment obligation of $80,000 to the properties sold based on their proportionate net FMVs (90% to parcels A and B, 10% to parcel C). Irs amendment Sale of a Business The installment sale of an entire business for one overall price under a single contract is not the sale of a single asset. Irs amendment Allocation of Selling Price To determine whether any of the gain on the sale of the business can be reported on the installment method, you must allocate the total selling price and the payments received in the year of sale between each of the following classes of assets. Irs amendment Assets sold at a loss. Irs amendment Real and personal property eligible for the installment method. Irs amendment Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. Irs amendment Inventory. Irs amendment   The sale of inventories of personal property cannot be reported on the installment method. Irs amendment All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Irs amendment   If inventory items are included in an installment sale, you may have an agreement stating which payments are for inventory and which are for the other assets being sold. Irs amendment If you do not, each payment must be allocated between the inventory and the other assets sold. Irs amendment   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Irs amendment Use your basis in the inventory to figure the cost of goods sold. Irs amendment Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. Irs amendment Residual method. Irs amendment   Except for assets exchanged under the like-kind exchange rules, both the buyer and seller of a business must use the residual method to allocate the sale price to each business asset sold. Irs amendment This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. Irs amendment   The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. Irs amendment This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b). Irs amendment   A group of assets constitutes a trade or business if goodwill or going concern value could, under any circumstances, attach to the assets or if the use of the assets would constitute an active trade or business under section 355. Irs amendment   The residual method provides for the consideration to be reduced first by cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). Irs amendment The consideration remaining after this reduction must be allocated among the various business assets in a certain order. Irs amendment   For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order. Irs amendment Certificates of deposit, U. Irs amendment S. Irs amendment Government securities, foreign currency, and actively traded personal property, including stock and securities. Irs amendment Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. Irs amendment However, see Regulations section 1. Irs amendment 338-6(b)(2)(iii) for exceptions that apply to debt instruments issued by persons related to a target corporation, contingent debt instruments, and debt instruments convertible into stock or other property. Irs amendment Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of business. Irs amendment All other assets except section 197 intangibles. Irs amendment Section 197 intangibles except goodwill and going concern value. Irs amendment Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Irs amendment   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. Irs amendment For example, if an asset is described in both (4) and (6), include it in (4). Irs amendment Agreement. Irs amendment   The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market value of any of the assets. Irs amendment This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Irs amendment Reporting requirement. Irs amendment   Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets. Irs amendment Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. Irs amendment The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Irs amendment Sale of Partnership Interest A partner who sells a partnership interest at a gain may be able to report the sale on the installment method. Irs amendment The sale of a partnership interest is treated as the sale of a single capital asset. Irs amendment The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. Irs amendment (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. Irs amendment ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. Irs amendment The gain allocated to the other assets can be reported under the installment method. Irs amendment For more information on the treatment of unrealized receivables and inventory, see Publication 541. Irs amendment Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. Irs amendment You received a $100,000 down payment and the buyer's note for $120,000. Irs amendment The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. Irs amendment The total selling price is $220,000. Irs amendment Your selling expenses are $11,000. Irs amendment The selling expenses are divided among all the assets sold, including inventory. Irs amendment Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). Irs amendment The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. Irs amendment Asset FMV Claimed Basis Inventory $ 10,000 -0- $ 8,000 Land 42,000 -0- 15,000 Building 48,000 $9,000 36,000 Machine A 71,000 27,200 63,800 Machine B 24,000 12,960 22,040 Truck 6,500 18,624 5,376   $201,500 $67,784 $150,216         Under the residual method, you allocate the selling price to each of the assets based on their FMV ($201,500). Irs amendment The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. Irs amendment The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis, and the gain for each asset are shown in the following chart. Irs amendment   Sale  Price Sale   Exp. Irs amendment Adj. Irs amendment   Basis Gain Inventory $ 10,000 $ 500 $ 8,000 $ 1,500 Land 42,000 2,100 15,000 24,900 Building 48,000 2,400 36,000 9,600 