Publication 537 (2014) INSTALLMENT SALES

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Introduction

Note. Section references within this publication are to the Internal Revenue Code and regulation references are to the Income Tax Regulations under the Code.

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. If you realize a gain on an installment sale, you may be able to report part of your gain when you receive each payment. This method of reporting gain is called the installment method. You cannot use the installment method to report a loss. You can choose to report all of your gain in the year of sale.

This publication discusses the general rules that apply to using the installment method. It also discusses more complex rules that apply only when certain conditions exist or certain types of property are sold.

If you sell your home or other nonbusiness property under an installment plan, you may need to read only the General Rules. If you sell business or rental property or have a like-kind exchange or other complex situation, also see the appropriate discussion under Other Rules.

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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.

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.

The installment sales method cannot be used for the following.

Sale of inventory. 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. See Sale of a Business under Other Rules, later.

Dealer sales. 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. This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. However, the rule does not apply to an installment sale of property used or produced in farming.

Special rule. 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. For more information, see section 453(l).

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

Installment obligation. 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.

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.

See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale.

Sale at a loss. If your sale results in a loss, you cannot use the installment method. If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale.

Unstated interest. 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. See Unstated Interest and Original Issue Discount (OID) under Other Rules, later.

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.

Each payment on an installment sale usually consists of the following three parts.

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. You do not include in income the part that is the return of your basis in the property. Basis is the amount of your investment in the property for installment sale purposes.

Interest Income

You must report interest as ordinary income. Interest is generally not included in a down payment. 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. Interest provided in the agreement is called stated interest. If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. See Unstated Interest and Original Issue Discount (OID) under Other Rules, later.

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.

You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. 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.

Worksheet A. Figuring Adjusted Basis and Gross Profit Percentage

 Keep for Your Records

 -------------------------------------------------------------------

 1. Enter the selling price for the property                  ______

 2. Enter your adjusted basis for the

    property                            ______

 3. Enter your selling expenses         ______

 4. Enter any depreciation recapture    ______

 5. Add lines 2, 3, and 4.

    This is your adjusted basis for

    installment sale purposes                                 ______

 6. Subtract line 5 from line 1. If zero or less, enter -0-.

    This is your gross profit                                 ______

    If the amount entered on line 6 is zero,

stop

 here.

    You cannot use the installment method.

 7. Enter the contract price for the property                 ______

 8. Divide line 6 by line 7. This is your gross profit

    percentage                                                ______

 -------------------------------------------------------------------

The selling price is the total cost of the property to the buyer and includes any of the following.

Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount.

Adjusted basis for installment sale purposes. Your adjusted basis is the total of the following three items.

Basis is your investment in the property for installment sale purposes. The way you figure basis depends on how you acquire the property. The basis of property you buy is generally its cost. The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently.

While you own property, various events may change your original basis. Some events, such as adding rooms or making permanent improvements, increase basis. Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. The result is adjusted basis.

For more information on how to figure basis and adjusted basis, see Publication 551. 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, at http://www.irs.gov/publications/p4895.

Selling expenses. Selling expenses relate to the sale of the property. They include commissions, attorney fees, and any other expenses paid on the sale. Selling expenses are added to the basis of the sold property.

Depreciation recapture. If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. See Depreciation Recapture Income under Other Rules, later.

Gross profit. Gross profit is the total gain you report on the installment method.

To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. If the property you sold was your home, subtract from the gross profit any gain you can exclude. See Sale of Your Home, later, under Reporting Installment Sale Income.

Contract price. Contract price equals:

A certain percentage of each payment (after subtracting interest) is reported as installment sale income. This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price.

The gross profit percentage generally remains the same for each payment you receive. However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes.

Example. You sell property at a contract price of $6,000 and your gross profit is $1,500. Your gross profit percentage is 25% ($1,500 ÷ $6,000). 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. The remainder (balance) of each payment is the tax-free return of your adjusted basis.

Amount to report as installment sale income. Multiply the payments you receive each year (less interest) by the gross profit percentage. The result is your installment sale income for the tax year. In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. For a detailed discussion, see Payments Received or Considered Received under Other Rules, later.

Selling Price Reduced

If the selling price is reduced at a later date, the gross profit on the sale also will change. You then must refigure the gross profit percentage for the remaining payments. Refigure your gross profit using Worksheet B. You will spread any remaining gain over future installments.

Worksheet B. New Gross Profit Percentage -- Selling Price Reduced

 Keep for Your Records

 ---------------------------------------------

  1. Enter the reduced selling

     price for the property             ______

  2. Enter your adjusted

     basis for the

     property                 ______

  3. Enter your selling

     expenses                 ______

  4. Enter any depreciation

     recapture                ______

  5. Add lines 2, 3, and 4.             ______

  6. Subtract line 5 from line 1.

     This is your adjusted

     gross profit                       ______

  7. Enter any installment sale

     income reported in

     prior year(s)                      ______

  8. Subtract line 7 from line 6        ______

  9. Future installments                ______

 10. Divide line 8 by line 9.

     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.

 =============================================

In 2012, you sold land with a basis of $40,000 for $100,000. Your gross profit was $60,000. You received a $20,000 down payment and the buyer's note for $80,000. The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2013. Your gross profit percentage is 60%. You reported a gain of $12,000 on each payment received in 2012 and 2013.

In 2014, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2014, 2015, and 2016 are reduced to $15,000 for each year.

The new gross profit percentage, 46.67%, is figured on Example--Worksheet B.

