For use in preparing Returns
For the latest information about developments related to Pub. 537, such as legislation enacted after it was published, go to IRS.gov/Pub537.
Reporting form for Qualified Opportunity Fund (QOF) investments. Form 8997, Initial and Annual Statement of Qualified Opportunity Fund (QOF) Investments, is used to report holdings, deferred gains, and dispositions of QOF investments. See the instructions for Form 8997 for more information. Like-kind exchanges. Beginning after December 31, 2017, section 1031 like-kind exchange treatment applies only to exchanges of real property held for use in a trade or business or for investment, other than real property held primarily for sale. See Like-Kind Exchange, later. Photographs of missing children. The IRS is a proud partner with the National Center for Missing & Exploited Children® (NCMEC). Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.
Note. Section references within this publication are to the Internal Revenue Code, and regulation references are to the Income Tax Regulations under the Code. This publication discusses the general rules that apply to using the installment method. It also discusses more complex rules that apply only when certain conditions exist or certain types of property are sold. If you sell your home or other nonbusiness property under an installment plan, you may need to read only the General Rules section, later. If you sell business or rental property or have a like-kind exchange or other complex situation, also see the appropriate discussion under Other Rules, later.
Comments and suggestions. We welcome your comments about this publication and suggestions for future editions. You can send us comments through IRS.gov/FormComments. Or, you can write to the Internal Revenue Service, Tax Forms and Publications, 1111 Constitution Ave. NW, IR-6526, Washington, DC 20224. Although we can’t respond individually to each comment received, we do appreciate your feedback and will consider your comments and suggestions as we revise our tax forms, instructions, and publications. Don’t send tax questions, tax returns, or payments to the above address. You may want to see:
Publication
Form (and Instructions)
If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method. See Electing Out of the Installment Method, later, for information on recognizing the entire gain in the year of sale.
You can use the following discussions or Form 6252 to help you determine gross profit, contract price, gross profit percentage, and installment sale income. Each payment on an installment sale usually consists of the following three parts.
You must report interest as ordinary income. Interest is generally not included in a down payment. However, you may have to treat part of each later payment as interest, even if it’s not called interest in your agreement with the buyer. Interest provided in the agreement is called stated interest. If the agreement doesn’t provide for enough stated interest, there may be unstated interest or original issue discount (OID). See Unstated Interest and Original Issue Discount (OID), later.
If the selling price is reduced at a later date, the gross profit on the sale will also change. You must then refigure the gross profit percentage for the remaining payments. Refigure your gross profit using Worksheet B. You will spread any remaining gain over future installments.
Example. In 2019, you sold land with a basis of $40,000 for $100,000. Your gross profit was $60,000. You received a $20,000 down payment and the buyer's note for $80,000. The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2020. Your gross profit percentage is 60%. You reported a gain of $12,000 on each payment received in 2019 and 2020. In 2021, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2021, 2022, and 2023 are reduced to $15,000 for each year. The new gross profit percentage, 46.67%, is figured on Example—Worksheet B. You will report a gain of $7,000 (46.67% of $15,000) on each of the $15,000 installments due in 2021, 2022, and 2023.
Generally, you will use Form 6252 to report installment sale income from casual sales of real or personal property during the tax year. You will also have to report the installment sale income on Schedule D (Form 1040), Form 4797, or both. If the property was your main home, you may be able to exclude part or all of the gain. For more information on how to report your income from an installment sale, see Reporting an Installment Sale, later.
The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. The following topics are discussed.
If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you don’t receive all the sale proceeds in that year. To figure the amount of gain to report, use the FMV of the buyer's installment obligation that represents the buyer's debt to you. Notes, mortgages, and land contracts are examples of obligations that are included at FMV. You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. If you use the cash method of accounting, the FMV of the obligation will never be considered to be less than the FMV of the property sold (minus any other consideration received).
Example. You sold a parcel of land for $50,000. You received a $10,000 down payment and will receive the balance over the next 10 years at $4,000 a year, plus 8% interest. 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, to a broker for negotiating the sale. The land cost $25,000, and you owned it for more than 1 year. You decide to elect out of the installment method and report the entire gain in the year of sale. The recognized gain of $22,000 is long-term capital gain. You include the entire gain in income in the year of sale, so you don’t include in income any principal payments you receive in later tax years. The interest on the note is ordinary income and is reported as interest income each year.
