Tax Treatment of an Installment Sale

Some taxpayers sell things and do not receive full payment.

An installment sale is the sale of property in which at least one payment is received after the tax year in which the sale occurred. You must report the gain on an installment sale by the method of installment sales, unless the taxpayers “renounces this option” no later than the due date for filing your tax return (including extensions) in the year of sale.

 

Tax Treatment of an Installment Sale

You can “give up this option” and declare all the gain as income in the year of the sale on Form 4797 or Schedule D (Form 1040) and Form 8949. The rules of the installment sales method do not apply to sales that result in losses. You can not use the installment method to report income from sales of inventory or stock and securities traded on a securities market established (for example stocks and bonds). Any part of the gain from the sale of depreciable property that has to be reported as ordinary income under the recapture rules of depreciation require that income must be declared in the year of sale.

 

Total Profit under Installment Sales Method

Your total profit under installment sales method usually is the amount by which the sale price of the property sold exceeds its adjusted basis in the property. The sales price includes money and the fair market value of the property received from the sale of the property, selling expenses paid by the buyer and the existing debt that affects the property that the buyer assumed or which is subject.

 

Use Form 6252, Installment Out Income (Income installment sales)

Under the installment sales method, you include in income each year a portion of the profit received, or deemed to have been received. Use Form 6252, Installment Out Income (Income installment sales) to report an installment sale in the year in which the sale occurred and for each year you received payment in installments. You will need to file Form 1040 and may need to attach Form 4797 and Schedule D of Form 1040. According to Publication 537, the IRS allows taxpayers to defer gains on major sales of property or other investments with an installment sale agreement. This arrangement permits sellers to declare a prorated portion of their capital gains over several years, as long as the proper paperwork is completed during the year of the sale.

 

Using the Installment Method Form 6252

Under the installment method, the payments received by the seller are divided into two classes:

  • gain from the sale, and
  • return of the seller’s basis (cost) in the property.

In an installment sale must report interest as ordinary income in the same manner as all other interest income. If the installment sale contract does not provide for adequate interest stated, then you may be required to rename part of the installment payments as “imputed” interest or interest under rules of the issuance discount original, even if you have a loss. You must use the applicable federal rate (AFR, for its acronym in English) to calculate the interest not specified on the sale. The rates are published each month in the Internal Revenue Bulletin (Internal Revenue Bulletin).

The installment sale method can be very useful for taxpayers but they must report this information in the correct way.