When qualifying property is sold and payments are received in the year of sale, the installment sale method of accounting for the transaction is available. Under the installment method, a portion of a gain resulting from the sale is reported as each payment is received. Each payment will generally consist of three parts: gain on sale, interest, and basis recovery.
In the year an installment sale occurs, the gross profit percentage is calculated to determine how much of each payment is gain. It is calculated by dividing the amount of gross profit by the contract sales price. The gross profit percentage is calculated for the year of sale only, and the same percentage is used in subsequent years.
Reporting an installment sale on an individual’s return will require a few forms and schedules. Form 6252, Installment Sale Income, is used to calculate gross profit percentage and income from installment sales. The amount of gain is transferred to either Schedule D or to Form 4797, depending upon the type of qualifying property sold. The amount of interest income from the sale is reported as such, generally when received, and the amount of basis recovery isn’t subject to tax.
A taxpayer may elect to report the entire gain in the year of sale even though payments will be made in installments (i.e. electing out of the installment method).
Certain types of sales are not reported under the installment method, such as:
- Sale of inventory in the ordinary course of business and
- Sale of stock or securities traded on an established securities market.
Reporting sales under the installment method allows taxpayers an opportunity to defer a portion of their tax liability. Their tax is due when payments are made, as opposed to recognizing the entire gain in the year of sale. However, electing out of the installment method could also be beneficial, for example if tax rates are higher in years after the sale than. When it comes to tax deductions and credits, every taxpayer’s situation is different and there are a lot of items to consider. A Certified Public Accountant can help you evaluate your situation and determine which tax deduction and credits are applicable.
Submitted by: Michael Kalifeh, Shareholder, Tax Services, (850) 668-8100.