How installment sales work

Your property disposition meets the timing requirement if at least one payment is to be received after the close of the tax year in which the disposition occurs. The definition turns on a payment falling after that tax year.

If your sale qualifies, you generally must report the gain using the installment method unless you elect out. The installment sale rules do not apply if you make that election or your transaction is one for which the method may not apply.

If you finance the buyer's purchase of your home by holding a note, mortgage, or other financial agreement, you probably have an installment sale. You may be able to report your nonexcludable gain on an installment basis. Generally, you must still report all recognized recapturable depreciation gain in the year of sale.

Each installment sale payment you receive usually has three parts: interest income, a return of your adjusted basis in the property, and gain on the sale. You must report the interest as ordinary income. Interest is generally not included in your down payment.

You calculate your gross profit percentage by dividing your gross profit from the sale by your contract price. After subtracting interest from a payment, you report that percentage of the remaining payment as installment sale income. Your gross profit percentage generally remains the same for each payment.

Under the statutory installment method, your income recognized for a tax year equals the payments received that year multiplied by the ratio of gross profit to total contract price. The gross profit includes the profit realized or to be realized when payment is completed.

Your basis represents your investment in the property. How you determine it depends on how you acquired the property. For property you buy, your basis is generally its cost. For installment sale purposes, the basis total includes your adjusted basis, selling expenses, and depreciation recapture.

If you sell property for which you claimed or could have claimed depreciation, you must report any depreciation recapture income in the year of sale. You must do so even if you receive no installment payment that year.

For an installment sale subject to the general reporting rule, you report gain exceeding recapture income under the installment method. Recapture income is the aggregate amount that section 1245 or 1250 would treat as ordinary income if you received all payments in the year of disposition. It also includes the portion of section 751 relating to those sections.

If you sell property used in your business or property earning rent or royalty income, your installment sale may produce capital gain, ordinary gain, or both. All or part of your gain may be ordinary gain from depreciation recapture.

You cannot use the installment method to report gain from selling stock or securities traded on an established securities market. You must report your entire gain in the year of sale, meaning the year in which the trade date occurs.

You cannot report sales of inventories of personal property using the installment method. You must report all gain or loss in the year of sale even if you receive payment later. If your installment sale includes inventory and other assets, you may have an agreement identifying which payments are for inventory and which are for the other assets.

The statutory definition of an installment sale also excludes dealer dispositions as defined in section 453(l). It excludes dispositions of personal property of a kind you would have to include in inventory if you held it at the close of your tax year.

If you dispose of personal property under a revolving credit plan, the general installment reporting rule does not apply. All payments you are to receive are treated as received in the year of disposition.

If you sell depreciable property to certain related persons, you generally cannot use the installment method. You count the buyer's entire payment obligation as collected during the sale year, including amounts due later. For this rule, depreciable property means any property your buyer can depreciate.

You can use the installment method for such a sale if no significant tax deferral benefit will result. You must also show to the IRS's satisfaction that avoiding federal income tax was not one of the principal purposes of your sale.

If your buyer assumes a mortgage greater than your installment sale basis in the property, you recover your entire basis. You treat the mortgage amount exceeding that basis as a payment received in the year of sale.

If your buyer gives you a note payable on demand or readily tradable, you treat the note as a payment in the year you receive it. That treatment can cause your sale to stop qualifying as an installment sale, such as when no other payments are due after the close of the sale's tax year.

If treating that note as a current payment means your sale no longer qualifies, you determine the amount realized under Regulations section whose reference consists of "1.1001", a hyphen, and "1(g)".

If you sell property other than publicly traded stocks or securities at a gain and will receive a payment in a later tax year, you generally use Form 6252 to report the sale under the installment method unless you elect otherwise.

If you elect out, you generally report your entire gain in the year of sale even though you do not receive all the proceeds that year. If your buyer's installment obligation is a debt instrument, you use Regulations section whose reference consists of "1.1001", a hyphen, and "1(g)" to figure the gain to report.

To elect out under the individual Schedule D instructions, you report your full gain on Form 8949 with a timely filed return, including extensions, for the year of sale. If you filed your original return on time, you can make the election on an amended return filed no later than six months after your return's due date, excluding extensions, writing "Filed pursuant to section" followed by "301.9100", a hyphen, and "2" at the top and filing it where you filed your original return.

Unless regulations provide otherwise, your statutory election deadline is the return filing due date, including extensions, for the year of disposition. You must make the election in the manner prescribed by regulations. You may revoke it only with the Secretary's consent.

If you later reduce your selling price, your gross profit changes. You must refigure gross profit using Worksheet B and recalculate your gross profit percentage for the remaining payments. You spread your remaining gain over future installments.

If you sell separate and unrelated assets of the same type under one contract, you report the sale as one transaction for the installment method. However, you must report any asset sold at a loss separately without using that method. You report the remaining assets sold at a gain together.

Section 453A generally applies to your installment obligation only if the property's sales price exceeds $150,000. For this threshold, you treat sales or exchanges in the same transaction or a series of related transactions as one sale or exchange.

For the deferred tax interest rule to apply, your obligation must remain outstanding at the close of the year it arose. The face amount of all such obligations you hold that arose during that year and remain outstanding at year end must exceed $5 million.

Unless regulations provide otherwise, you apply that threshold and section 453A(c)(4) by treating persons considered a single employer under section 52(a) or (b) as one person.

Your obligation is excluded from these section 453A rules if it arises from your disposition as an individual of personal use property within section 1275(b)(3), or from property used or produced in farming within section 2032A(e)(4) or (5). Obligations from dispositions described in section 453(l)(2)(B) are also excluded, but remain subject to the timeshare and residential lot interest rules in section 453(l)(3).

If section 453A applies to your installment obligation and it directly secures debt principal or interest under the debt terms or underlying arrangements, including an arrangement allowing you to satisfy debt with the obligation, the pledge rule treats your net debt proceeds as a payment limited to the contract price remaining after prior actual or deemed payments, excluding later payments disregarded under the pledge rule. The payment occurs at the later of when the debt becomes secured by the obligation or when you receive the proceeds, and you disregard subsequent payments on the obligation for section 453 purposes to the extent their aggregate does not exceed the amount previously treated as received under the pledge rule.

If you give an installment obligation as a gift, the gift is a disposition. Your gain or loss is the difference between your basis in the obligation and its fair market value when you make the gift. Gifts between spouses or former spouses have separate transfer rules.

If you transfer an installment obligation between spouses or former spouses incident to divorce, you recognize no gain or loss. A transfer is incident to divorce if it occurs within one year after the marriage ends or is related to its end. The recipient receives the same tax treatment that would have applied to you.

If your installment obligation transfers to someone other than your buyer because of your death, the transfer is not a disposition. Your unreported gain is not treated as gross income to you, and no income is reported on your final return because of that transfer. The recipient is taxed on installment payments as you would have been.