Mch. Irs amendment A 71,000 3,550 63,800 3,650 Mch. Irs amendment B 24,000 1,200 22,040 760 Truck 6,500 325 5,376 799 Goodwill 18,500 925 -0- 17,575   $220,000 $11,000 $150,216 $58,784 The building was acquired in 2005, the year the business began, and it is section 1250 property. Irs amendment There is no depreciation recapture income because the building was depreciated using the straight line method. Irs amendment All gain on the truck, machine A, and machine B is depreciation recapture income since it is the lesser of the depreciation claimed or the gain on the sale. Irs amendment Figure depreciation recapture in Part III of Form 4797. Irs amendment The total depreciation recapture income reported in Part II of Form 4797 is $5,209. Irs amendment This consists of $3,650 on machine A, $799 on the truck, and $760 on machine B (the gain on each item because it was less than the depreciation claimed). Irs amendment These gains are reported in full in the year of sale and are not included in the installment sale computation. Irs amendment Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. Irs amendment The selling prices of the truck and machines are also removed from the total selling price because gain on these items is reported in full in the year of sale. Irs amendment The selling price equals the contract price for the installment sale ($108,500). Irs amendment The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. Irs amendment   Selling  Price Install- ment  Sale  Basis Gross  Profit Land $ 42,000 $17,100 $24,900 Building 48,000 38,400 9,600 Goodwill 18,500 925 17,575 Total $108,500 $56,425 $52,075         The gross profit percentage (gross profit ÷ contract price) for the installment sale is 48% ($52,075 ÷ $108,500). Irs amendment The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. Irs amendment 95 Building— $9,600 ÷ $108,500 8. Irs amendment 85 Goodwill— $17,575 ÷ $108,500 16. Irs amendment 20 Total 48. Irs amendment 00 The sale includes assets sold on the installment method and assets for which the gain is reported in full in the year of sale, so payments must be allocated between the installment part of the sale and the part reported in the year of sale. Irs amendment The selling price for the installment sale is $108,500. Irs amendment This is 49. Irs amendment 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). Irs amendment The selling price of assets not reported on the installment method is $111,500. Irs amendment This is 50. Irs amendment 7% ($111,500 ÷ $220,000) of the total selling price. Irs amendment Multiply principal payments by 49. Irs amendment 3% to determine the part of the payment for the installment sale. Irs amendment The balance, 50. Irs amendment 7%, is for the part reported in the year of the sale. Irs amendment The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. Irs amendment When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Irs amendment Only the part for the installment sale (49. Irs amendment 3%) is used in the installment sale computation. Irs amendment The only payment received in 2013 is the down payment of $100,000. Irs amendment The part of the payment for the installment sale is $49,300 ($100,000 × 49. Irs amendment 3%). Irs amendment This amount is used in the installment sale computation. Irs amendment Installment income for 2013. Irs amendment   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. Irs amendment Income Land—22. Irs amendment 95% of $49,300 $11,314 Building—8. Irs amendment 85% of $49,300 4,363 Goodwill—16. Irs amendment 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. Irs amendment   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. Irs amendment 3% of the total payments you receive on the buyer's note during the year. Irs amendment Unstated Interest and Original Issue Discount (OID) An installment sale contract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the principal payment. Irs amendment Interest provided in the contract is called stated interest. Irs amendment If an installment sale contract does not provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest. Irs amendment If section 483 applies to the contract, this interest is called unstated interest. Irs amendment If section 1274 applies to the contract, this interest is called original issue discount (OID). Irs amendment An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). Irs amendment Treatment of unstated interest and OID. Irs amendment   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Irs amendment As a result, the buyer cannot deduct the unstated interest. Irs amendment The seller must report the unstated interest as income. Irs amendment   Personal-use property is any property in which substantially all of its use by the buyer is not in connection with a trade or business or an investment activity. Irs amendment   If the debt is subject to the section 483 rules and is also subject to the below-market loan rules, such as a gift loan, compensation-related loan, or corporation-shareholder loan, then both parties are subject to the below-market loan rules rather than the unstated interest rules. Irs amendment Rules for the seller. Irs amendment   If either section 1274 or section 483 applies to the installment sale contract, you must treat part of the installment sale price as interest, even though interest is not called for in the sales agreement. Irs amendment If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. Irs amendment   Include the unstated interest in income based on your regular method of accounting. Irs amendment Include OID in income over the term of the contract. Irs amendment   The OID includible in income each year is based on the constant yield method described in section 1272. Irs amendment (In some cases, the OID on an installment sale contract also may include all or part of the stated interest, especially if the stated interest is not paid