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taxmap/pubs/p225-042.htm#en_us_publink1000218495

Installment Method(p60)


rule
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Installment Method

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. A farmer who is not required to maintain an inventory can use the installment method to report gain from the sale of property used or produced in farming. See Inventory, later, for information on the sale of farm property where inventory items are included in the assets sold.
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, later, for information on recognizing the entire gain in the year of sale.
taxmap/pubs/p225-042.htm#en_us_publink1000218496

Sale at a loss.(p60)


rule
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If your sale results in a loss, you cannot use the installment method. If the loss is on an installment sale of business assets, you can deduct it only in the tax year of sale.
taxmap/pubs/p225-042.htm#en_us_publink1000218497

Figuring Installment Sale Income(p60)


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previous topic occurrence Installment Sale next topic occurrence

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.
taxmap/pubs/p225-042.htm#en_us_publink1000218498

Interest income.(p60)


rule
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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, later.
EIC
You must continue to report the interest income on payments you receive in subsequent years as interest income.
taxmap/pubs/p225-042.htm#en_us_publink1000218500

Adjusted basis and installment sale income (gain on sale).(p60)


rule
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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.
taxmap/pubs/p225-042.htm#en_us_publink1000218501

Figuring adjusted basis for installment sale purposes.(p60)


rule
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You can use Worksheet 10-1 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.
taxmap/pubs/p225-042.htm#en_us_publink1000218502
Pencil
Worksheet 10-1. Figuring Adjusted Basis and Gross Profit Percentage
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             
taxmap/pubs/p225-042.htm#en_us_publink1000218504

Selling price.(p60)
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The selling price is the total cost of the property to the buyer. It includes: Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount.
taxmap/pubs/p225-042.htm#en_us_publink1000218505

Adjusted basis for installment sale purposes.(p61)
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Your adjusted basis is the total of the following three items.
taxmap/pubs/p225-042.htm#en_us_publink1000218506

Adjusted basis.(p61)
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Basis is the amount of 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.
taxmap/pubs/p225-042.htm#en_us_publink1000218507

Selling expenses.(p61)
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Selling expenses are any expenses that 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.
taxmap/pubs/p225-042.htm#en_us_publink1000218508

Depreciation recapture.(p61)
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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 in Publication 537.
taxmap/pubs/p225-042.htm#en_us_publink1000218509

Gross profit.(p61)
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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.
taxmap/pubs/p225-042.htm#en_us_publink1000218510

Contract price.(p61)
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Contract price equals:
  1. The selling price, minus
  2. The mortgages, debts, and other liabilities assumed or taken by the buyer, plus
  3. The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes.
taxmap/pubs/p225-042.htm#en_us_publink1000218511

Gross profit percentage.(p61)
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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.
taxmap/pubs/p225-042.htm#en_us_publink1000218512

Amount to report as installment sale income.(p61)


rule
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Multiply the payments you receive each year (less interest) by the gross profit percentage. The result is your installment sales 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, later.
taxmap/pubs/p225-042.htm#en_us_publink1000218513

Selling price reduced.(p61)
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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 10-2. New Gross Profit Percentage — Selling Price Reduced. You will spread any remaining gain over future installments.
taxmap/pubs/p225-042.htm#en_us_publink1000218514
Pencil
Worksheet 10-2. New Gross Profit Percentage — Selling Price Reduced
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.
taxmap/pubs/p225-042.htm#en_us_publink1000218517

Example.(p61)

In 2007, 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 2008. Your gross profit percentage is 60%. You reported a gain of $12,000 on each payment received in 2007 and 2008.
In 2009, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2009, 2010, and 2011 are reduced to $15,000 for each year.
The new gross profit percentage, 46.67%, is figured in Example — Worksheet 10-2.
You will report a gain of $7,000 (46.67% of $15,000) on each of the $15,000 installments due in 2009, 2010, and 2011.
taxmap/pubs/p225-042.htm#en_us_publink1000218518
Pencil
Example —
Worksheet 10-2. 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.
taxmap/pubs/p225-042.htm#en_us_publink1000218521

Electing out of the installment method.(p61)


rule
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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 make this election, do not report your sale on Form 6252. Instead, report it on Schedule D (Form 1040), Form 4797, or both.
taxmap/pubs/p225-042.htm#en_us_publink1000218522

When to elect out.(p62)
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Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place.
However, if you timely file your tax return for the year the sale takes place without making the election, you still can make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Write "Filed pursuant to section 301.9100-2" at the top of the amended return and file it where the original return was filed.
taxmap/pubs/p225-042.htm#en_us_publink1000218523

Revoking the election.(p62)
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Once made, the election can be revoked only with IRS approval. A revocation is retroactive.
taxmap/pubs/p225-042.htm#en_us_publink1000218524

