US Internal Revenue Service: p537--1998

8/14/2019 US Internal Revenue Service: p537--1998

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ContentsIntroduction ........................................ 1

What Is an Installment Sale? ............ 2

General Rules ..................................... 2Figuring Installment Income ........... 2Reporting Installment Income ......... 3

Other Rules ......................................... 3Electing Out of Installment Method 3Payments Received ........................ 4Escrow Account .............................. 5Depreciation Recapture Income ..... 5Sale to Related Person .................. 5Like-Kind Exchange ........................ 6Contingent Payment Sale ............... 6Single Sale of Several Assets ........ 6Sale of a Business .......................... 7Unstated Interest ............................ 8Disposition of Installment Obligation 9Repossession ................................. 10

Reporting an Installment Sale .......... 11

How To Get More Information .......... 16

Index .................................................... 17

IntroductionAn installment sale is a sale of property whereyou receive at least one payment after theclose of the tax year of the sale. If you dis-pose of property in an installment sale, youreport part of your gain or profit when youreceive each installment payment. You can-not use the installment method to report aloss.

This publication discusses the generalrules that apply to all installment sales. It alsodiscusses more complex rules that apply onlywhen certain conditions exist or certain types

of property are sold. There are two examplesof reporting installment sales on Form 6252at the end of the publication.

If you sold your home or other nonbusi-ness property under an installment plan, youwill need to read only the General Rules. Ifyou sold business or rental property or had alike-kind exchange or other complex situation,see the appropriate discussion under OtherRules.

If you sold your entire interest in a passiveactivity, special rules apply to the treatmentof passive activity losses. Generally, you arein a passive activity if you have a trade orbusiness activity in which you do not mate-rially participate or have a rental activity. SeePublication 925 for information on this topic.

Useful ItemsYou may want to see:

Publication

523 Selling Your Home

541 Partnerships

544 Sales and Other Dispositions ofAssets

550 Investment Income and Expenses

551 Basis of Assets

925 Passive Activity and At-Risk Rules

Departmentof theTreasury

InternalRevenueService

Publication 537Cat. No. 15067V

Installment

Sales

For use in preparing

1998 Returns


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your gross profit percentage for the remainingpayments. Refigure your gross profit usingthe reduced sale price and then subtract thegain already reported. Spread the remaininggain over the remaining installments. Youcannot go back and refigure the gain you re-ported in earlier years.

Example. In 1996, you sold land with abasis of $40,000 for $100,000. Your grossprofit was $60,000. You received a $20,000down payment and the buyer's note for$80,000. The note provides for four annualpayments of $20,000 each, plus 12% interest,beginning in 1997. Your gross profit percent-age is 60%. You reported a gain of $12,000on each payment received in 1996 and 1997.

In 1998, you and the buyer agreed to re-duce the purchase price to $85,000 and pay-ments during 1998, 1999, and 2000 are re-duced to $15,000 for each year.

The new gross profit percentage, 46.67%,is figured as follows.

You will report a gain of $7,000 (46.67%of $15,000) on each of the $15,000 install-ments due in 1998, 1999, and 2000.

ReportingInstallment Income

Form 6252. You must use Form 6252 to re-port a sale of property as an installment sale.Use the form to report the sale in the year ittakes place and to report payments received

in later years. Attach it to your tax return foreach year.

Form 6252 will help you determine thegross profit, contract price, gross profit per-centage, and how much of each payment re-ceived during the tax year to include in in-come.

Form 6252 is divided into the followingparts.

1) Part I, Gross Profit and Contract Price,is completed for the year of sale.

2) Part II , Installment Sale Income, is com-pleted for the year of sale and for anyyear you receive a payment or are con-sidered to have received a payment.

3) Part III, Related Party Installment SaleIncome, is completed if you sold theproperty to a related person, as dis-cussed later under Sale to Related Per-son.

Year of sale. Answer the questions at thebeginning of the form and complete Part I andPart II. Question 3 asks whether you sold theproperty to a related party. If you answerYes, answer question 4 and complete PartIII.

Later years. Answer the questions at thebeginning of the form and complete Part II foreach year in which you receive a payment onthe sale. If you sold the property to a related

person, you may have to complete Part IIIalso.

Schedule D (Form 1040). Enter the gainfigured on Form 6252 for personal-use prop-erty (capital assets) on Schedule D (Form1040), Capital Gains and Losses. If your gainfrom the installment sale qualifies for long-term capital gain treatment in the year of sale,it will continue to qualify in later tax years.Your gain is long-term if you owned theproperty for more than one year when yousold it.

Form 4797. An installment sale of propertyused in your business or that earns rent orroyalty income may result in a capital gain,an ordinary gain, or both. All or part of anygain from its disposition may be ordinary gainfrom depreciation recapture. Use Form 4797to report these transactions and to determinethe ordinary or capital gain or loss.

Sale of your home. If you sell your home,you may be able to exclude all or part of thegain on the sale. See Publication 523 for in-formation about excluding the gain. If the saleis an installment sale, any gain you excludeis not included in gross profit when figuringyour gross profit percentage.

Seller-financed mortgage. Special re-porting procedures apply if you finance thesale of your home to an individual.

When you report interest income receivedfrom a buyer who uses the property as apersonal residence, write the buyer's name,address, and social security number (SSN)on line 1 of Schedule B (Form 1040) orSchedule 1 (Form 1040A).

When deducting the mortgage interest,the buyer must write your name, address, andSSN on line 11 of Schedule A (Form 1040).

If either person fails to include the otherperson's SSN, a $50 penalty may apply.

Other RulesThe rules discussed in this part of the publi-cation apply only in certain circumstances orto certain types of property. The rules coverthe following topics.

1) Electing out of the installment method.

2) Payments received, including thoseconsidered received.

3) An escrow account.

4) Depreciation recapture income.

5) A sale to a related person.

6) A like-kind exchange.

7) A contingent payment sale.

8) A single sale of several assets.

9) The sale of a business.

10) Unstated interest.

11) Disposition of an installment obligation.

12) A repossession.

Electing Out ofInstallment MethodYou must use the installment method to re-port an installment sale unless you elect notto use that method. If you make the election,you generally report the entire gain in the year

of sale, even though you will not be paid allof the selling price in that year.

To figure the gain to report, use the FMVof the buyer's installment obligation. Notes,mortgages, and land contracts are examplesof obligations that are included at FMV.

You must figure the FMV of the buyer'sinstallment obligation, whether or not youwould actually be able to sell it. If you use thecash method of accounting, the FMV of theobligation will never be considered less thanthe FMV of the property sold (minus any otherconsideration received). If you use an accrualmethod of accounting, you must always usethe full face value of the installment obligationas its FMV.

Example. You sold a parcel of land for$50,000. You received a $10,000 down pay-ment and will receive the balance over thenext 10 years at $4,000 a year, plus 8% in-terest. The buyer gave you a note for$40,000. The note had an FMV of $40,000.You paid a commission of 6%, or $3,000, toa broker for negotiating the sale. The landcost $25,000 and you owned it for more thanone year. You decide to elect out of the in-stallment method and report the entire gainin the year of sale.

The recognized gain of $22,000 is long-term capital gain. Since you include the entiregain in income in the year of sale, you do notinclude in income any principal payments you

receive in later tax years. The interest on thenote is ordinary income and is reported asinterest income each year.

How to elect out. To make this election, donot report your sale on Form 6252. Instead,report it on Schedule D (Form 1040) or Form4797, whichever applies.

When to elect out. Make this election by thedue date, including extensions, for filing yourtax return for the year the sale takes place.Once made, the election generally cannot berevoked. However, you can apply to the IRSto revoke the election not to use the install-ment method. You will not be allowed to re-

voke the election if either of the following sit-uations applies.

1) One of the purposes is to avoid federalincome tax.

2) The tax year in which any payment wasreceived has closed.

You may qualify for an automatic exten-sion of six months from the due date of thereturn, excluding extensions, to make thiselect ion. See Regulations sections301.91002(b) and (d) for more information.You can read the full text of these provisionsat some IRS offices and public libraries.

1) Reduced selling price ........................... $85,0002) Minus: Basis .......................................... 40,0003) Adjusted gross profit ............................. $45,0004) Minus: Gain reported in 1996 & 1997 .. 24,0005) Gain to be reported ............................... $21,0006) Selling price to be received:

Reduced selling price ......... $85,000

Minus: Payments receivedin 1996 and 1997 ............... 40,000 $45,000

Gain realized:

Selling price ............................................... $50,0007) New gross profit percentage(line 5 line 6) ...................................... 46.67% Minus: Property's adj. basis ........ $25,000

Commission ..................... 3,000 28,000Gain realized .............................................. $22,000

Gain recognized in year of sale:

Cash ........................................................... $10,000Market value of note .................................. 40,000Total realized in year of sale ..................... $50,000Minus: Property's adj. basis ........ $25,000

Commission ..................... 3,000 28,000Gain recognized ......................................... $22,000

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ered received on the later of either of the fol-lowing dates.

