If you sell property with payment in installments and you receive at least one of the installments after the year of the sale, you can report part of your gain for federal income tax purposes when you receive the payments instead of reporting the entire gain in the year you make the sale. However, you are not obligated to use the installment method and you could report the entire gain in the year of the sale.
According to the IRS, the installment method does not apply to regular sales of inventory of personal property or sales of personal property by dealers who regularly sell the same type of personal property on an installment plan. This also applies to real property held for sale in the ordinary course of business. But this rule does not apply to installment sales of property used or produced in farming. And dealers of residential lots and time-shares could use the installment method for certain sales if they elect to pay a special interest charge. The installment method cannot be used for the sale of stocks or securities traded on an established exchange.
When you use the installment method, you must file Form 6252 to report the portion of the gain that you receive each year. You file this form for the year of the sale and for each year you receive an installment. Interest income on an installment sale is reported as ordinary income, the same as other interest income. If the installment sale contract does not provide for an adequate rate of interest, you may be required to report imputed interest on the sale for tax purposes.
The portion of each installment payment that is reported as income is based on the gross profit percentage that is calculated on Form 6252. The gross profit for these purposes is the total selling price minus selling expenses less your adjusted basis in the property. You would also subtract any depreciation that must be recaptured as ordinary income if you had previously claimed a tax deduction for depreciation on the property.
The gross profit percentage is then applied to each payment you receive on the installment sale, including the down payment, to determine the installment sale income to be reported for tax purposes.
The installment sale income determined on Form 6252 would also have to be reported on Schedule D or Form 4797. You would file Schedule D if the property you sold was personal use property. You would file Form 4797 if the property was used in your business or generated rent or royalty income.
If the installment sale was for the sale of your home, you may qualify to exclude all or part of the gain. You generally must have owned and lived in the home as your main home for at least two of the last five years.
If you make an installment sale to a related person and the sale involves depreciable property, you generally could not use the installment method. There is an exception if you can show the IRS that you did not derive any substantial tax deferral benefit from the installment sale.
There is also a special rule if you make an installment sale of property to a related person and that person sells or disposes of the property before making all the installment payments or within two years after you initially sell the property. Under this rule you would treat all or part of the amount realized on the second sale or disposition by the related person as if you had realized it at that time. But the IRS points out that this special rule would not apply if the avoidance of federal income tax was not one of the principal purposes of the second sale or disposition of the property.
If you sell an entire business with payment in installments, you would have to allocate the selling price among the assets that make up the business. You could use the installment method only for the assets that qualify for this method. For example, inventory, dealer property and stocks and securities would not qualify for the installment method. This allocation would generally come from Form 8594, Asset Acquisition Statement Under Section 1060, that you generally must file when you sell a business.
Form 6252, Installment Sale Income, IRS
Publication 537, Installment Sales, IRS
Topic 705 – Installment Sales, IRS