Example -- Worksheet B. New Gross Profit Percentage -- Selling Price Reduced

 ----------------------------------------------

  1. Enter the reduced selling

     price for the property            

 85,000

  2. Enter your adjusted

     basis for the

     property                  

40,000

  3. Enter your selling

     expenses                  

   -0-

  4. Enter any depreciation

     recapture                

   -0-

  5. Add lines 2, 3, and 4              

 40,000

  6. Subtract line 5 from line 1.

     This is your adjusted

     gross profit                      

 45,000

  7. Enter any installment sale

     income reported in

     prior year(s)                      

 24,000

  8. Subtract line 7 from

     line 6                            

 21,000

  9. Future installments                

 45,000

 10. Divide line 8 by line 9.

     This is your new gross

     profit percentage*                

 46.67%

 ----------------------------------------------

 * Apply this percentage to all future

 payments to determine how much of each of

 those payments is installment sale income.

 ==============================================

You will report a gain of $7,000 (46.67% of $15,000) on each of the $15,000 installments due in 2014, 2015, and 2016.

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. You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. See Schedule D (Form 1040) and Form 4797, later. If the property was your main home, you may be able to exclude part or all of the gain. See Sale of Your Home, later.

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. Attach it to your tax return for each year.

Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income.

Which parts to complete. Which part to complete depends on whether you are filing the form for the year of sale or a later year.

Year of sale. Complete lines 1 through 4, Part I, and Part II. If you sold property to a related party during the year, also complete Part III.

Later years. Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale.

If you sold a marketable security to a related party after May 14, 1980, and before 1987, complete Form 6252 for each year of the installment agreement, even if you did not receive a payment. (After 1986, the installment method is not available for the sale of marketable securities.) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Complete Part III unless you received the final payment during the tax year.

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. 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. Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year.

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). 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. Your gain is long-term if you owned the property for more than 1 year when you sold it.

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. All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. For trade or business property held for more than 1 year, enter the amount from line 26 of Form 4797, line 4. 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."

Sale of Your Home

If you sell your home, you may be able to exclude all or part of the gain on the sale. See Publication 523 for information about excluding the gain. If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage.

Seller-financed mortgage. If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures.

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.

When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions.

If either person fails to include the other person's SSN, a penalty will be assessed.

Other Rules

The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. The following topics are discussed.

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.

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. Notes, mortgages, and land contracts are examples of obligations that are included at FMV.

You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. 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).

Example. You sold a parcel of land for $50,000. 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. The buyer gave you a note for $40,000. The note had an FMV of $40,000. You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. The land cost $25,000, and you owned it for more than one year. You decide to elect out of the installment method and report the entire gain in the year of sale.

 Gain realized:

 Selling price                                $50,000

 Minus: Property's adj.             $25,000

        basis

        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.             $25,000

        basis

        Commission                    3,000    28,000

                                    -------   -------

Gain recognized                              $22,000

                                              =======

The recognized gain of $22,000 is long-term capital gain. 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. The interest on the note is ordinary income and is reported as interest income each year.

How to elect out. To make this election, do not report your sale on Form 6252. Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both.

When to elect out. Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place.

Automatic six-month extension. 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). Write "Filed pursuant to section

Revoking the election. Once made, the election can be revoked only with IRS approval. A revocation is retroactive. You will not be allowed to revoke the election if either of the following applies.

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. Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. The recapture income is also included in Part I of Form 6252. However, the gain equal to the recapture income is reported in full in the year of the sale. Only the gain greater than the recapture income is reported on the installment method. For more information on depreciation recapture, see chapter 3 in Publication 544.

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. Determining gross profit is discussed under General Rules, earlier.

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. 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. These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition, later.

Sale of Depreciable Property

If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Instead, all payments to be received are considered received in the year of sale. However, see Exception, below. Depreciable property for this rule is any property the purchaser can depreciate.

Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount.

In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income.

Exception. 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. 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.

Related person. Related persons include the following.

For information about which entities are controlled entities, see section

.

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.

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.

See Exception, later.

Related person. Related persons include the following.

In 2013, 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. His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). He received $100,000 in 2013 and included $50,000 in income for that year ($100,000 × 0.50). Bob made no improvements to the property and sold it to Alfalfa Inc., in 2014 for $600,000 after making the payment for that year. The amount realized from the second disposition is $600,000. Harvey figures his installment sale income for 2014 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

 2013 and 2014                               - 200,000

                                             ---------

 Amount treated as received because of

   second disposition                         $300,000

 Add: Payment from Bob in 2014               + 100,000

                                             ---------

 Total payments received and treated as

   received for 2014                          $400,000

 Multiply by gross profit %                      × .50

                                             ---------

 Installment sale income for 2014             $200,000

                                             =========

Harvey will not include in his installment sale income any principal payments he receives on the installment obligation for 2015, 2016, and 2017 because he has already reported the total payments of $500,000 from the first disposition ($100,000 in 2013 and $400,000 in 2014).