1) The date the debt becomes secured.

2) The date you receive the debt proceeds.

A debt is secured by an installment obli-gation to the extent that payment of principalor interest on the debt is directly secured(under the terms of the loan or any underlyingarrangement) by any interest in the install-ment obligation.

Limit. The net debt proceeds treated asa payment on the pledged installment obli-gation cannot be more than the excess of theamount in item 1 over the amount in item 2,below.

1) The total contract price on the install-ment sale.

2) Any payments received on the install-ment obligation before the date the netdebt proceeds are treated as a payment.

Installment payments. The pledge ruleaccelerates the reporting of the installmentobligation payments. Do not report paymentsreceived on the obligation after it has beenpledged until the payments received are morethan the amount reported under the pledgerule.

Exception. The pledge rule does notapply to debt incurred after December 17,1987, to refinance a debt under the followingcircumstances.

1) The debt was outstanding on December17, 1987.

2) The debt was secured by that installmentsale obligation on that date and at alltimes thereafter until the refinancing oc-curred.

A refinancing as a result of the creditor'scalling of the debt is treated as a continuation

of the original debt if a person other than thecreditor or a person related to the creditorprovides the refinancing.

This exception applies only to the refi-nancing that does not exceed the principal ofthe original debt immediately before the refi-nancing. Any excess is treated as a paymenton the installment obligation.

Escrow AccountIn some cases, the sales agreement, or alater agreement, may call for the buyer toestablish an irrevocable escrow account fromwhich the remaining installment payments(including interest) are to be made. Generally,these sales cannot be reported on the in-

stallment method. The buyer's obligation ispaid in full when the balance of the purchaseprice is deposited into the escrow account.When an escrow account is established, youno longer rely on the buyer for the rest of thepayments, but on the escrow arrangement.

Example. You sell property for $10,000.The sales agreement calls for a down pay-ment of $1,000 and payment of $1,500 ineach of the next 6 years to be made from anirrevocable escrow account containing thebalance of the purchase price plus interest.You cannot report the sale on the installmentmethod because the full purchase price isconsidered received in the year of sale. Youmust report the entire gain in the year of sale.

Escrow established in a later year. If youmake an installment sale and in a later yearan irrevocable escrow account is establishedto pay the remaining installments plus inter-est, the amount placed in the escrow accountrepresents payment of the balance of the in-stallment obligation. Therefore, you cannotuse the installment method to report anypayments you receive from the escrow ac-count.

Substantial restriction. If an escrow ar-

rangement imposes a substantial restrictionon your right to receive the sale proceeds, thesale can be reported on the installmentmethod, provided it otherwise qualifies. Foran escrow arrangement to impose a sub-stantial restriction, it must serve a bona fidepurpose of the buyer, that is, a real and defi-nite restriction placed on the seller or a spe-cific economic benefit conferred on the buyer.

DepreciationRecapture IncomeIf you sell property for which you claimed de-preciation deductions, report any depreciationrecapture income in the year of sale, whetheror not an installment payment was received

that year. Figure your depreciation recaptureincome (including the section 179 deductionand the section 179A deduction recapture) inPart III of Form 4797. Report the recaptureincome in Part II of Form 4797 as ordinaryincome in the year of sale. The recapture in-come is also included in Part I of Form 6252.However, the gain equal to the recapture in-come is not reported on the installmentmethod. Report any gain greater than the re-capture income on the installment method.For more information on depreciation recap-ture, see chapter 3 in Publication 544.

The ordinary recapture income reported inthe year of sale is included in your installmentsale basis in determining your gross profit onthe installment sale. See the discussion under

General Rules, earlier.

Sale toRelated PersonTwo special rules apply to an installment salebetween related persons. Test your saleagainst Rule 1 first. If Rule 1 does not apply,test your sale against Rule 2. For purposesof these rules, spouses, children, grandchild-ren, brothers, sisters, and parents are allconsidered related persons. A partnershipor corporation in which you have an interest,or an estate or trust with which you have aconnection, can also be considered a relatedperson.

For more information on these kinds ofsales, see section 453 of the Internal Reve-nue Code.

Rule 1Sale of DepreciablePropertyIf you sell depreciable property to certain re-lated persons, you cannot report the sale us-ing the installment method. Instead, all pay-ments to be received are considered receivedin the year of sale. Depreciable property forthis rule is any property that the purchasercan depreciate.

Payments to be received include the totalof all noncontingent payments and the FMVof any payment contingent as to amount.

In the case of contingent payments forwhich the FMV cannot be reasonably deter-mined, the basis is recovered ratably. Thepurchaser cannot increase the basis of anyproperty acquired in the sale by any amountbefore the seller includes the amount in in-come.

Exceptions to Rule 1. Rule 1 will not applyif no significant tax deferral benefit will bederived from the sale. It does not apply if youcan show to the satisfaction of IRS that

avoidance of federal income tax was not oneof the principal purposes of the sale.

Rule 2Sale and ResaleGenerally, a special rule applies if you (aninstallment seller) make a first disposition(sale or exchange) to a related person whothen makes a second disposition (sale, ex-change, or gift) under the following circum-stances.

1) The related person makes the seconddisposition before making all paymentson the first disposition.

2) The related person makes the seconddisposition within 2 years of the first dis-

position.

Under this rule, you treat part or all of theamount the related person realizes (or theFMV if the disposed property is not sold orexchanged) from the second disposition as ifyou received it from the first disposition at thetime of the second disposition.

Example 1. In 1997, Harvey Green soldfarm land to his son Bob for $500,000, whichwas to be paid in five equal payments over 5years, plus adequate stated interest on thebalance due. His installment sale basis forthe farm land was $250,000 and the propertywas not subject to any outstanding liens ormortgages. His gross profit percentage is50% (gross profit of $250,000 contract priceof $500,000). He received $100,000 in 1997and included $50,000 in income for that year($100,000 0.50). Bob made no improve-ments to the property and sold it to Alfalfa Inc.in 1998 for $600,000 after making the pay-ment for that year. The amount realized fromthe second disposition is $600,000. Harveyfigures his installment sale income for 1998as follows:

Harvey will not include in his installmentsale income any principal payments he re-ceives on the installment obligation for 1999,2000, and 2001 because he has already re-ported the total payments of $500,000 fromthe first disposition ($100,000 in 1997 and$400,000 in 1998).

Example 2. Assume the facts are thesame as Example 1 except that Bob sells theproperty for only $400,000. The gain for 1998is figured as follows:

Lesser of: 1) Amount realized on seconddisposition, or 2) Contract price on firstdisposition .............................................. $500,000Subtract: Sum of payments from Bob in1997 and 1998 ....................................... 200,000Amount treated as payment because ofsecond disposition ................................. $300,000

Add: Payment from Bob in 1998 ........... + 100,000

Total payments received and treated asreceived for 1998 ................................... $400,000

Multiply by gross profit % ............. ......... .50Installment sale income for 1998 .......... $200,000

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Harvey receives a $100,000 payment in

1999 and another in 2000. They are not taxedbecause he treated the $200,000 from thedisposition in 1998 as a payment receivedand paid tax on the gain. In 2001, he receivesthe final $100,000 payment. He figures thegain he must recognize in 2001 as follows:

Exceptions to Rule 2. These rules do notapply to a second disposition, and any latertransfer, if you can show, to the satisfactionof the IRS, that neither the first disposition (tothe related person) nor the second dispositionhad as one of its principal purposes theavoidance of federal income tax. Generally,an involuntary second disposition will qualifyunder the nontax avoidance exception, suchas when a creditor of the related personforecloses on the property or the related per-son declares bankruptcy.

The nontax avoidance exception also ap-plies to a second disposition that is also an

installment sale if the terms of payment underthe installment resale are substantially equalto or longer than those for the first installmentsale. However, the exception does not applyif the resale terms permit significant deferralof recognition of gain from the first sale as, forexample, if amounts from the resale are col-lected sooner.

In addition, any sale or exchange of stockto the issuing corporation is not treated as afirst disposition. An involuntary conversion isnot treated as a second disposition if the firstdisposition occurred before the threat of con-version. A transfer after the death of theperson making the first disposition or the re-lated person's death, whichever is earlier, isnot treated as a second disposition.

Like-Kind ExchangeIf you trade business or investment propertyfor the same kind of property, you can post-pone reporting part of the gain. These tradesare known as like-kind exchanges. Theproperty you receive in a like-kind exchangeis treated as if it were a continuation of theproperty you give up.

In a like-kind exchange, you do not haveto report any part of your gain if you receiveonly like-kind property. However, if you alsoreceive money or other property in the ex-change, you must report your gain to the ex-tent of the money and the FMV of the otherproperty received.

Lesser of: 1) Amount realized on seconddisposition, or 2) Contract price on firstdisposition .............................................. $400,000

For more information on like-kind ex-changes, see Like-Kind Exchangesin chapter1 of Publication 544.

Installment payments. If, in addition tolike-kind property, you receive an installmentobligation in the exchange, the following rulesapply.