More information.(p62)
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See Electing Out of the Installment Method in Publication 537 for more information.
taxmap/pubs/p225-042.htm#en_us_publink1000218525

Form 6252.(p62)


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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.
taxmap/pubs/p225-042.htm#en_us_publink1000218526

Inventory.(p62)


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If you are not required to maintain an inventory, you may be able to use the installment method to report the sale of property you use or produce in your farming business. For examples of farm inventory, see Farm Inventory in chapter 2.
The sale of farm inventory items 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.
taxmap/pubs/p225-042.htm#en_us_publink1000218527

Disposition of installment obligation.(p62)


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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.
taxmap/pubs/p225-042.htm#en_us_publink1000218528

Cancellation.(p62)
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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 fair market value (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.
taxmap/pubs/p225-042.htm#en_us_publink1000218529

Transfer due to death.(p62)
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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 the 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.
taxmap/pubs/p225-042.htm#en_us_publink1000218530

More information.(p62)
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For more information on the disposition of an installment obligation, see Publication 537.
taxmap/pubs/p225-042.htm#en_us_publink1000218531

Sale of depreciable property.(p62)
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You generally cannot report gain from the sale of depreciable property to a related person on the installment method. See Sale to a Related Person in Publication 537.
You cannot use the installment method to report any depreciation recapture income up to the gain on the sale. However, report any gain greater than the recapture income on the installment method.
The recapture income reported in the year of sale is included in your installment sale basis to determine your gross profit on the installment sale.
Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Report the depreciation recapture income in Part II of Form 4797 as ordinary income in the year of sale.
Deposit
If you sell depreciable business property, prepare Form 4797 first in order to figure the amount to enter on line 12 of Part I, Form 6252. See the Form 6252 instructions for details.
For more information on the section 179 deduction, see Section 179 Expense Deduction in chapter 7. For more information on depreciation recapture, see Depreciation Recapture in  
chapter 9.
taxmap/pubs/p225-042.htm#en_us_publink1000218533

Payments Received or Considered Received(p62)


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previous topic occurrence Payments Received or Considered Received next topic occurrence

You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale.
In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. However, as discussed later, the buyer's assumption of your debt is treated as a recovery of basis, rather than as a payment, in many cases.
taxmap/pubs/p225-042.htm#en_us_publink1000218534

Buyer pays seller's expenses.(p62)


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If the buyer pays any of your expenses related to the sale of your property, it is considered a payment to you in the year of sale. Include these expenses in the selling and contract prices when figuring the gross profit percentage.
taxmap/pubs/p225-042.htm#en_us_publink1000218535

Buyer assumes mortgage.(p62)


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If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply.
taxmap/pubs/p225-042.htm#en_us_publink1000218536

Mortgage less than basis.(p62)
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If the buyer assumes a mortgage that is not more than your installment sale basis in the property, it is not considered a payment to you. It is considered a recovery of your basis. The contract price is the selling price minus the mortgage.
taxmap/pubs/p225-042.htm#en_us_publink1000218537

Example.(p62)

You sell property with an adjusted basis of $19,000. You have selling expenses of $1,000. The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 8% interest) in each of the next 4 years).
The selling price is $25,000 ($15,000 + $10,000). Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). The contract price is $10,000 ($25,000 − $15,000 mortgage). Your gross profit percentage is 50% ($5,000 ÷ $10,000). You report half of each $2,000 payment received as gain from the sale. You also report all interest you receive as ordinary income.
taxmap/pubs/p225-042.htm#en_us_publink1000218538

Mortgage more than basis.(p62)
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If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. The part of the mortgage greater than your basis is treated as a payment received in the year of sale.
To figure the contract price, subtract the mortgage from the selling price. This is the total amount you will receive directly from the buyer. Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). The contract price is then the same as your gross profit from the sale.
Deposit
If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%.
taxmap/pubs/p225-042.htm#en_us_publink1000218540

Example.(p62)

The selling price for your property is $9,000. The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Your adjusted basis in the property is $4,400. You have selling expenses of $600, for a total installment sale basis of $5,000. The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). This amount is included in the contract price and treated as a payment received in the year of sale. The contract price is $4,000:
Selling price$9,000
Minus: Mortgage (6,000)
Amount actually received $3,000
Add difference: 
Mortgage$6,000 
Minus: Installment sale basis  5,000 1,000
Contract price $4,000
 
Your gross profit on the sale is also $4,000:
Selling price$9,000
Minus: Installment sale basis (5,000)
Gross profit $4,000
Your gross profit percentage is 100%. Report 100% of each payment (less interest) as gain from the sale. Treat the $1,000 difference between the mortgage and your installment sale basis as a payment and report 100% of it as gain in the year of sale.
taxmap/pubs/p225-042.htm#en_us_publink1000218543