Example 2. Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. The gain for 2014 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

 2013 and 2014                               - 200,000

                                             ---------

 Amount treated as received because of

   second disposition                         $200,000

 Add: Payment from Bob in 2014               + 100,000

                                             ---------

 Total payments received and treated as

   received for 2014                          $300,000

 Multiply by gross profit %                      × .50

                                             ---------

 Installment sale income for 2014             $150,000

                                             =========

Harvey receives a $100,000 payment in 2015 and another in 2016. They are not taxed because he treated the $200,000 from the disposition in 2014 as a payment received and paid tax on the installment sale income. In 2017, he receives the final $100,000 payment. He figures the installment sale income he must recognize in 2017 as follows:

 Total payments from the first disposition

 received by the end of 2017                     $500,000

 Minus the sum of:

   Payment from 2013                  $100,000

   Payment from 2014                   100,000

   Amount treated as

   received in 2014                    200,000

                                      --------

 Total on which gain was previously

 recognized                                     - 400,000

                                                ---------

 Payment on which gain is recognized for

 2017                                            $100,000

 Multiply by gross profit %                         × .50

                                                 --------

 Installment sale income for 2017                 $50,000

                                                 ========

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. 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.

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. However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale.

In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. 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.

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. These trades are known as like-kind exchanges. The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up.

You do not have to report any part of your gain if you receive only like-kind property. 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.

For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544.

Installment payments. 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.

In 2014, George Brown trades personal property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. He also receives an installment note for $800,000 in the trade. Under the terms of the note, he is to receive $100,000 (plus interest) in 2015 and the balance of $700,000 (plus interest) in 2016.

George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). His gross profit is $600,000 ($1,000,000 - $400,000 installment sale basis). The contract price is $800,000 ($1,000,000 - $200,000). The gross profit percentage is 75% ($600,000 ÷ $800,000). He reports no gain in 2014 because the like-kind property he receives is not treated as a payment for figuring gain. He reports $75,000 gain for 2015 (75% of $100,000 payment received) and $525,000 gain for 2016 (75% of $700,000 payment received).

Deferred exchanges. 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. Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. 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. See Regulations section 15a.453-1(c).

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. You also have to allocate part of the selling price to each asset. If you sell assets that constitute a trade or business, see Sale of a Business, later.

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. 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. This becomes the net FMV.

A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. It must be reported separately. The remaining assets sold at a gain are reported together.

Example. 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. 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.

Your installment sale basis for each parcel was $15,000. Your net gain was $85,000 ($130,000 - $45,000). You report the gain on the installment method.

The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively.

The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels.

Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. 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. 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. You report this loss of $5,000 ($10,000 selling price - $15,000 installment sale basis) in the year of sale. However, if parcel C was held for personal use, the loss is not deductible.

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).

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.

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.

The sale of inventories of personal property cannot be reported on the installment method. All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years.

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. If you do not, each payment must be allocated between the inventory and the other assets sold.

Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Use your basis in the inventory to figure the cost of goods sold. Deduct the part of the selling expenses allocated to inventory as an ordinary business expense.

Residual method. 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. This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets.

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. 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).

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.

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). The consideration remaining after this reduction must be allocated among the various business assets in a certain order.

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.

If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. For example, if an asset is described in both (4) and (6), include it in (4).

Agreement. 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. This agreement is binding on both parties unless the IRS determines the amounts are not appropriate.

Reporting requirement. 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. Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred.

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. The sale of a partnership interest is treated as the sale of a single capital asset. The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. (The term "unrealized receivables" includes depreciation recapture income, discussed earlier.)

The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. The gain allocated to the other assets can be reported under the installment method.

For more information on the treatment of unrealized receivables and inventory, see Publication 541.

Example -- Sale of a Business

On June 4, 2014, you sold the machine shop you had operated since 2006. You received a $100,000 down payment and the buyer's note for $120,000. The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2015. The total selling price is $220,000. Your selling expenses are $11,000.

The selling expenses are divided among all the assets sold, including inventory. Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price).

The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:

                        Depreciation       Adj.

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). The remaining $18,500 ($220,000 - $201,500) is allocated to your section

intangible, goodwill.

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.

                 Sale      Sale       Adj.

Price

Exp.

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. A        71,000     3,550     63,800     3,650

 Mch. 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 2006, the year the business began, and it is section

property. There is no depreciation recapture income because the building was depreciated using the straight line method.

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. Figure depreciation recapture in Part III of Form 4797.

The total depreciation recapture income reported in Part II of Form 4797 is $5,209. 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). These gains are reported in full in the year of sale and are not included in the installment sale computation.

Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. 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.

The selling price equals the contract price for the installment sale ($108,500). The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart.

                             Installment

                 Selling            Sale       Gross

Price

Basis

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). The gross profit percentage for each asset is figured as follows:

                                  Percentage

 Land -- $24,900 ÷ $108,500            22.95

 Building -- $9,600 ÷ $108,500          8.85

 Goodwill -- $17,575 ÷ $108,500        16.20

                                      ------

 Total                                 48.00

                                      ======

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. The selling price for the installment sale is $108,500. This is 49.3% of the total selling price of $220,000 ($108,500 ÷ $220,000). The selling price of assets not reported on the installment method is $111,500. This is 50.7% ($111,500 ÷ $220,000) of the total selling price.

Multiply principal payments by 49.3% to determine the part of the payment for the installment sale. The balance, 50.7%, is for the part reported in the year of the sale.

The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Only the part for the installment sale (49.3%) is used in the installment sale computation.

The only payment received in 2014 is the down payment of $100,000. The part of the payment for the installment sale is $49,300 ($100,000 × 49.3%). This amount is used in the installment sale computation.

Installment income for 2014. Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2014.

                                      Income

 Land -- 22.95% of $49,300           $11,314

 Building -- 8.85% of $49,300          4,363

 Goodwill -- 16.2% of $49,300          7,987

                                     -------

 Total installment income for 2014   $23,664

                                     =======

You figure installment income for years after 2014 by applying the same gross profit percentages to 49.3% of the total payments you receive on the buyer's note during the year.

