Real Estate & Taxes:

What are Installment Sales?

An installment sale refers to the method in which your client receives at least one payment on his property after the end of the tax year in which he sold that property. When one sells 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, your client agrees to receive payment of his property from the buyer in installments over the years. This way each year the client pays taxes on the gains plus the interest for the installment that he receives 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 client's installment sale income.

Each payment of the installment sale contains three parts:

Interest income – This is basically the interest that your client made off the sale. Even if he did not make any interest earnings off the sale, he still has 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 client's adjusted basis in the property – You don't have to report this for the taxes. This is all that your client has invested in the property to acquire and rebuild it over the years. This is basically the value of the house. Your client is 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 your client received the payment in.

The advantage of the installment sale is that your client doesn't pay tax on all his gain from the sale, he only pays partial tax on the partial gain that is part of the installments over the years.

The disadvantage of the installment sale is that the client doesn't get all his money upfront. What does that mean for the client? This brings up trust. Can your client 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.