Buyer assumes other debts.(p62)


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If the buyer assumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of sale.
If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Compare the debt to your installment sale basis in the property being sold. If the debt is less than your installment sale basis, none of it is treated as a payment. If it is more, only the difference is treated as a payment. If the buyer assumes more than one debt, any part of the total that is more than your installment sale basis is considered a payment. These rules are the same as the rules discussed earlier under Buyer assumes mortgage. However, they apply only to the following types of debt the buyer assumes.
If the buyer assumes any other type of debt, such as a personal loan or your legal fees relating to the sale, it is treated as if the buyer had paid off the debt at the time of the sale. The value of the assumed debt is then considered a payment to you in the year of sale.
taxmap/pubs/p225-042.htm#en_us_publink1000218544

Property used as a payment.(p63)


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If you receive property rather than money from the buyer, it is still considered a payment in the year received. However, see Trading property for like-kind property, later. Generally, the amount of the payment is the property's FMV on the date you receive it.
taxmap/pubs/p225-042.htm#en_us_publink1000218545

Exception.(p63)
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If the property the buyer gives you is payable on demand or readily tradable, the amount you should consider as payment in the year received is:
taxmap/pubs/p225-042.htm#en_us_publink1000218546

Debt not payable on demand.(p63)
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Any evidence of debt you receive from the buyer that is not payable on demand is not considered a payment. This is true even if the debt is guaranteed by a third party, including a government agency.
taxmap/pubs/p225-042.htm#en_us_publink1000218547

Fair market value (FMV).(p63)
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This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of all the necessary facts.
taxmap/pubs/p225-042.htm#en_us_publink1000218548

Third-party note.(p63)
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If the property the buyer gives you is a third-party note (or other obligation of a third party), you are considered to have received a payment equal to the note's FMV. Because the FMV of the note is itself a payment on your installment sale, any payments you later receive from the third party are not considered payments on the sale. The excess of the note's face value over its FMV is interest. Exclude this interest in determining the selling price of the property. However, see Exception under Property used as a payment, earlier.
taxmap/pubs/p225-042.htm#en_us_publink1000218549

Example.(p63)

You sold real estate in an installment sale. As part of the down payment, the buyer assigned to you a $50,000, 8% third-party note. The FMV of the third-party note at the time of the sale was $30,000. This amount, not $50,000, is a payment to you in the year of sale. The third-party note had an FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable return of capital. The remaining 40% is interest taxed as ordinary income.
taxmap/pubs/p225-042.htm#en_us_publink1000218550

Bond.(p63)
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A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. For more information on the amount you should treat as a payment, see Exception under Property used as a payment, earlier.
If you receive a government or corporate bond for a sale before October 22, 2004, and the bond has interest coupons attached or can be readily traded in an established securities market, you are considered to have received payment equal to the bond's FMV. However, see Exception under Property used as a payment, earlier.
taxmap/pubs/p225-042.htm#en_us_publink1000218551

Buyer's note.(p63)
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The buyer's note (unless payable on demand) is not considered payment on the sale. However, its full face value is included when figuring the selling price and the contract price. Payments you receive on the note are used to figure your gain in the year received.
taxmap/pubs/p225-042.htm#en_us_publink1000218552

Sale to a related person.(p63)


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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. For information on these rules, see the Instructions for Form 6252 and Sale to a Related Person in Publication 537.
taxmap/pubs/p225-042.htm#en_us_publink1000218553

Trading property for like-kind property.(p63)


rule
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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. See Like-Kind Exchanges in chapter 8 for a discussion of like-kind property.
If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine installment sale income each year.
taxmap/pubs/p225-042.htm#en_us_publink1000218554

Unstated interest.(p63)


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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 Internal Revenue Code section 483 applies to the contract, this interest is called unstated interest.
If Internal Revenue Code section 1274 applies to the contract, this interest is called original issue discount (OID).
Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Therefore, 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 Internal Revenue Code 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.
Unstated interest reduces the stated selling price of the property and the buyer's basis in the property. It increases the seller's interest income and the buyer's interest expense.
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 applicable federal rate (AFR).
EIC
The AFRs are published monthly in the Internal Revenue Bulletin (IRB). You can get this information by contacting an IRS office. IRBs are also available on the IRS website at www.irs.gov.
taxmap/pubs/p225-042.htm#en_us_publink1000218556

More information.(p63)
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For more information, see Unstated Interest and Original Issue Discount (OID) in Publication 537.
taxmap/pubs/p225-042.htm#en_us_publink1000218557

Example.(p63)

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.