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. Interest provided in the contract is called stated interest.

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. If section 483 applies to the contract, this interest is called unstated interest. If section 1274 applies to the contract, this interest is called original issue discount (OID).

An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later).

Treatment of unstated interest and OID. Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. As a result, the buyer cannot deduct the unstated interest. The seller must report the unstated interest as income.

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.

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.

Rules for the seller. 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. If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest.

Include the unstated interest in income based on your regular method of accounting. Include OID in income over the term of the contract.

The OID includible in income each year is based on the constant yield method described in section 1272. (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.)

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. Reduce the selling price by any stated principal treated as interest to determine the gain.

Report unstated interest or OID on your tax return, in addition to stated interest.

Rules for the buyer. 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. These rules do not apply to personal-use property (for example, property not used in a trade or business).

Adequate stated interest. 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. The present value of a payment is determined based on the test rate of interest, defined next. (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value.) 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.

Test rate of interest. The test rate of interest for a contract is the 3-month rate. The 3-month rate is the lower of the following applicable federal rates (AFRs).

The AFR depends on the month the binding contract for the sale or exchange of property is made or the month of the sale or exchange and the term of the instrument. For an installment obligation, the term of the instrument is its weighted average maturity, as defined in Regulations section

Seller financed sales. For sales or exchanges of property (other than new section 38 property, which includes most tangible personal property subject to depreciation) involving seller financing of $5,557,200 or less, the test rate of interest cannot be more than 9%, compounded semiannually. For seller financing over $5,557,200 and for all sales or exchanges of new section 38 property, the test rate of interest is 100% of the AFR.

For information on new section 38 property, see section 48(b) as in effect before the enactment of Public Law 101-508.

Certain land transfers between related persons. In the case of certain land transfers between related persons (described later), the test rate is no more than 6 percent, compounded semiannually.

Internal Revenue Code sections 1274 and 483. If an installment sale contract does not provide for adequate stated interest, generally either section 1274 or section 483 will apply to the contract. These sections recharacterize part of the stated principal amount as interest. Whether either of these sections applies to a particular installment sale contract depends on several factors, including the total selling price and the type of property sold.

Determining whether section 1274 or section 483 applies. For purposes of determining whether either section 1274 or section 483 applies to an installment sale contract, all sales or exchanges that are part of the same transaction (or related transactions) are treated as a single sale or exchange and all contracts arising from the same transaction (or a series of related transactions) are treated as a single contract. Also, the total consideration due under an installment sale contract is determined at the time of the sale or exchange. Any payment (other than a debt instrument) is taken into account at its FMV.

Section 1274

Section 1274 applies to a debt instrument issued for the sale or exchange of property if any payment under the instrument is due more than 6 months after the date of the sale or exchange and the instrument does not provide for adequate stated interest. Section 1274, however, does not apply to an installment sale contract that is a cash method debt instrument (defined next) or that arises from the following transactions.

This is any debt instrument given as payment for the sale or exchange of property (other than new section

property) with a stated principal of $3,969,500 or less if the following items apply.

The section

rules (discussed next) apply to debt instruments issued in a land sale between related persons to the extent the sum of the following amounts does not exceed $500,000.

The section

rules, if otherwise applicable, apply to debt instruments issued in a sale of land to the extent the stated principal amount exceeds $500,000, or if any party to the sale is a nonresident alien.

Related persons include an individual and the members of the individual's family and their spouses. Members of an individual's family include the individual's spouse, brothers and sisters (whole or half), ancestors, and lineal descendants. Membership in the individual's family can be the result of a legal adoption.

Section 483

Section 483 generally applies to an installment sale contract that does not provide for adequate stated interest and is not covered by section 1274. Section 483, however, generally does not apply to an installment sale contract that arises from the following transactions.

Exceptions to Sections 1274 and 483

Sections 1274 and 483 do not apply under the following circumstances.

For information on figuring unstated interest and OID and other special rules, see sections

and

and the related regulations. In the case of an installment sale contract that provides for contingent payments, see Regulations sections

If you are using the installment method and you dispose of the installment obligation, generally you will have a gain or loss to report. It is considered gain or loss on the sale of the property for which you received the installment obligation. If the original installment sale produced ordinary income, the disposition of the obligation will result in ordinary income or loss. If the original sale resulted in a capital gain, the disposition of the obligation will result in a capital gain or loss. If the original installment sale resulted in a section 1231 capital gain (or loss), the disposition of the obligation will result in either a long-term capital gain or an ordinary loss.

Rules To Figure Gain or Loss

Use the following rules to figure your gain or loss from the disposition of an installment obligation.

Figure your basis in an installment obligation by multiplying the unpaid balance on the obligation by your gross profit percentage. Subtract that amount from the unpaid balance. The result is your basis in the installment obligation.

Example. Several years ago, you sold property on the installment method. The buyer still owes you $10,000 of the sale price. This is the unpaid balance on the buyer's installment obligation to you. Your gross profit percentage is 60%, so $6,000 (60% × $10,000) is the profit owed you on the obligation. The rest of the unpaid balance, $4,000, is your basis in the obligation.

Transfer between spouses or former spouses. No gain or loss is recognized on the transfer of an installment obligation between spouses or former spouses if the transfer is incident to a divorce. A transfer is incident to a divorce if it occurs within one year after the date on which the marriage ends or is related to the end of the marriage. The same tax treatment of the transferred obligation applies to the transferee spouse or former spouse as would have applied to the transferor spouse or former spouse. The basis of the obligation to the transferee spouse (or former spouse) is the adjusted basis of the transferor spouse.