at least annually. Irs amendment )   If you do not use the installment method to report the sale, report the entire gain under your method of accounting in the year of sale. Irs amendment Reduce the selling price by any stated principal treated as interest to determine the gain. Irs amendment   Report unstated interest or OID on your tax return, in addition to stated interest. Irs amendment Rules for the buyer. Irs amendment   Any part of the stated selling price of an installment sale contract treated by the buyer as interest reduces the buyer's basis in the property and increases the buyer's interest expense. Irs amendment These rules do not apply to personal-use property (for example, property not used in a trade or business). Irs amendment Adequate stated interest. Irs amendment   An installment sale contract generally provides for adequate stated interest if the contract's stated principal amount is at least equal to the sum of the present values of all principal and interest payments called for under the contract. Irs amendment The present value of a payment is determined based on the test rate of interest, defined next. Irs amendment (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. Irs amendment ) In general, an installment sale contract provides for adequate stated interest if the stated interest rate (based on an appropriate compounding period) is at least equal to the test rate of interest. Irs amendment Test rate of interest. Irs amendment   The test rate of interest for a contract is the 3-month rate. Irs amendment The 3-month rate is the lower of the following applicable federal rates (AFRs). Irs amendment The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the first month in which there is a binding written contract that substantially provides the terms under which the sale or exchange is ultimately completed. Irs amendment The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the month in which the sale or exchange occurs. Irs amendment Applicable federal rate (AFR). Irs amendment   The AFR depends on the month the binding
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The Irs Amendment

Irs amendment Publication 575 - Additional Material Table of Contents Worksheet A. Irs amendment Simplified Method 1. Irs amendment Enter the total pension or annuity payments received this year. Irs amendment Also, add this amount to the total for Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a 1. Irs amendment   2. Irs amendment Enter your cost in the plan (contract) at the annuity starting date plus any death benefit exclusion. Irs amendment * See Cost (Investment in the Contract) , earlier 2. Irs amendment   Note: If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year's worksheet on line 4 below (even if the amount of your pension or annuity has changed). Irs amendment Otherwise, go to line 3. Irs amendment   3. Irs amendment Enter the appropriate number from Table 1 below. Irs amendment But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, enter the appropriate number from Table 2 below. Irs amendment 3. Irs amendment   4. Irs amendment Divide line 2 by the number on line 3 4. Irs amendment   5. Irs amendment Multiply line 4 by the number of months for which this year's payments were made. Irs amendment If your annuity starting date was before 1987, enter this amount on line 8 below and skip lines 6, 7, 10, and 11. Irs amendment Otherwise, go to line 6 5. Irs amendment   6. Irs amendment Enter any amounts previously recovered tax free in years after 1986. Irs amendment This is the amount shown on line 10 of your worksheet for last year 6. Irs amendment   7. Irs amendment Subtract line 6 from line 2 7. Irs amendment   8. Irs amendment Enter the smaller of line 5 or line 7 8. Irs amendment   9. Irs amendment Taxable amount for year. Irs amendment Subtract line 8 from line 1. Irs amendment Enter the result, but not less than zero. Irs amendment Also, add this amount to the total for Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Irs amendment  Note: If your Form 1099-R shows a larger taxable amount, use the amount figured on this line instead. Irs amendment If you are a retired public safety officer, see Insurance Premiums for Retired Public Safety Officers , earlier, before entering an amount on your tax return 9. Irs amendment   10. Irs amendment Was your annuity starting date before 1987? □ Yes. Irs amendment STOP. Irs amendment Do not complete the rest of this worksheet. Irs amendment  □ No. Irs amendment Add lines 6 and 8. Irs amendment This is the amount you have recovered tax free through 2013. Irs amendment You will need this number if you need to fill out this worksheet next year 10. Irs amendment   11. Irs amendment Balance of cost to be recovered. Irs amendment Subtract line 10 from line 2. Irs amendment If zero, you will not have to complete this worksheet next year. Irs amendment The payments you receive next year will generally be fully taxable 11. Irs amendment   * A death benefit exclusion (up to $5,000) applied to certain benefits received by employees who died before August 21, 1996. Irs amendment Table 1 for Line 3 Above   IF the age at  annuity starting date was . Irs amendment . Irs amendment . Irs amendment         AND your annuity starting date was—     BEFORE November 19, 1996,  enter on line 3 . Irs amendment . Irs amendment . Irs amendment AFTER November 18, 1996,  enter on line 3 . Irs amendment . Irs amendment . Irs amendment   55 or under 300 360   56-60 260 310   61-65 240 260   66-70 170 210   71 or over 120 160 Table 2 for Line 3 Above   IF the combined ages at annuity starting date were . Irs amendment . Irs amendment . Irs amendment   THEN enter on line 3 . Irs amendment . Irs amendment . Irs amendment         110 or under   410         111-120   360         121-130   310         131-140   260         141 or over   210       Prev  Up  Next   Home   More Online Publications