The installment sale is not something you elect into. It applies automatically, if the sale qualifies. This post on installment sale rules just covers the…

The installment sale is not something you elect into. It applies automatically, if the sale qualifies. This post on installment sale rules just covers the basics - planning techniques will come later.

Sell an eligible asset, receive even one payment after the close of your tax year, and you have an installment sale - the gain comes in as the payments come in, unless you affirmatively elect out on the return.

When you sell an asset, you may take back a promissory note or have an earnout. The installment gain is the amount realized in excess of your adjusted basis and selling expenses.

A payment can have three parts: interest, gain and return of basis.

The calculated interest is taxed as interest income. The principal payment is divided between gain and basis recovery. This is accomplished under the installment sale rules by applying the “gross profit percentage” to the principal payments received during the year, using Form 6252.

Gross profit percentage = eligible gross profit ÷ contract price.

The buyer's note funds its own tax bill as it pays down - to the extent the gain qualifies for installment treatment.

When do installment sale rules apply? Not all the time.

The rules exclude inventory and generally exclude dealer property, and ordinary depreciation recapture is taxed in the year of sale regardless of when you are paid. Publicly traded stock and securities do not qualify either.

If you are selling a business, or real estate, the ordinary income from recapture or inventories is taxable at the time of sale, even if you are being paid over time. The installment method can apply to the remaining eligible gain.

That means the purchase-price allocation matters. In a business asset sale, the tax treatment has to be worked through asset by asset. Receiving no cash does not necessarily mean paying no tax when debt relief, deemed payments and current recapture can be taxable. Interest can also be taxable before cash is received.

Sometimes when rules are simple, we don’t spend enough time on the details. The installment sale rules show up in situations where the details can really matter.

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#TaxPlanning #BusinessOwners #InstallmentSales