The nonrecognition rule does not apply if the spouse or former spouse receiving the obligation is a nonresident alien.

Gift. A gift of an installment obligation is a disposition. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you make the gift.

For gifts between spouses or former spouses, see Transfer between spouses or former spouses, earlier.

Cancellation. If an installment obligation is canceled or otherwise becomes unenforceable, it is treated as a disposition other than a sale or exchange. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you cancel it. If the parties are related, the FMV of the obligation is considered to be no less than its full face value.

Forgiving part of the buyer's debt. If you accept part payment on the balance of the buyer's installment debt to you and forgive the rest of the debt, you treat the settlement as a disposition of the installment obligation. Your gain or loss is the difference between your basis in the obligation and the amount you realize on the settlement.

No Disposition

The following transactions generally are not dispositions.

Reduction of selling price. If you reduce the selling price but do not cancel the rest of the buyer's debt to you, it is not considered a disposition of the installment obligation. You must refigure the gross profit percentage and apply it to payments you receive after the reduction. See Selling Price Reduced under General Rules, earlier.

Assumption. If the buyer of your property sells it to someone else and you agree to let the new buyer assume the original buyer's installment obligation, you have not disposed of the installment obligation. It is not a disposition even if the new buyer pays you a higher rate of interest than the original buyer.

Transfer due to death. The transfer of an installment obligation (other than to a buyer) as a result of the death of the seller is not a disposition. Any unreported gain from the installment obligation is not treated as gross income to the decedent. No income is reported on the decedent's return due to the transfer. Whoever receives the installment obligation as a result of the seller's death is taxed on the installment payments the same as the seller would have been had the seller lived to receive the payments.

However, if an installment obligation is canceled, becomes unenforceable, or is transferred to the buyer because of the death of the holder of the obligation, it is a disposition. The estate must figure its gain or loss on the disposition. If the holder and the buyer were related, the FMV of the installment obligation is considered to be no less than its full face value.

Repossession

If you repossess your property after making an installment sale, you must figure the following amounts.

The rules for figuring these amounts depend on the kind of property you repossess. The rules for repossessions of personal property differ from those for real property. Special rules may apply if you repossess property that was your main home before the sale. See Regulations section

Gain or loss. Add any repossession costs to your basis in the obligation. If the FMV of the property you repossess is more than this total, you have a gain. This is gain on the installment obligation, so it is all ordinary income. If the FMV of the repossessed property is less than the total of your basis plus repossession costs, you have a loss. You included the full gain in income in the year of sale, so the loss is a bad debt. How you deduct the bad debt depends on whether you sold business or nonbusiness property in the original sale. See chapter 4 of Publication 550 for information on nonbusiness bad debts and chapter 10 of Publication 535, Business Expenses, for information on business bad debts.

Installment method used to report original sale. The following paragraphs explain how to figure your basis in the installment obligation and the character of any gain or loss if you used the installment method to report the gain on the original sale.

Basis in installment obligation. Multiply the unpaid balance of your installment obligation by your gross profit percentage. Subtract that amount from the unpaid balance. The result is your basis in the installment obligation.

Gain or loss. If the FMV of the repossessed property is more than the total of your basis in the obligation plus any repossession costs, you have a gain. If the FMV is less, you have a loss. Your gain or loss on the repossession is of the same character (capital or ordinary) as your gain on the original sale.

Use Worksheet C to determine the taxable gain or loss on a repossession of personal property reported on the installment method.

Worksheet C. Figuring Gain or Loss on Repossession of Personal Property

 Note. Use this worksheet only if you used the installment method to

 report the gain on the original sale.

Keep for Your Records

 --------------------------------------------------------------------

 1. Enter the fair market value of the repossessed

    property                                                   ______

 2. Enter the unpaid balance of the

    installment obligation                             ______

 3. Enter your gross profit percentage for

    the installment sale                               ______

 4. Multiply line 2 by line 3. This is your

    unrealized profit                                  ______

 5. Subtract line 4 from line 2. This is the basis of the

    obligation                                                 ______

 6. Enter your costs of repossessing the property              ______

 7. Add lines 5 and 6                                          ______

 8. Subtract line 7 from line 1. This is your gain or loss on

    the repossession                                           ______

 --------------------------------------------------------------------

You sold your piano for $1,500 in December 2013 for $300 down and $100 a month (plus interest). The payments began in January 2014. Your gross profit percentage is 40%. You reported the sale on the installment method on your 2013 income tax return. After the fourth monthly payment, the buyer defaulted on the contract (which has an unpaid balance of $800) and you are forced to repossess the piano. The FMV of the piano on the date of repossession is $1,400. The legal costs of foreclosure and the expense of moving the piano back to your home total $75. You figure your gain on the repossession as illustrated in Example --Worksheet C.

Example -- Worksheet C. Figuring Gain or Loss on Repossession of Personal Property

 Note. Use this worksheet only if you used the

 installment method to report the gain on the

 original sale.

 ----------------------------------------------------

 1. Enter the fair market value of the

    repossessed property                      

 1,400

 2. Enter the unpaid balance of

    the installment

    obligation                          

 800

 3. Enter your gross profit

    percentage for the installment

    sale                                

 40%

 4. Multiply line 2 by line 3. This is

    your unrealized

    profit                              

 320

 5. Subtract line 4 from line 2. This is the

    basis of the obligation                    

   480

 6. Enter your costs of repossessing the

    property                                  

    75

 7. Add lines 5 and 6                          

   555

 8. Subtract line 7 from line 1. This is your

    gain or loss on the

    repossession                              

   845

 ----------------------------------------------------

Your basis in repossessed personal property is its FMV at the time of the repossession.

