An installment sale refers to the method in which you receive at least one payment on your property after the end of the tax year in which you sold that property. When you sell a property that is subject to the capital gains tax, one of the best methods to save money over the years is to use the installment method. Under this method, you agree to receive payment of your property from the buyer in installments over the years. This way each year you pay taxes on the gains plus the interest for the installment that you receive by the close of the tax year. You don't report income that you received for the adjusted basis of the property. Use form 6252 to report your installment sale income.
Each payment of the installment sale contains three parts:
Interest income This is basically the interest that you made off the sale. Even if you did not make any interest earnings off the sale, you still have to pay the government a minimum interest on that sale. This minimum interest on the sale is figured using the federal rate (AFR).
Return of your adjusted basis in the property You don't have to report this for the taxes. This is all that you have invested in the property to acquire and rebuild it over the years. This is basically the value of the house. You are not subject to capital gains tax for this income.
Gain on the sale A certain percentage of the payment each year is going to be the gain you made off the sale. This is what you report for the tax year that you received the payment in.
The advantage of the installment sale is that you don't pay tax on all your gain from the sale you only pay partial tax on the partial gain that is part of the installments over the years.
The disadvantage of the installment sale is that you don't get all your money upfront. What does that mean for you? This brings up trust. Can you really trust someone with payments for the next five or six years? You can but it's a little hard these days.
The Tax Relief Extension Act of 1999 brings about some new restrictions on the use of this tax. Taxpayers using the "accrual method" can no longer use this method. The only exceptions are selling of farm properties and selling of residential lots and timeshares.