How to File Taxes for Installment Sales

Installment sales often have different definitions depending on the context of the phrase. For example, purchasing an auto using a bank or credit union loan is NOT an installment sale. Although you'll be paying back your loan on a monthly basis, the seller or car dealer is receiving payment in full. For tax purposes, an installment sale typically relates to a sale or disposition of an asset in one tax year and one or more payments from the buyer are due in subsequent tax years. The benefit to the taxpayer: The ability to defer some portion of the income (interest and profit) earned for the sale to another tax year(s).

Difficulty: Moderate

Instructions

Things You'll Need:

• Data on the cost of the item being sold.
• Amount of accumulated depreciation taken in prior years.
• Agreed upon selling price.
• Amount of scheduled installment payments.

File Taxes for Installment Sales

1. Structure the sale of an asset to a buyer agreeable to make multiple payments to you. If you want the transaction to be treated as an installment sale, make sure the payment period will extend longer than one tax year.

2. Calculate your "adjusted cost basis" for the item being sold. Add your cost to buy the property and any selling expenses you've incurred. Deduct any accumulated depreciation you've taken on prior years' taxes. The resulting amount is your adjusted basis for the property being sold. Don't forget to also deduct any loan balance you might owe for the item.

3. Determine your gross profit (gain) by subtracting your adjusted basis from your agreed upon selling price. This is the amount of your income that can be deferred over the period of repayment on an annual basis.

4. Break down your scheduled payments into three categories: Interest income Return of your adjusted cost for the item Your gain (profit) on the sale of the assetThe interest portion must be reported as "ordinary income". The remaining amount of the payment will be split between a recovery of your cost (adjusted basis) and your profit on the sale.

5. Calculate the amounts of your expected payments by determining your "profit percentage" for the sale. For example, you sell your car to someone for $12,000. Your adjusted basis for the auto is $9,600. Your profit, $2,400, represents 20 percent of of the selling price, or your profit percentage. Consequently, 80% of your scheduled payment should be allocated to repayment of your cost and 20 percent will represent income. Therefore, should your buyer agree to pay you $500 per month, $400 would be allocated to your cost (tax free) and $100 per month would be income to you.

6. The amount of interest and profit you receive during the tax year will be recorded as taxable income, while the amount applied to the recovery of of your cost (adjusted basis) will be free of taxes.

7. Accounting for installment sales can be a bit complicated and/or confusing. If you aren't totally confident that you have calculated all amounts correctly, have a qualified tax advisor review all of your data and provide valuable advice.

Tips & Warnings

• If you have spent money "improving" the property being sold, add this amount to your purchase price to calculate an appropriate cost basis.
• Calculate a fair interest rate/amount into the scheduled payment or risk that the IRS will require you to estimate an amount.
• Use clear simple English to construct your sales and installment agreement so anyone reading the document will understand the sale and repayment terms.
• Use caution when including one or more installment sales in your taxes as IRS typically scrutinizes these rather closely.
• If selling similar items is a common feature of your regular business, you may not be allowed to treat these transactions as installment sales regardless of your documentation. The IRS may mandate that profits be taxed as ordinary income.
• Try to be sure you have documented installment sales correctly to avoid future tax problems. Consulting a tax advisor is always a wise consideration for these transactions.

Resources

• IRS information regarding installment sales

Who Can Help Sponsored

• Ask a Lawyer Online Now