Fair market value (FMV). The FMV of repossessed property is a question of fact to be established in each case. If you bid for the property at a lawful public auction or judicial sale, its FMV is presumed to be the price it sells for, unless there is clear and convincing evidence to the contrary.

Real Property

The rules for the repossession of real property allow you to keep essentially the same adjusted basis in the repossessed property you had before the original sale. You can recover this entire adjusted basis when you resell the property. This, in effect, cancels out the tax treatment that applied to you on the original sale and puts you in the same tax position you were in before that sale.

As a result, the total payments you have received from the buyer on the original sale must be considered income to you. You report, as gain on the repossession, any part of the payments you have not yet included in income. These payments are amounts you previously treated as a return of your adjusted basis and excluded from income. However, the total gain you report is limited. See Limit on taxable gain, later.

Mandatory rules. The rules concerning basis and gain on repossessed real property are mandatory. You must use them to figure your basis in the repossessed real property and your gain on the repossession. They apply whether or not you reported the sale on the installment method. However, they apply only if all of the following conditions are met.

Additional consideration includes money and other property you pay or transfer to the buyer. For example, additional consideration is paid if you reacquire the property subject to a debt that arose after the original sale.

Conditions not met. If any one of these three conditions is not met, use the rules discussed under Personal Property, earlier, as if the property you repossess were personal rather than real property. Do not use the rules for real property.

Figuring gain on repossession. Your gain on repossession is the difference between the following amounts.

See the earlier discussions under

for items considered payment on the sale.

Limit on taxable gain. Taxable gain is limited to your gross profit on the original sale minus the sum of the following amounts.

This method of figuring taxable gain, in essence, treats all payments received on the sale as income but limits your total taxable gain to the gross profit you originally expected on the sale.

Indefinite selling price. The limit on taxable gain does not apply if the selling price is indefinite and cannot be determined at the time of repossession. For example, a selling price stated as a percentage of the profits to be realized from the buyer's development of the property is an indefinite selling price.

Character of gain. The taxable gain on repossession is ordinary income or capital gain, the same as the gain on the original sale. However, if you did not report the sale on the installment method, the gain is ordinary income.

Repossession costs. Your repossession costs include money or property you pay to reacquire the real property. This includes amounts paid to the buyer of the property, as well as amounts paid to others for such items as those listed below.

Repossession costs do not include the FMV of the buyer's obligations to you that are secured by the real property or the costs of reacquiring those obligations.

Use Worksheet D to determine the taxable gain on a repossession of real property reported on the installment method.

Worksheet D. Taxable Gain on Repossession of Real Property

 Note. Use this worksheet to determine taxable gain on the

 repossession of real property if you used the installment method

 to report the gain on the original sale.

Keep for Your Records

 -----------------------------------------------------------------

 1. Enter the total of all payments received or treated as

    received before repossession                            ______

 2. Enter the total gain already reported as income         ______

 3. Subtract line 2 from line 1. This is your gain on the

    repossession                                            ______

 4. Enter your gross profit on the original sale            ______

 5. Enter your costs of repossessing the property           ______

 6. Add line 2 and line 5                                   ______

 7. Subtract line 6 from line 4                             ______

 8. Enter the lesser of line 3 or

    line 7. This is your taxable gain on the repossession   ______

 -----------------------------------------------------------------

You sold a tract of land in January 2012 for $25,000. You accepted a $5,000 down payment, plus a $20,000 mortgage secured by the property and payable at the rate of $4,000 annually plus interest (9.5%). The payments began on January 1, 2013. Your adjusted basis in the property was $19,000 and you reported the transaction as an installment sale. Your selling expenses were $1,000. You figured your gross profit as follows:

 Selling price                 $25,000

 Minus:

    Adjusted basis    $19,000

    Selling expenses    1,000   20,000

                      -------  -------

 Gross profit                   $5,000

                               =======

For this sale, the contract price equals the selling price. The gross profit percentage is 20% ($5,000 gross profit ÷ $25,000 contract price).

In 2012, you included $1,000 in income (20% × $5,000 down payment). In 2013, you reported a profit of $800 (20% × $4,000 annual installment). In 2014, the buyer defaulted and you repossessed the property. You paid $500 in legal fees to get the property back. Your taxable gain on the repossession is figured as illustrated in Example--Worksheet D.

Example -- Worksheet D. Taxable Gain on Repossession of Real Property

 Note. Use this worksheet to determine taxable gain on

 the repossession of real property if you used the

 installment method to report the gain on the original

 sale.

 ------------------------------------------------------

 1. Enter the total of all payments received or

    treated as received before

    repossession                                

 9,000

 2. Enter the total gain already reported as

    income                                      

 1,800

 3. Subtract line 2 from line 1. This is your

    gain on the repossession                    

 7,200

 4. Enter your gross profit on the original

    sale                                        

 5,000

 5. Enter your costs of repossessing the

    property                                    

   500

 6. Add line 2 and line 5                        

 2,300

 7. Subtract line 6 from line 4                  

 2,700

 8. Enter the lesser of line 3 or

    line 7. This is your taxable gain on the

    repossession                                

 2,700

 ------------------------------------------------------

Your basis in the repossessed property is determined as of the date of repossession. It is the sum of the following amounts.