1) The contract price is reduced by theFMV of the like-kind property received inthe trade.

2) The gross profit is reduced by any gainon the trade that can be postponed.

3) Like-kind property received in the tradeis not considered payment on the in-stallment obligation.

Example. In 1998, George Brown tradespersonal property with an installment salebasis of $400,000 for like-kind property hav-ing an FMV of $200,000. He also receives aninstallment note for $800,000 in the trade.Under the terms of the note, he is to receive$100,000 (plus interest) in 1999 and the bal-ance of $700,000 (plus interest) in 2000.

George's selling price is $1,000,000($800,000 installment note + $200,000 FMVof like-kind property received). His gross profit

is $600,000 ($1,000,000

$400,000 install-ment sale basis). The contract price is$800,000 ($1,000,000 $200,000). Thegross profit percentage is 75% ($600,000 $800,000). He reports no gain in 1998 be-cause the like-kind property he receives is nottreated as a payment for figuring gain. Hereports $75,000 gain for 1999 (75% of$100,000 payment received) and $525,000gain for 2000 (75% of $700,000 payment re-ceived).

Deferred exchanges. A deferred exchangeis one in which you have transferred theproperty and are to receive like-kind propertyat a later date. Under this type of exchange,the person receiving your property may berequired to place funds in an escrow accountor trust. If certain rules are met, these fundswill not be considered a payment until youhave the right to receive the funds or, if ear-lier, the end of the exchange period. SeeRegulations section 1.1031(k)1(j)(2) forthese rules.

Contingent Payment SaleFor installment sales, a contingent paymentsale is one whose total selling price cannotbe determined by the end of the tax year inwhich the sale takes place.

If the selling price cannot be determinedby the end of the tax year, the contract priceand the gross profit percentage cannot bedetermined (using the same rules that apply

to an installment sale with a fixed sellingprice). This happens, for example, if you sellyour business and the selling price includesa percentage of its profits in future years.

For rules on using the installment methodfor a contingent payment sale or a contingentpayment sale with unstated interest, seeRegulations section 15A.4531(c).

Single Saleof Several AssetsIf you sell different types of assets in a singlesale, you must identify each asset to deter-mine whether you can use the installmentmethod to report the sale of that asset. You

also have to allocate part of the selling priceto each asset. If you sell assets that constitutea trade or business, see Sale of a Business,next.

Unless an allocation of the selling pricehas been agreed to by both parties in anarm's-length transaction, you must allocatethe selling price to an asset based on its FMV.If the buyer assumes a debt, or takes theproperty subject to a debt, you must reducethe FMV by the debt. This is the net FMV.

A sale of separate and unrelated assetsof the same type under a single contract isreported as one transaction for the installmentmethod. However, if an asset is sold at a loss,its disposition cannot be reported on the in-stallment method. It must be reported sepa-rately. The remaining assets sold at a gainare reported together.

Example. You sold three separate andunrelated parcels of real property (A, B, andC) under a single contract calling for a totalselling price of $130,000. The total sellingprice consisted of a cash payment of $20,000,the buyer's assumption of a $30,000 mort-gage on parcel B, and an installment obli-gation of $80,000 payable in eight annual in-stallments, plus interest at 8% a year.

Your installment sale basis for each parcelwas $15,000. Your net gain was $85,000($130,000 $45,000). You report the gain onthe installment method.

The sales contract did not allocate theselling price or the cash payment received inthe year of sale among the individual parcels.The FMV of parcels A, B, and C were$60,000, $60,000, and $10,000, respectively.

Since the installment sale basis for parcelC was more than its FMV, it was sold at a lossand must be treated separately. You mustallocate the total selling price and theamounts received in the year of sale betweenparcel C and the remaining parcels.

Of the total $130,000 selling price, youmust allocate $120,000 to parcels A and Btogether and $10,000 to parcel C. You should

allocate the cash payment of $20,000 re-ceived in the year of sale and the notereceivable on the basis of the proportionatenet FMV. The allocation is figured as follows:

You cannot report the sale of parcel C onthe installment method because the sale re-sults in a loss. You report this loss of $5,000($10,000 selling price $15,000 installmentsale basis) in the year of sale. However, ifparcel C was held for personal use, the lossis not deductible.

You allocate the installment obligation of$80,000 to the properties sold based on theirproportionate net FMVs (90% to parcels Aand B, 10% to parcel C).

Subtract: Sum of payments from Bob in1997 and 1998 ....................................... 200,000Amount treated as payment because ofsecond disposition ................................. $200,000

Add: Payment from Bob in 1998 ........... + 100,000Total payments received and treated asreceived for 1998 ................................... $300,000

Multiply by gross profit % .............. ........ .50Installment sale income for 1998 .......... $150,000

Total payments from the first dispositionreceived by the end of 2001 ................. $500,000

Minus the sum of:Payment from 1997 .......... $100,000Payment from 1998 .......... 100,000Amount treated as pay-ment in 1998 .................... 200,000

Total on which gain was previouslyrecognized ............................................ 400,000Payment on which gain is recognizedfor 2001 ................................................. $100,000

Multiply by gross profit % .......... ........... .50Installment sale income for 2001 ......... $50,000

Parcels Aand B Parcel C

FMV ..................................... $120,000 $10,000Minus: Mortgage assumed .. 30,000 -0-Net FMV .............................. $90,000 $10,000

Proportionate net FMV:Percentage of total .............. 90% 10%

Payments in year of sale:$20,000 90% .................... $18,000$20,000 10% .................... $2,000

Excess of parcel B mortgage

over installment sale basis .. 15,000

Allocation of payments re-ceived (or considered re-ceived) in year of sale . .. .. .. .. $33,000 $2,000

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Sale of a BusinessThe installment sale of an entire business forone overall price under a single contract isnot the sale of a single asset.

Allocation of selling price. The selling pricemust be allocated for each asset class for thefollowing reasons.

1) The sale of a business generally in-cludes real and personal property that

can be reported on the installmentmethod and inventory items that cannot.

2) Any depreciation recapture income fromthe sale of depreciable property cannotbe reported on the installment method.It is reported in full in the year of the sale.

3) Assets sold at a loss cannot be reportedon the installment method.

Inventory. If inventory items are includedin an installment sale, you may have anagreement stating which payments are forinventory and which are for the other assetsbeing sold. If you do not, each payment mustbe allocated between the inventory and theother assets sold.

The sale of inventory items cannot be re-ported on the installment method. All gain orloss on their sale must be reported in the yearof sale, even if you are paid in later years.

Report the amount you receive (or will re-ceive) on the sale of inventory items as ordi-nary business income. Use your basis in theitems to figure the cost of goods sold anddeduct the part of the selling expenses allo-cated to inventory as an ordinary businessexpense.

Residual method. Except for assets ex-changed under the like-kind exchange rules,both the buyer and seller of a business mustuse the residual method to allocate the saleprice to each business asset transferred. Thismethod determines gain or loss from thetransfer of each asset.

The residual method must be used for anytransfer of a group of assets that constitutesa trade or business and for which the buyer'sbasis is determined only by the amount paidfor the assets. This applies to both direct andindirect transfers, such as the sale of a busi-ness or the sale of a partnership interest inwhich the basis of the buyer's share of thepartnership assets is adjusted for the amountpaid. A group of assets constitutes a tradeor business if goodwill or going concern valuecould, under any circumstances, attach to theassets.

The residual method provides for the saleprice to first be reduced by cash, demanddeposits, and similar accounts transferred bythe seller. The sale price remaining after this

reduction must be allocated among the vari-ous business assets in a specified order.

The allocation must be made among thefollowing assets in proportion to (but not inexcess of) their FMV on the purchase date inthe following order.

1) Certificates of deposit, U.S. governmentsecurities, readily marketable stock orsecurities, and foreign currency.

2) All other assets except section 197 in-tangibles.

3) Section 197 intangibles, except intangi-ble assets in the nature of goodwill andgoing concern value.

4) Section 197 intangibles in the nature ofgoodwill and going concern value.

More information. For more information,see Sale of a Business in chapter 2 of Publi-cation 544. For more information on section197 intangibles, see chapter 12 of Publication535.

How to report the sale of a business. Boththe seller and buyer must prepare and attach

Form 8594, Asset Acquisition Statement Un-der Section 1060, to their income tax returnfor the year the sale occurred. If the amountallocated to any asset is increased or de-creased after Form 8594 is filed, a supple-mental statement in Part III of a new Form8594 must be completed.

Sale of partnership interest. A partner whosells a partnership interest at a gain may beable to report the sale on the installmentmethod. The sale of a partnership interest istreated as the sale of a single capital asset.However, the partner must allocate a portionof the proceeds to ordinary income if thepartnership's assets included unrealizedreceivables and inventory items. (The term

unrealized receivables includes depreciationrecapture income, discussed earlier.)

The gain allocated to the unrealizedreceivables and the inventory cannot be re-ported under the installment method. Thegain allocated to the other assets can be re-ported under the installment method.

