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The Online Advisor - August 1999
Installment sales: A review of the tax considerations
Taxpayers who sell property at a gain and who receive one or more payments in a year after the year of the sale are taxed in accordance with special installment sales rules.
Example: Paul Revere sells his horse for $1,000, payable $400 down, plus six annual installments of $100 each. Paul's horse originally cost $200, so his total taxable gain is $800. Part of each payment received is taxable gain. To determine the taxable portion, total gain is divided by the sales price ($800 ÷ $1,000 = 80%). Paul's taxable gain in the year of sale is $320 (80% x $400 down payment). In each of the next six years, his gain will be $80 (80% x $100 annual payment).
This example assumes that Paul is not a dealer in horses. Installment sales treatment is not available for sales of property normally considered inventory.
An installment sale has the same tax characteristics as if the sale had been made for cash. If Paul's horse is a capital asset held for more than one year, each year's gain will be a long-term capital gain.
The installment sales method cannot be used for either sales at a loss or for gains on sales of securities traded on an established market. Also, special rules apply to gains on depreciable property, to sales of interests in passive activities, and to sales between related parties.
If your tax situation makes it more advantageous to report the entire gain from an installment sale in the year of sale, you may elect not to use the installment method.
Installment sales rules are complex. Special provisions apply to many types of transactions. Reporting gain from a sale in installments can be a very smart tax move, but it's wise to work through the tax numbers before making the sale. For details or assistance, give us a call.