To figure your adjusted basis in the installment obligation at the time of repossession, multiply the unpaid balance by the gross profit percentage. Subtract that amount from the unpaid balance.

Use Worksheet E to determine the basis of real property repossessed.

Worksheet E. Basis of Repossessed Real Property

 Keep for Your Records

 ----------------------------------------------------------------------

 1. Enter the unpaid balance on the installment

    obligation                                                   ______

 2. Enter your gross profit percentage for the installment

    sale                                                         ______

 3. Multiply line 1 by line 2. This is your unrealized profit    ______

 4. Subtract line 3 from line 1. This is your adjusted basis in

    the installment obligation on the date of the

    repossession                                                 ______

 5. Enter your taxable gain on the repossession                  ______

 6. Enter your costs of repossessing the property                ______

 7. Add lines 4, 5, and 6. This is your basis in the

    repossessed real property                                    ______

 ----------------------------------------------------------------------

Assume the same facts as in the previous example. The unpaid balance of the installment obligation (the $20,000 note) is $16,000 at the time of repossession because the buyer made a $4,000 payment. The gross profit percentage on the original sale was 20%. Therefore, $3,200 (20% × $16,000 still due on the note) is unrealized profit. You figure your basis in the repossessed property as illustrated in Example--Worksheet E.

Example -- Worksheet E. Basis of Repossessed Real Property

 --------------------------------------------------------

 1. Enter the unpaid balance on the

    installment obligation                        

 16,000

 2. Enter your gross profit percentage for the

    installment sale                              

    20%

 3. Multiply line 1 by line 2. This is your

    unrealized profit                            

  3,200

 4. Subtract line 3 from line 1. This is your

    adjusted basis in the installment

    obligation on the date of the

    repossession                                  

 12,800

 5. Enter your taxable gain on the

    repossession                                  

  2,700

 6. Enter your costs of repossessing the

    property                                      

    500

 7. Add lines 4, 5, and 6. This is your basis in

    the repossessed real property                

 16,000

 -------------------------------------------------------

If you resell the repossessed property, the resale may result in a capital gain or loss. To figure whether the gain or loss is long-term or short-term, your holding period includes the period you owned the property before the original sale plus the period after the repossession. It does not include the period the buyer owned the property.

If the buyer made improvements to the reacquired property, the holding period for these improvements begins on the day after the date of repossession.

Bad debt. If you repossess real property under these rules, you cannot take a bad debt deduction for any part of the buyer's installment obligation. This is true even if the obligation is not fully satisfied by the repossession.

If you took a bad debt deduction before the tax year of repossession, you are considered to have recovered the bad debt when you repossess the property. You must report the bad debt deduction taken in the earlier year as income in the year of repossession. However, if any part of the earlier deduction did not reduce your tax, you do not have to report that part as income. Your adjusted basis in the installment obligation is increased by the amount you report as income from recovering the bad debt.

Interest on Deferred Tax

Generally, you must pay interest on the deferred tax related to any obligation that arises during a tax year from the disposition of property under the installment method if both of the following apply.

You must pay interest in subsequent years if installment obligations that originally required interest to be paid are still outstanding at the close of a tax year.

Exceptions. This interest rule does not apply to dispositions of:

First, find the underpayment rate in effect for the month with or within which your tax year ends. The underpayment rate is published quarterly in the Internal Revenue Bulletin, available at IRS.gov. Then multiply that rate by the deferred tax. The deferred tax is equal to the balance of the unrecognized gain at the end of the tax year multiplied by your maximum tax rate (ordinary or capital gain, as appropriate) in effect for the tax year.

For information on interest on dealer sales of timeshares and residential lots under the installment method, see section 453(l).

How to report the interest. Enter the interest as additional tax on your tax return. Individuals include it in the amount to be entered on the other taxes line (Form 1040, U.S. Individual Income Tax Return, line 62, or Form 1040NR, U.S. Nonresident Alien Income Tax Return, line 60).

U.S. corporations include the interest on the other taxes line on Form 1120, U.S. Corporation Income Tax Return, Schedule J, line 9f.

Foreign corporations using Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, include the interest on the other taxes line (Form 1120-F, Schedule J, line 8).

Corporations can deduct the interest in the year it is paid or accrued. For individuals and other taxpayers, this interest is not deductible. Follow the instructions for your return.

Reporting an Installment Sale

Form 6252. Use Form 6252 to report a sale of property on the installment method. The form is used to report the sale in the year it takes place and to report payments received in later years. Also, if you sold property to a related person, you may have to file the form each year until the installment debt is paid off, whether or not you receive a payment in that year.

Related person. If you sold property to a related person during the year, complete lines 1 through 4 and Parts I, II, and III of Form 6252.

If you sold a marketable security to a related party after May 14, 1980, and before 1987, complete Form 6252 for each year of the installment agreement, even if you did not receive a payment. (After 1986, the installment method is not available for the sale of marketable securities.) Complete lines 1 through 4 each year. Complete Part II for any year in which you receive a payment. Complete Part III for each year except for the year in which you receive the final payment.

If you sold property other than a marketable security to a related party after May 14, 1980, complete Form 6252 for the year of the sale and for the 2 years after the year of sale, even if you did not receive a payment in those years. Complete lines 1 through 4. Complete Part II for each of the 2 years after the year of sale in which you receive a payment. Complete Part III for each of the 2 years after the year of the sale unless you received the final payment during the year.