For more information on the treatment ofunrealized receivables and inventory, seePublication 541.

Example

On January 4, 1998, you sold the machineshop you operated since 1988. You receiveda $100,000 down payment and the buyer's

note for $120,000. The note payments are$15,000 each, plus 10% interest, due everyJuly 1 and January 1, beginning in 1999. Thetotal selling price is $220,000. Your sellingexpenses are $11,000. The selling expensesare divided among all the assets sold, in-cluding inventory.

Your selling expense for each asset is 5%of the asset's selling price ($11,000 sellingexpense $220,000 total selling price).

The FMV, adjusted basis, and depreci-ation claimed on each asset sold are as fol-lows:

Under the residual method, you allocatethe selling price to each of the assets basedon their FMV ($201,500). The remainingamount is allocated to your section 197 in-tangible, goodwill ($18,500).

The assets included in the sale, their sell-ing prices based on their FMVs, the sellingexpense allocated to each asset, the adjustedbasis, and the gain for each asset are shownin the following chart.

The building was acquired in 1988, theyear the business began, and it is section1250 property. There is no depreciation re-

capture income because the building wasdepreciated using the straight line method.

All gain on the truck, machine A, and ma-chine B is depreciation recapture incomesince it is the lesser of the depreciationclaimed or the gain on the sale. Figure de-preciation recapture in Part III of Form 4797.

The total depreciation recapture incomereported in Part II of Form 4797 is $5,209.This consists of $3,650 on machine A, $799on the truck, and $760 on machine B (thegain on each item since it was less than thedepreciation claimed). These gains are re-ported in full in the year of sale and are notincluded in the installment sale computation.

Of the $220,000 total selling price, the$10,000 for inventory assets cannot be re-

ported on the installment method. The sellingprices of the truck and machines are also re-moved from the total selling price becausegain on these items is reported in full in theyear of sale.

The selling price equals the contract pricefor the installment sale ($108,500). The as-sets included in the installment sale, theirselling price, and their installment sale basisare shown in the following chart.

The gross profit percentage(gross profit contract price) for the installment sale is48% ($52,075 $108,500). The gross profitpercentage for each asset is figured as fol-lows:

Since the sale includes assets sold on theinstallment method and assets for which thegain is reported in full in the year of sale,payments must be allocated between the in-stallment part of the sale and the part re-ported in the year of sale. The selling pricefor the installment sale is $108,500. This is49.3% of the total selling price of $220,000($108,500 $220,000). The selling price ofassets not reported on the installment methodis $111,500. This is 50.7% ($111,500 $220,000) of the total selling price.

Multiply principal payments by 49.3% todetermine the part of the payment for the in-stallment sale. The balance, 50.7%, is for thepart reported in the year of the sale.

The gain on the sale of the inventory,machines, and truck is reported in full in theyear of sale. When you receive principalpayments in later years, no part of the pay-ment for the sale of these assets is includedin gross income. Only the part for the in-

SalePrice

SaleExp.

Adj.Basis Gain

Inventory ..... $10,000 $500 $8,000 $1,500Land ........... 42,000 2,100 15,000 24,900Building ....... 48,000 2,400 36,000 9,600Mch. A ........ 71,000 3,550 63,800 3,650Mch. B ........ 24,000 1,200 22,040 760Truck .......... 6,500 325 5,376 799Goodwill ...... 18,500 925 -0- 17,575

$220,000 $11,000 $150,216 $58,784

SellingPrice

Install-mentSale

BasisGrossProfit

Land .......................... $42,000 $17,100 $24,900Build ing ... .. .. .. .. .. .. .. .. .. 48,000 38,400 9,600Goodwill . ................... 18,500 925 17,575Total .......................... $108,500 $56,425 $52,075

PercentageLand $24,900 $108,500 .......................... 22.95Building $9,600 $108,500 ....................... 8.85Goodwill $17,575 $108,500 .................... 16.20Total ............................................................... 48.00

Depre-ciation Adjusted

Asset FMV Claimed Basis

Inventory . .. .. .. .. .. .. .. .. .. .. . $10,000 -0- $8,000Land . .... ... ... ... ... ... ... .. ... . 42,000 -0- 15,000Building ........................ 48,000 $9,000 36,000Machine A .................... 71,000 27,200 63,800Machine B .................... 24,000 12,960 22,040Truck .. .. .. .. .. .. .. .. .. .. .. .. .. .. 6,500 18,624 5,376

201,500 67,784 150,216

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stallment sale (49.3%) is used in the install-ment sale computation.

The only payment received in 1998 is thedown payment of $100,000. The part of thepayment for the installment sale is $49,300($100,000 49.3%). This amount is used inthe installment sale computation.

Installment income for 1998. Your install-ment income for each asset is the gross profitpercentage for that asset times $49,300, theinstallment income received in 1998.

Installment income after 1998. You figureinstallment income for years after 1998 byapplying the same gross profit percentagesto 49.3% of the total payments you receiveon the buyer's note during the year.

Unstated Interest

An installment sale contract generally pro-vides that each deferred payment on the salewill include interest or that there will be aninterest payment in addition to the principalpayment. Interest provided in the contract iscalled stated interest.

If an installment sale contract with someor all payments due more than one year afterthe date of sale does not provide for interest,part of each payment due more than 6months after the date of sale may be treatedas interest. The amount treated as interest iscalled unstated interest.

When the stated interest rate in the con-tract is lower than the applicable federal rate(AFR), defined below, unstated interest is thedifference between interest figured at the

federal rate and any interest figured at therate specified in the sales contract.Generally, the unstated interest rules do

not apply to a debt given in consideration fora sale or exchange of personal-use property.Personal-use property is any property inwhich substantially all of its use by the buyeris not in connection with a trade or businessor an investment activity.

Applicable federal rate (AFR). The AFRdepends on the month the binding contract forthe sale or exchange of property is made andthe term of the instrument. For an installmentobligation, the term of the instrument is itsweighted average maturity, as defined inRegulations section 1.12731(e)(3). The AFR

for each term is shown below.

For a term of 3 years or less, the AFR isthe federal short-term rate.

For a term of over 3 years, but not over9 years, the AFR is the federal mid-termrate.

For a term of over 9 years, the AFR is thefederal long-term rate.

The applicable federal rates are publishedmonthly in the Internal Revenue Bulletin. Youcan get this information by contacting an IRSoffice.

Effects of Unstated InterestIf the unstated interest rules apply, you andthe buyer must treat part of the installmentsale price as interest. The unstated interestrules require you to treat part of each pay-ment as interest, even though it is not calledinterest in your agreement with the buyer.Unstated interest reduces the stated sellingprice of the property and increases your in-terest income. It also reduces the buyer'sbasis in the property and increases the buy-er's interest expense.

If you do not use the installment methodto report the sale, you report the entire gainin the year of sale. You must reduce theselling price by the total unstated interest be-fore you can determine the gain.

You must report the unstated interest plusany interest specified under the contract onyour tax return.

Figuring Unstated InterestA debt instrument must provide for adequatestated interest. If not, unstated interest isfigured on the debt. Generally, a debt instru-ment provides for adequate stated interest ifit calls for interest at a rate no lower than thetest rate of interest applicable to the debt in-strument.

Test rate of interest. The test rate of interestfor a debt instrument is the 3-month rate. The3-month rate is the lower of either of the fol-lowing AFRs.

1) The lowest AFR in effect during the3-month period ending with the firstmonth in which there is a binding writtencontract that substantially sets forth theterms under which the sale or exchangeis ultimately consummated.

2) The lowest AFR in effect during the3-month period ending with the month inwhich the sale or exchange occurs.

Special rules. For sales or exchangesof property (other than new section 38 prop-erty, which includes most tangible personalproperty) involving seller financing of$3,823,100 or less, the test rate of interestcannot be more than 9%, compoundedsemiannually. For seller financing over$3,823,100, and for all sales or exchangesof new section 38 property, the test rate ofinterest is 100% of the AFR.

For information on new section 38 prop-erty, see section 48(b) of the Internal Reve-nue Code, as in effect before the enactmentof Public Law 101508.

Relationship of Internal Revenue Codesections 1274 and 483. Unstated interest isimposed under section 1274 or 483 of theCode, depending on the characteristics(amount, kind of property, etc.) of the debtinstrument and the sale or exchange forwhich it is given in consideration.

Section 1274 applies to any debt instru-ment issued for the sale or exchange ofproperty if some or all payments due underthe debt instrument are due more than 6months after the date of sale or exchange.The AFR is determined under section 1274and interest determined under that section istreated as original issue discount.

Section 483 applies to sales or exchangesof property not covered by the provisions ofsection 1274. Interest determined under sec-tion 483 is treated as unstated interest.

Section 483 rules. The section 483 rulesapply to payments on the sale or exchangeof property under a contract in which the fol-lowing conditions exist.

1) Some or all payments are due more thanone year after the date of sale or ex-change.

2) There is total unstated interest (or inad-equate stated interest).

Unstated interest is figured on any paymentthat meets the following conditions.

1) The payment constitutes all or part of theselling price.

2) The payment is due more than 6 monthsafter the date of sale or exchange.

Total unstated interest. Total unstatedinterest is the amount equal to the excess ofitem 1 over item 2, listed next.

1) The sum of payments due under thecontract.

2) The sum of the present values of thepayments and the present values of anyinterest payments due under the con-tract.

Transactions to which section 483 rulesapply. The section 483 rules apply to thefollowing items.

1) Debt instruments from the transactionslisted below.

a) The sale or exchange of a farm for$1,000,000 or less by the followingpersons.

i) An individual.

ii) An estate.

iii) A testamentary trust.

iv) A small business corporation(defined in section 1244(c)(3)

of the Internal Revenue Code).v) A domestic partnership that

meets requirements similar tothose of section 1244(c)(3).

b) The sale or exchange of a mainhome by the owner.

c) The sale or exchange of propertywith total payments (principal andinterest) of $250,000 or less.

d) Certain land transfers between re-lated persons.

2) A cash method debt instrument.

Sale of a farm. The section 483 rulesapply to the sale of a farm if the selling price

cannot exceed $1,000,000. If the selling pricecan exceed $1,000,000, the section 1274rules (discussed later) apply. For determiningthe selling price, all sales and exchanges thatare part of the same transaction (or a seriesof transactions) are treated as one sale orexchange.

Sale with total payments of $250,000or less. The section 483 rules apply if thesum of the following amounts does not ex-ceed $250,000.

1) The total payments (interest and princi-pal) due under the debt instrument andunder all other debt instruments receivedas consideration for the sale or ex-change.

IncomeLand22.95% of $49,300 ................. ........ $11,314Building8.85% of $49,300 ...................... 4,363Goodwill16.2% of $49,300 ..................... 7,987Total installment income for 1998 ........ ..... $23,664

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2) The total of any other consideration tobe received for the sale or exchange.

The section 1274 rules apply if the amountexceeds $250,000.

Any consideration (other than a debt in-strument) is taken into account at its FMV.All sales and exchanges that are part of thesame transaction (or series of related trans-actions) are treated as one sale or exchange.

Land sale between related persons.The section 483 rules apply to debt instru-ments issued in a land sale between relatedpersons to the extent the sum of the followingamounts does not exceed $500,000.

The stated principal of the debt instru-ment issued in the sale or exchange.

The total stated principal of any otherdebt instruments for prior land sales be-tween these individuals during the calen-dar year.

The section 1274 rules, if otherwise ap-plicable, apply to debt instruments issued ina sale of land to the extent the stated principalamount is in excess of $500,000, or if anyparty to the sale is a nonresident alien.

Related persons include an individual andthe members of the individual's family andtheir spouses. Members of an individual'sfamily include the individual's spouse, brotherand sister (whether by whole or half blood),ancestors, and lineal descendants.

Cash method debt instrument. This isany debt instrument given as considerationfor the sale or exchange of property (otherthan new section 38 property) with a statedprincipal of $2,730,800 or less if the followingitems apply.

1) The lender (holder) does not use an ac-crual method of accounting and is not adealer in the type of property sold orexchanged.

2) Both the borrower (issuer) and the lenderjointly elect to account for interest on thedebt instrument under the cash methodof accounting.

3) Section 1274 of the Internal RevenueCode would apply except for the electionin (2) above.

Exceptions to section 483 rules. The un-stated interest rules do not apply to the fol-lowing types of transactions.

Sale price of $3,000 or less. If it can bedetermined at the time of sale or exchangeof the property that the selling price will notexceed $3,000, the unstated interest rules donot apply to the sale or exchange.

Carrying charges. The buyer of personal

property does not figure unstated interest ifany part of the payment includes separatelystated carrying charges.

Additional exceptions. See the dis-cussion of the exceptions that apply to bothsections 483 and 1274, later.

Section 1274 rules. The section 1274 rulesapply to any debt instrument given in consid-eration for the sale or exchange of propertyunder the following conditions in both 1) and2).

1) The stated redemption price at maturityfor the debt instrument exceeds theamount in either a) or b), below.

a) The stated principal when there isadequate stated interest.

b) The imputed principal in all othercases.

2) Some or all payments under the debtinstrument are due more than 6 monthsafter the date of the sale or exchange.

Imputed principal. There is adequatestated interest under section 1274 if thestated principal for a debt instrument is lessthan or equal to the imputed principal. Theimputed principal of any debt instrument isequal to the sum of the present values of allpayments under the debt instrument. Thepresent value of any payment is determinedby using the AFR for the date of sale or ex-change. If a debt instrument has a single fixedinterest rate paid or compounded at leastannually, and the rate is equal to or greaterthan the test rate, there is adequate statedinterest.

Issue price. In transactions to whichsection 1274 applies, the issue price of thedebt instrument must be determined. Wherethere is adequate stated interest, the issueprice is the stated principal. If the debt in-strument does not provide for adequatestated interest, the issue price of the instru-

ment is the imputed principal of the debt in-strument. The issue price of a debt instrumentis generally used to determine the sale price(in whole or in part) of any property acquiredfor the debt instrument.

Exceptions to imputed principal rules.The imputed principal rules do not apply toany of the debt instruments involved intransactions listed earlier under Transactionsto which section 483 rules apply. (Also seeExceptions to sections 483 and 1274, below.)

Assumption of debt instrument. Do notapply the imputed principal rules to the as-sumption of a debt instrument or if propertyis taken subject to the debt instrument. How-ever, these rules do apply if the terms orconditions of the debt instrument are modified

or the nature of the transaction is changed.

Exceptions to sections 483 and 1274. Theunstated interest and imputed principal rulesdo not apply in the following circumstances.

Publicly traded debt instruments orproperty. Transactions involving publiclytraded debt instruments or any debt instru-ment issued in consideration for the sale orexchange of publicly traded property are notsubject to these rules. A publicly traded in-strument is one that is traded on an estab-lished securities market.

Patents. When all substantial rights to apatent, or an undivided interest in propertythat includes part of all substantial rights to apatent, are sold or exchanged, do not figureunstated interest or imputed principal on anyamount contingent on the productivity, use,or disposition of the property transferred. Thisrule applies only if long-term capital gain orloss treatment applies to the sale (see Publi-cation 544).

Annuities. Payments that depend inwhole or in part on the life expectancy of anyindividual do not require the computation ofunstated interest or imputed principal.

Personal-use property. Debt instru-ments issued in consideration for the sale orexchange of personal-use property wheresubstantially all of its use by the buyer is forother than a trade or business or as income-producing property are not subject to the un-stated interest or imputed principal rules.

More information. For information on figur-ing unstated interest and other special rules,see sections 483 and 1274 of the InternalRevenue Code and their regulations.

Disposition ofInstallment ObligationA disposition generally includes a sale, ex-change, cancellation, bequest, distribution,or transmission of an installment obligation.An installment obligation is the buyer's note,

deed of trust, or other evidence the buyer willmake future payments to you.

If you are using the installment methodand you dispose of the installment obligation,you generally have a gain or loss to report. Itis considered gain or loss on the sale of theproperty for which you received the install-ment obligation. If the original installment saleproduced ordinary income, the disposition ofthe obligation will result in ordinary incomeor loss. If the original sale resulted in a capitalgain, the disposition of the obligation will re-sult in a capital gain or loss.

Use the following rules to figure your gainor loss from the disposition of an installmentobligation.

1) If you sell or exchange the obligation,or if you accept less than face value insatisfaction of the obligation, the gain orloss is the difference between your basisin the obligation and the amount you re-alize.

2) If you dispose of the obligation in anyother way, the gain or loss is the differ-ence between your basis in the obli-gation and its FMV at the time of thedisposition. This rule applies, for exam-ple, when you give the installment obli-gation to someone else or cancel thebuyer's debt to you.

Basis. Figure your basis in an installment

obligation by multiplying the unpaid balanceon the obligation by your gross profit per-centage. Subtract that amount from the un-paid balance. The result is your basis in theinstallment obligation.

Example. Several years ago, you soldproperty on the installment method. Thebuyer still owes you $10,000 of the sale price.This is the unpaid balance on the buyer's in-stallment obligation to you. Because yourgross profit percentage is 60%, $6,000 (60% $10,000) is the profit owed you on the obli-gation. The rest of the unpaid balance,$4,000, is your basis in the obligation.

Transfer between spouses or formerspouses. No gain or loss is recognized onthe transfer of an installment obligation be-tween a husband and wife or a former hus-band and wife if incident to a divorce. Atransfer is incident to a divorce if it occurswithin one year after the date on which themarriage ends or is related to the end of themarriage. The same tax treatment of thetransferred obligation applies to thetransferee spouse or former spouse as wouldhave applied to the transferor spouse or for-mer spouse. The basis of the obligation tothe transferee spouse (or former spouse) isthe adjusted basis of the transferor spouse.

The nonrecognition rule does not apply ifthe spouse or former spouse receiving theobligation is a nonresident alien.