If the related person to whom you sold your property disposes of it, you may have to immediately report the rest of your gain in Part III. See Sale and Later Disposition under Sale to a Related Person, earlier, for more information.

Several assets. If you sell two or more assets in one installment sale, you may have to separately report the sale of each asset. The same is true if you sell all the assets of your business in one installment sale. See Single Sale of Several Assets and Sale of a Business, earlier.

If you have only a few sales to separately report, use a separate Form 6252 for each one. However, if you have to separately report the sale of multiple assets that you sold together, prepare only one Form 6252 and attach a schedule with all the required information for each asset. Complete Form 6252 by following the steps listed below.

If you are reporting payments from an installment sale as income in respect of a decedent or as a beneficiary of a trust, including a partial interest in such a sale, you may not be able to provide all the information asked for on Form 6252. To the extent possible, follow the instructions given above and provide as many details as possible in a statement attached to Form 6252.

For more information on how to complete Form 6252, see the form instructions.

Other forms. The gain from Form 6252 is entered on Form 4797, or both. See Reporting Installment Sale Income under General Rules, earlier.

Schedule D (Form 1040). Although the references in this publication are to the Schedule D for Form 1040, the rules discussed also apply to Schedule D for Form 1041, U.S. Income Tax Return for Estates and Trusts, Form 1065, U.S. Return of Partnership Income, Form 1120, U.S. Corporation Income Tax Return, and Form 1120S, U.S. Income Tax Return for an S Corporation.

Form 4797. Form 4797 is used with estate and trust, partnership, corporation, and S corporation returns, as well as individual returns.

How To Get Tax Help

Do you need help with a tax issue or preparing your tax return, or do you need a free publication or form?

Preparing and filing your tax return. Find free options to prepare and file your return on IRS.gov or in your local community if you qualify.

The Volunteer Income Tax Assistance (VITA) program offers free tax help to people who generally make $53,000 or less, persons with disabilities, the elderly, and limited-English-speaking taxpayers who need help preparing their own tax returns. The Tax Counseling for the Elderly (TCE) program offers free tax help for all taxpayers, particularly those who are 60 years of age and older. TCE volunteers specialize in answering questions about pensions and retirement-related issues unique to seniors.

Getting answers to your tax law questions. IRS.gov and IRS2Go are ready when you are--24 hours a day, 7 days a week.

You can download or print all of the forms and publications you may need on

Otherwise, you can:

You should receive your order within 10 business days.

Where to file your tax return.

Go to IRS.gov and click on the Tools bar to use these and other self-service options.

You can make electronic payments online, by phone, or from a mobile device. Paying electronically is safe and secure. The IRS uses the latest encryption technology and does not store banking information. It's easy and secure and much quicker than mailing in a check or money order. Go to IRS.gov and click on the Payments tab or the "Pay Your Tax Bill" icon to make a payment using the following options.

Click on the Payments tab or the "Pay Your Tax Bill" icon on IRS.gov to find more information about these additional options.

Go to IRS.gov and click on the Tools tab and then

Understanding an IRS notice or letter. Enter "Understanding your notice" in the search box on IRS.gov to find additional information about your IRS notice or letter.

Visiting the IRS. Locate the nearest Taxpayer Assistance Center using the Office Locator tool on IRS.gov. Enter "office locator" in the search box. Or choose the "Contact Us" option on the IRS2Go app and search Local Offices. Before you visit, use the Locator tool to check hours and services available.

Watching IRS videos. The IRS Video portal http://www.irsvideos.gov contains video and audio presentations on topics of interest to individuals, small businesses, and tax professionals. You'll find video clips of tax topics, archived versions of live panel discussions and Webinars, and audio archives of tax practitioner phone forums.

Getting tax information in other languages. For taxpayers whose native language is not English, we have the following resources available.

What is the Taxpayer Advocate Service?

The Taxpayer Advocate Service (TAS) is an independent organization within the Internal Revenue Service that helps taxpayers and protects taxpayer rights. Our job is to ensure that every taxpayer is treated fairly and that you know and understand your rights under the Taxpayer Bill of Rights.

What Can the Taxpayer Advocate Service Do For You?

We can help you resolve problems that you can't resolve with the IRS. And our service is free. If you qualify for our assistance, you will be assigned to one advocate who will work with you throughout the process and will do everything possible to resolve your issue. TAS can help you if:

How Can You Reach Us?

We have offices in every state, the District of Columbia, and Puerto Rico. Your local advocate's number is in your local directory and at http://www.taxpayeradvocate.irs.gov. You can also call us at 1-877-777-4778.

How Can You Learn About Your Taxpayer Rights?

The Taxpayer Bill of Rights describes ten basic rights that all taxpayers have when dealing with the IRS. Our Tax Toolkit at http://www.taxpayeradvocate.irs.gov can help you understand what these rights mean to you and how they apply. These are your rights. Know them. Use them.

How Else Does the Taxpayer Advocate Service Help Taxpayers?

TAS works to resolve large-scale problems that affect many taxpayers. If you know of one of these broad issues, please report it to us at http://www.irs.gov/sams.

Low Income Taxpayer Clinics

Low Income Taxpayer Clinics (LITCs) serve individuals whose income is below a certain level and need to resolve tax problems such as audits, appeals, and tax collection disputes. Some clinics can provide information about taxpayer rights and responsibilities in different languages for individuals who speak English as a second language. To find a clinic near you, visit http://www.irs.gov/litc or see IRS Publication 4134, Low Income Taxpayer Clinic List.