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Gift. A gift of an installment obligation is adisposition. The gain or loss is the differencebetween your basis in the obligation and itsFMV at the time you make the gift.

For gifts between spouses or formerspouses, see Transfers between spouses orformer spouses, above.

Cancellation. If an installment obligation iscanceled or otherwise becomes unenforce-able, it is treated as a disposition other thana sale or exchange. Your gain or loss is thedifference between your basis in the obli-gation and its FMV at the time you cancel it.If the parties are related, the FMV of the ob-ligation is considered to be no less than its fullface value.

Forgiving part of the buyer's debt. If youaccept part payment on the balance of thebuyer's installment debt to you and forgive therest of the debt, you treat the settlement asa disposition of the installment obligation. Thegain or loss is the difference between yourbasis in the obligation and the amount yourealize on the settlement.

If you reduce the selling price but do notcancel the rest of the buyer's debt to you, itis not considered a disposition of the install-ment obligation. You must refigure the gross

profit percentage and apply it to paymentsyou receive after the reduction. See Sellingprice reducedunder General Rules, earlier.

Assumption. If the buyer of your propertysells it to someone else and you agree to letthe new buyer assume the original buyer'sinstallment obligation, you have not disposedof the installment obligation. It is not a dispo-sition even if the new buyer pays you a higherrate of interest than the original buyer.

Transfer due to death. The transfer of aninstallment obligation (other than to a buyer)as a result of the death of the seller (or otherholder of the obligation) is not a disposition.Any unreported gain from the installment ob-

ligation is not treated as gross income to thedecedent. No income is reported on the de-cedent's return due to the transfer. Thismeans whoever receives the installment obli-gation as a result of the seller's death is taxedon the installment payments the same as theseller would have been if the seller had livedto receive the payments.

However, if an installment obligation iscanceled, becomes unenforceable, or istransferred to the buyer because of the deathof the holder of the obligation, it is a disposi-tion. The estate must figure its gain or losson the disposition. If the holder and the buyerwere related, the FMV of the installment obli-gation is considered to be no less than its fullface value.

RepossessionIf you repossess your property after makingan installment sale, you must figure the fol-lowing amounts.

1) Your gain (or loss) on the repossession.

2) Your basis in the repossessed property.

The rules for figuring these amounts de-pend on the kind of property you repossess.The rules for repossessions of personalproperty differ from those for real property.Special rules may apply if you repossessproperty that was your main home before thesale.

The repossession rules apply whether ornot title to the property was ever transferredto the buyer. It does not matter how you re-possess the property, whether you forecloseor the buyer voluntarily surrenders the prop-erty to you. However, it is not a repossessionif the buyer puts the property up for sale andyou repurchase it.

For the repossession rules to apply, therepossession must at least partially discharge(satisfy) the buyer's installment obligation toyou. The discharged obligation must be se-cured by the property you repossess. Thisrequirement is met if the property is auctionedoff after you foreclose and you apply the in-stallment obligation to your bid price at theauction.

Reporting the repossession. You reportgain or loss from a repossession on the sameform you used to report the original sale. Ifyou reported the sale on Form 4797, useForm 4797 to report the gain or loss on therepossession.

Personal PropertyIf you repossess personal property, you mayhave a gain or a loss on the repossession. Insome cases, you may also have a bad debt.

To figure your gain or loss, subtract thetotal of your basis in the installment obligationand any repossession expenses you havefrom the FMV of the property. If you receiveanything from the buyer besides the repos-sessed property, it is added to the property'sFMV before making this calculation.

How you figure your basis in the install-ment obligation depends on whether or notyou reported the original sale on the install-ment method. The method you used to reportthe original sale also affects the character ofyour gain or loss on the repossession.

For sales not reported on the installmentmethod: (see Electing Out of InstallmentMethod, earlier.)

Basis in installment obligation. Your basisis figured on its full face value or its FMVat the time of the original sale, whicheveryou used to figure your gain or loss in theyear of sale. From this amount, subtractall payments of principal you have receivedon the obligation. The result is your basisin the installment obligation. If only part ofthe obligation is discharged by the repos-session, figure your basis in only that part.

Gain or loss. To your basis in the obligation,add any repossession costs. If the FMVof the property you repossess is more thanthis total, you have a gain. Because it isgain on the installment obligation, it is allordinary income. If the FMV of the repos-

sessed property is less than the total ofyour basis plus repossession costs, youhave a loss. Because you included the fullgain in income in the year of sale, the lossis a bad debt. How you deduct the baddebt depends on whether you sold busi-ness or nonbusiness property in the ori-ginal sale. See Publication 550 for infor-mation on nonbusiness bad debts andchapter 14 of Publication 535 for informa-tion on business bad debts.

For sales reported on the installmentmethod:

Basis in installment obligation. Multiply theunpaid balance of your installment obli-

gation by your gross profit percentage.Subtract that amount from the unpaid bal-ance. The result is your basis in the in-stallment obligation.

Gain or loss. If the FMV of the repossessedproperty is more than the total of your ba-sis in the obligation plus any repossessioncosts, you have a gain. If the FMV is less,you have a loss. Your gain or loss on therepossession is the same character (capi-tal or ordinary) as your gain on the originalsale.

Use the following worksheet to deter-mine the taxable gain or loss on arepossession of personal property re-

ported on the installment method.

Example. You sold your piano for $1,500in December 1997 for $300 down and $100a month (plus interest). The payments beganin January 1998. Your gross profit percentageis 40%. You reported the sale on the install-ment method on your 1997 income tax return.After the fourth monthly payment, the buyerdefaults on the contract (which has an unpaidbalance of $800) and you are forced to fore-close on the piano. The FMV of the piano onthe date of repossession is $1,400. The legalcosts of foreclosure and the expense ofmoving the piano back to your home total$75. You figure your gain on the repossessionas follows:

Basis in repossessed property. Your basisin repossessed personal property is its FMVat the time of the repossession.

Fair market value (FMV). The FMV of re-possessed property is a question of fact tobe established in each case. If you bid for theproperty at a lawful public auction or judicialsale, its FMV is presumed to be the price it

sells for, unless there is clear and convincingevidence to the contrary.

Real PropertyThe rules for the repossession of real prop-erty allow you to keep essentially the sameadjusted basis in the repossessed propertyas you had before the original sale. You canrecover this entire adjusted basis when youresell the property. This, in effect, cancelsout the tax treatment that applied to you onthe original sale and puts you in the same taxposition you were in before that sale.

Therefore, you must regard as income toyou the total payments you have receivedfrom the buyer on the original sale. You re-

1) FMV of property repossessed .................2) Unpaid balance of installment

obligation .....................................3) Unrealized profit

(line 2 gross profit %) ..............4) Basis of obligation

(line 2 line 3) ............................5) Plus: Repossession costs ...........6) Gain or loss on repossession

(line 1 line 5) ........................................

1) FMV of property repossessed ................ $1,4002) Unpaid balance of installment

obligation .................................... $8003) Unrealized profit

(line 2 gross profit %) .............. 3204) Basis of obligation

(line 2 line 3) ........................... 4805) Plus: Repossession costs ... ... ... . 75 5556) Gain on repossession

(line 1 line 5) ........................................ $845

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port, as gain on the repossession, any partof the payments you have not yet included inincome. These payments are amounts youpreviously treated as a return of your adjustedbasis and excluded from income. However,the total gain you report is limited, as dis-cussed later.

Conditions. The following rules are man-datory. You must use them to figure yourbasis in the repossessed real property andyour gain on the repossession. They applywhether or not you reported the sale on theinstallment method. However, they apply onlyif all of the following conditions are met.

1) The repossession must be to protectyour security rights in the property.

2) The installment obligation satisfied bythe repossession must have been re-ceived in the original sale.

3) You cannot pay any additional consid-eration to the buyer to get your propertyback, unless either of the situationslisted below apply.

a) The reacquisition and payment ofthe additional consideration wereprovided for in the original contractof sale.

b) The buyer has defaulted, or defaultis imminent.

Additional consideration includes moneyand other property you pay or transfer to thebuyer. For example, additional considerationis paid if you reacquire the property subjectto a debt that arose after the original sale.

Conditions not met. If any one of thesethree conditions is not met, use the rulesdiscussed under Personal Property, earlier,as if the property you repossess were per-sonal rather than real property. Do not use therules for real property.

Figuring gain on repossession. Your gain

on repossession is the difference between thefollowing amounts.

1) The total payments received, or consid-ered received, on the sale.

2) The total gain already reported as in-come.

See the earlier discussions under PaymentsReceived for items considered payment onthe sale.

Limit on taxable gain. Taxable gain islimited to your gross profit on the original saleminus the sum of the following amounts.

1) The gain on the sale you reported asincome before the repossession.

2) Your repossession costs.This method of figuring taxable gain, in es-sence, treats all payments received on thesale as income, but limits your total taxablegain to the gross profit you originally expectedon the sale.

Indefinite selling price. The limit ontaxable gain does not apply if the selling priceis indefinite and cannot be determined at thetime of repossession. For example, a sellingprice stated as a percentage of the profits tobe realized from the buyer's development ofthe property is an indefinite selling price.

Character of gain. The taxable gain onrepossession is ordinary income or capitalgain, the same as the gain on the original

sale. However, if you did not report the saleon the installment method, the gain is ordi-nary income.

Repossession costs. Your repossessioncosts include money or property you pay toreacquire the real property. This includesamounts paid to the buyer of the property, aswell as amounts paid to others for such itemsas those listed below.

1) Court costs.

2) Legal fees.

3) Publishing, acquiring, filing, or recordingof title.

4) Lien clearance.

Repossession costs do not include theFMV of the buyer's obligations to you that aresecured by the real property.

Use the following worksheet to deter-mine the taxable gain on a repos-session of real property reported on

the installment method.

Example. You sold a tract of land inJanuary 1996 for $25,000. You accepted fromthe buyer a $5,000 down payment, plus a$20,000 mortgage secured by the propertyand payable at the rate of $4,000 annuallyplus interest (9.5%). The payments began onJanuary 1, 1997. Your adjusted basis in theproperty was $19,000 and you reported thetransaction as an installment sale. Your sell-ing expenses were $1,000. You figured yourgross profit as follows:

For this sale, the contract price equals theselling price. The gross profit percentage is20% ($5,000 gross profit $25,000 contractprice).

In 1996, you included $1,000 in income(20% $5,000 down payment). In 1997, youreported a profit of $800 (20% $4,000 an-nual installment). In 1998, the buyer de-faulted and you repossessed the property.You paid $500 in legal fees to get your prop-erty back. Your taxable gain on the repos-session is figured as follows:

Basis. Your basis in the repossessed prop-erty is determined as of the date of repos-session. It is the sum of the followingamounts.

1) Your adjusted basis in the installmentobligation.

2) Your repossession costs.

3) Your taxable gain on the repossession.

To figure your adjusted basis in the install-ment obligation at the time of repossession,multiply the unpaid balance by the gross profitpercentage. Subtract that amount from theunpaid balance.

Use the following worksheet to deter-mine the basis of real property re-possessed.

Example. Assume the same facts as thepreceding example. The unpaid balance ofthe installment obligation (the $20,000 note)is $16,000 at the time of repossession be-cause the buyer made a $4,000 payment.The gross profit percentage on the originalsale was 20%. Therefore, $3,200 (20% $16,000 still due on the note) is unrealizedprofit. You figure your basis in the repos-sessed property as follows:

Holding period for resales. If you resell therepossessed property, the resale may resultin a capital gain or loss. To figure whether thegain or loss is long-term or short-term, yourholding period includes the period you ownedthe property before the original sale plus theperiod after the repossession. It does not in-clude the period the buyer owned the prop-erty.

If the buyer made improvements to thereacquired property, the holding period forthese improvements begins on the day afterthe date of repossession.

Bad debt. If you repossess real propertyunder these rules, you cannot take a bad debtdeduction for any part of the buyer's install-ment obligation. This is true even if the obli-gation is not fully satisfied by the repos-session.

If you took a bad debt deduction beforethe tax year of repossession, you are con-sidered to have recovered the bad debt whenyou repossess the property. You must reportthe bad debt deduction you took in the earlieryear as income in the year of repossession.

However, if any part of the earlier deductiondid not reduce your tax, you do not have toreport that part as income. Your adjusted ba-sis in the installment obligation is increasedby the amount you report as income from re-covering the bad debt.

Reporting anInstallment Sale

Form 6252. Use Form 6252 to report a saleof property on the installment method. Theform is used to report the sale in the year it

1) Unpaid balance of obligation ....................2) Minus: Unrealized profit

(line 1 gross profit %) ................3) Adjusted basis (date of repossession) ......4) Plus: Taxable gain

on repossession .................Repossession costs ............

5) Basis of repossessed real property . .........

1) Payments received before repossession ..2) Minus: Gain reported ................................3) Gain on repossession ...............................

4) Gross profit on sale ...................................5) Gain reported (line 2) .....................

6) Plus: Repossession costs ............... Unpaid balance of obligation ..................... $16,0007) Subtract line 6 from line 4 .........................Minus: Unrealized profit ............................ 3,200

8) Taxable gain (lesser of line 3 or 7) ........... Adjusted basis (date of repossession) ...... $12,800Plus: Taxable gain

on repossession ................ $2,700Repossession costs .. .. .. .. .. 500 3,200

Basis of repossessed real property ........... $16,000

Selling price ............................................... $25,000

Minus:Adjusted basis ......................... $19,000Selling expenses ..................... 1,000 20,000

Gross profit ................................................ $5,000

1) Payments received before repossession . $9,000

2) Minus: Gain reported .............................. 1,8003) Gain on repossession ............................. $7,200

4) Gross profit on sale ................................. $5,0005) Gain reported (line 2) ................. $1,8006) Plus: Repossession costs ........... 500 2,3007) Subtract line 6 from line 4 ....................... $2,700

8) Taxable gain (lesser of line 3 or 7) ......... $2,700

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takes place and to report payments receivedin later years. Also, if you sold property to arelated person, you may have to file the formeach year until the installment debt is paid off,whether or not you receive a payment in thatyear.

Related person. If you sell marketablesecurities to a related person, complete PartIII, Form 6252, for each year of the installmentagreement, even if you do not receive a pay-ment in that year.

If you sell property other than marketablesecurities to a related person, complete PartIII for the year of sale and the 2 years fol-lowing the year of sale, even if you do notreceive a payment. After this 2-year period,you do not have to fill out Part III.

If the related person to whom you soldyour property disposes of it, you may have toimmediately report the rest of your gain inPart III. See Rule 2Sale and ResaleunderSale to Related Person, earlier, for more in-formation.

Several assets. If you sell two or moreassets in one installment sale, you may haveto separately report the sale of each asset.The same is true if you sell all the assets ofyour business in one installment sale. SeeSingle Sale of Several Assetsand Sale of aBusiness, earlier.

If you have only a few sales to separatelyreport, you can use a separate Form 6252 foreach one. However, if you have to separatelyreport the sales of many assets that you soldtogether, do not prepare a separate Form6252 for each one. Instead, prepare oneForm 6252 and attach a schedule with all theinformation for each asset that is required byForm 6252. Complete Form 6252 by followingthe steps listed below.

1) Answer the questions at the top of theform.

2) In the year of sale, do not complete PartI. Instead, write See attachedschedule in the margin.

3) For Part II, enter the total for all the as-sets on lines 24, 25, and 26.

4) For Part III, answer all the questions thatapply. If none of the exceptions underquestion 29 apply, enter the totals onlines 35, 36, and 37 for the disposedassets.

Special situations. If you are reportingpayments from an installment sale as incomein respect of a decedent or as a beneficiaryof a trust, including a partial interest in sucha sale, you may not be able to provide all theinformation asked for on Form 6252. To theextent possible, follow the instructions givenabove and provide as many details as possi-ble in a statement attached to Form 6252.

For more information on how to completeForm 6252, see the form instructions.

Other forms. The gain from Form 6252 iscarried over and entered on Schedule D(Form 1040), Capital Gains and Losses, Form4797, Sales of Business Property, or both.

Schedule D (Form 1040). Enter the gainfigured on Form 6252 for personal-use prop-erty (capital assets) on Schedule D (Form1040). If your gain from the installment salequalifies for long-term capital gain treatmentin the year of sale, it will continue to qualifyin later tax years. Your gain is long-term if youowned the property for more than one yearwhen you sold it.

Although the references in this publicationare to the Schedule D for Form 1040, therules discussed also apply to Schedule D forForms 1041 (estates and trusts), 1065 (part-nerships), 1120 or 1120A (corporations), or1120S (S corporations).

Form 4797. An installment sale of prop-erty used in your business or property thatearns rent or royalty income may result in acapital gain, an ordinary gain, or both. All orpart of any gain from its disposition may beordinary gain from depreciation recapture.Use Form 4797 to report these transactionsand to determine the ordinary or capital gainor loss.

Form 4797 is used with estate and trust,partnership, corporation, and S corporationreturns, as well as individual returns.

Payments past due. If you use the cashmethod of accounting, do not report paymentsof principal you have not yet received, evenif they are past due. However, if you use anaccrual method of accounting, you accrue anypayment due, even if you have not receivedit.

Examples

The following examples illustrate how to fillout Form 6252. Sample filled-in forms follow.

Example 1On November 1, 1998, Mark Moore sold a lotthat he bought on February 17, 1991, for$2,650. He borrowed more on the lot than hehad paid for it. At the time of the sale, $6,500remained outstanding on these loans. In thesales contract, the buyer agreed to assumethese loans and pay Mark $200 a month (plus7% interest) for 3 years. In addition, the buyermade a down payment of $1,000 on the sale.

Mark fills out his 1998 Form 6252 as fol-lows:

Question 1. Mark writes in a description ofthe lot he sold.

Questions 2a and 2b. Mark enters the datehe acquired the lot and the date he sold it.

Question 3. Because Mark sold the lot toAcme Design, a partnership of which he is amember, he checks the Yes box.

Question 4. The property Mark sold was nota marketable security (such as stock or abond). He answers No to this question. Be-cause he sold the lot to a related person, hemust complete Part III for 1998 and the next2 years.

Part I. Mark uses this part of the form tofigure the contract price and his gross profiton the sale.

Line 5. Mark enters the selling price,$14,700. This includes the $1,000 down pay-ment, the $7,200 (36 $200) in monthlypayments he is to receive, and the $6,500 inloans the buyer assumes.

Line 6. Mark enters the $6,500 in out-standing loans that the buyer assumes.

Line 7. Mark subtracts line 6 from line 5and enters the difference, $8,200.

Line 8. Because he did not make anyimprovements to the lot, Mark's basis at thetime of the sale was the lot's cost of $2,650.

Lines 9 and 10. Mark did not take de-preciation deductions on the lot (land is neverdepreciable). The amount on line 8 carriesover to line 10.

Line 11. Mark's only selling expenseswere $150 in legal fees. If he had advertisedthe lot for sale or paid commission on thesale, he would have included those amountsalso.

Line 12. Since no depreciation wasclaimed on the land, Mark has no recaptureof income.

Line 13. Mark's installment sale basis is$2,800, the total of his adjusted basis in theproperty plus his selling expenses.

Line 14. Mark subtracts line 13 from line5 and enters the result, $11,900.

Lines 15 and 16. The property Mark soldwas not his home. He carries the amount online 14 to line 16. This is his gross profit onthe sale.

Line 17. Mark subtracts line 13, $2,800,from line 6, $6,500. The result, $3,700, is theamount by which the assumed loans aremore than his installment sale basis in theproperty. This amount is treated as a paymentin the year of sale on line 20.

Line 18. The contract price is the sum ofall payments Mark will receive on the sale.This includes the down payment and all in-

stallment payments he will receive (line 7). Italso includes the paymentfigured on line 17.

Part II. In this part, Mark figures the gain fromthe sale he must report for 1998.

Line 19. Mark's gross profit percentagefor the sale is 100%. This is the gross profiton line 16, $11,900, divided by the contractprice on line 18, also $11,900.

Line 20. Mark carries the amount hetreats as a payment on line 17 to this line andit is added to the other payments he receivedin the year of sale.

Line 21. At the time of the sale, Markreceived a down payment of $1,000. In De-cember 1998, he received his first monthlyinstallment payment. The total payment was

$242, consisting of $42 interest (one month'sinterest on $7,200 figured at 7% a year) and$200 principal. This is the only installmentpayment he received in 1998. He enters thetotal received during 1998, $1,200 ($1,000 +$200), on this line. He reports the $42 intereston Form 1040.

Line 22. Mark enters $4,900, the sum ofline 20 plus line 21. This is the total of allpayments he is considered to have receivedin 1998.

Line 23. Since 1998 is the year of sale,Mark makes no entry here.

Line 24. The gross profit percentage (line19) is 100%. Therefore, the entire amount online 22, $4,900, is taxable gain. Mark entersthis amount on line 24.

Lines 25 and 26. Because the lot Marksold was not depreciable property, he doesnot have to recapture any depreciation de-ductions as ordinary gain. All his gain on thesale is long-term capital gain. He carries theamount on line 26 to Schedule D (Form 1040)where it is included with other long-term cap-ital gains.

Part III. Because Mark sold the lot to hispartnership, a related person, he must fillout this part. The property he sold was not amarketable security and he completes thispart for 1998, 1999, and 2000.

Line 27. Mark enters the name, address,and employer identification number of thepartnership that bought the lot.

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Line 28. The partnership did not sell thelot in 1998. Mark checks the No box and hedoes not have to fill out the rest of Part III.

Example 2

In December 1997, Cora Blue sold a paintingshe inherited. The buyer paid her $700 downand gave her an installment note for $3,800.The note calls for quarterly payments of $530until the $3,800 debt is paid off, in about 2years. Each $530 payment includes interest

figured at 10% a year on the outstandingdebt. She received her first 4 payments on thenote in 1998. The principal and interest shereceived in each payment is given in the tablebelow:

Cora rounds off cents on her tax return.She reports $314 interest as ordinary incomeon Form 1040. She completes Form 6252 asfollows:

Question 1. Cora states the property shesold was an oil painting.

Questions 2a and 2b. She enters the dateshe acquired the painting and the date shesold it.

Question 3. The buyer was not related toCora. She checks the No box.

Question 4. Because she checked No toquestion 3, Cora does not have to answer thisquestion or fill out Part III of the form.

Part I. Cora completed Part I of her Form6252 for the year of sale, 1997. She doesnot fill it out for the remaining years of theinstallment sale.

Part II. This is the only part of Form 6252 thatCora fills out.

Line 19. Cora figured a gross profit per-centage of 22.7% on her 1997 Form 6252.She uses the same percentage on her 1998Form 6252.

Line 20. Since this is not the year of sale,Cora enters zero on this line.

Line 21. Cora enters the total amount(minus interest) that she received on the salein 1998, $1,806.

Line 22. The amount on line 21 carriesover to line 22.

Line 23. Before 1998, Cora received onlythe $700 down payment.

Line 24. Cora multiplies the gross profitpercentage of 22.7% (line 19), by the amountshe was paid in 1998 (line 22), $1,806. Theresult, $410, is the gain she had on the salein 1998.

Lines 25 and 26. Cora did not use thepainting in a business. It was not depreciableand the recapture rules do not apply. Theamount on line 24 carries over to line 26. Hergain is long-term capital gain. She carries theamount on line 26 to Schedule D (Form1040), where it is included with other long-term capital gains.

Payment Interest Principal

First ....................................... $95.00 $435.00Second ... .. .. .. .. .. .. .. .. .. .. .. .. .. .. .. . 84.13 445.87Third ...................................... 72.98 457.02Fourth .................................... 61.55 468.45

$313.66 $1,806.34

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Mark Moore 222-0 0 -3333

Undeveloped land

2 17 91 11 1 98

14,700

6,500

8,200

2,650-0 -

2,650150

-0 -2,800

11,90 0

-0 -

11,90 0

3,70011,90 0

10 0 %3,700

1,20 04,900

4,900-0 -

4,900

Acme Design W. Main St reetSmall Town, NY 12899 10-7654321

OMB No. 1545-0228Installment Sale Income6252Form

See separate instructions. Attach to your tax return.

Department of the TreasuryInternal Revenue Service

Use a separate form for each sale or other disposition ofproperty on the installment method.

AttachmentSequence No. 79

Identifying numberName(s) shown on return

Description of property

/ / Date sold (month, day, year) Date acquired (month, day, year)

NoYesWas the property sold to a related party after May 14, 1980? See instructions. If No, skip line 4

Was the property you sold to a related party a marketable security? If Yes, complete Part III. If No,complete Part III for the year of sale and the 2 years after the year of sale NoYes

Gross Profit and Contract Price. Complete this part for the year of sale only.

1

Selling price including mortgages and other debts. Do not include interest whether stated or unstated

Mortgages and other debts the buyer assumed or took the property subject

to, but not new mortgages the buyer got from a bank or other source

2a

3

Subtract line 6 from line 5

4

Cost or other basis of property sold

55

Depreciation allowed or allowable

66

Adjusted basis. Subtract line 9 from line 8

77

Commissions and other expenses of sale

88

Income recapture from Form 4797, Part III. See instructions

99

Add lines 10, 11, and 12

1010

Subtract line 13 from line 5. If zero or less, stop here. Do not complete the rest of this form

11

If the property described on line 1 above was your main home, enter the amount of your excluded

gain. Otherwise, enter -0-. See instructions

11

12

Gross profit. Subtract line 15 from line 14

1213

Subtract line 13 from line 6. If zero or less, enter -0-

13

Contract price. Add line 7 and line 17

1414

Installment Sale Income. Complete this part for the year of sale and any year you receive a payment orhave certain debts you must treat as a payment on installment obligations.

15

Gross profit percentage. Divide line 16 by line 18. For years after the year of sale, see instructions

15

16

For year of sale only: Enter amount from line 17 above; otherwise, enter -0-

1617

Payments received during year. See instructions. Do not include interest whether stated or unstated

17

18

Add lines 20 and 21

18

Payments received in prior years. See instructions. Do not include

interest whether stated or unstated

19 19

20

Installment sale income. Multiply line 22 by line 19

2021

Part of line 24 that is ordinary income under recapture rules. See instructions

21

Subtract line 25 from line 24. Enter here and on Schedule D or Form 4797. See instructions

22 22

Related Party Installment Sale Income. Do not complete if you received the final payment this tax year.

Name, address, and taxpayer identifying number of related party

Did the related party, during this tax year, resell or dispose of the pro

Documents

US Internal Revenue Service: p537--1998