Unless you elected out of the installment method, you must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale. In certain situations, you’re considered to have received a payment, even though the buyer doesn’t pay you directly. These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. However, as discussed later, the buyer's assumption of your debt is treated as a recovery of your basis rather than as a payment in many cases.
If the buyer pays any of your expenses related to the sale of your property, it’s considered a payment to you in the year of sale. Include these expenses in the selling and contract prices when figuring the gross profit percentage.
If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply.
Mortgage not more than basis. If the buyer assumes a mortgage that isn’t more than your installment sale basis in the property, it isn’t considered a payment to you. It’s considered a recovery of your basis. The contract price is the selling price minus the mortgage.
Example. You sell property with an adjusted basis of $19,000. You have selling expenses of $1,000. The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 12% interest) in each of the next 4 years). The selling price is $25,000 ($15,000 + $10,000). Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). The contract price is $10,000 ($25,000 − $15,000 mortgage). Your gross profit percentage is 50% ($5,000 ÷ $10,000). You report half of each $2,000 payment received as gain from the sale. You also report all interest you receive as ordinary income.
Mortgage more than basis. If the buyer assumes a mortgage that’s more than your installment sale basis in the property, you recover your entire basis. The part of the mortgage greater than your basis is treated as a payment received in the year of sale. To figure the contract price, subtract the mortgage from the selling price. This is the total amount (other than interest) you’ll receive directly from the buyer. Add to this amount the payment you’re considered to have received (the difference between the mortgage and your installment sale basis). The contract price is then the same as your gross profit from the sale. .
Example. The selling price for your property is $9,000. The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and will assume an existing mortgage of $6,000. Your adjusted basis in the property is $4,400. You have selling expenses of $600, for a total installment sale basis of $5,000. The part of the mortgage that’s more than your installment sale basis is $1,000 ($6,000 − $5,000). This amount is included in the contract price and treated as a payment received in the year of sale. The contract price is $4,000. Your gross profit on the sale is also $4,000. Your gross profit percentage is 100%. Report 100% of each payment (less interest) as gain from the sale. Treat the $1,000 difference between the mortgage and your installment sale basis as a payment and report 100% of it as gain in the year of sale.
If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. You’re considered to receive a payment equal to the outstanding canceled debt.
Example. Maria Santiago loaned you $45,000 in 2017 in exchange for a note and a mortgage in a tract of land you owned. On April 1, 2021, she bought the land for $70,000. At that time, $30,000 of her loan to you was outstanding. She agreed to forgive this $30,000 debt and to pay you $20,000 (plus interest) on August 1, 2021, and $20,000 on August 1, 2022. She didn’t assume an existing mortgage. She canceled the $30,000 debt you owed her. You’re considered to have received a $30,000 payment at the time of the sale.
If the buyer assumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of sale. If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Compare the debt to your installment sale basis in the property being sold. If the debt is less than your installment sale basis, none of it’s treated as a payment. If it’s more, only the difference is treated as a payment. If the buyer assumes more than one debt, any part of the total that’s more than your installment sale basis is considered a payment. These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage. However, they only apply to the following types of debt the buyer assumes.
If the buyer assumes any other type of debt, such as a personal loan or your legal fees relating to the sale, it’s treated as if the buyer had paid off the debt at the time of the sale. The value of the assumed debt is then considered a payment to you in the year of sale.
If you receive property other than money from the buyer, it’s still considered a payment in the year received. However, see Like-Kind Exchange, later. Generally, the amount of the payment is the property's FMV on the date you receive it.
If you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation. This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. It doesn’t apply to the following dispositions.
The net debt proceeds are the gross debt minus the direct expenses of getting the debt. The amount treated as a payment is considered received on the later of the following dates.
A debt is secured by an installment obligation to the extent that payment of principal or interest on the debt is directly secured (under the terms of the loan or any underlying arrangement) by any interest in the installment obligation. For sales after December 16, 1999, payment on a debt is treated as directly secured by an interest in an installment obligation to the extent an arrangement allows you to satisfy all or part of the debt with the installment obligation.
In some cases, the sales agreement or a later agreement may call for the buyer to establish an irrevocable escrow account from which the remaining installment payments (including interest) are to be made. These sales can’t be reported on the installment method. The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement.
Example. You sell property for $100,000. The sales agreement calls for a down payment of $10,000 and payment of $15,000 in each of the next 6 years to be made from an irrevocable escrow account containing the balance of the purchase price plus interest. You can’t report the sale on the installment method because the full purchase price is considered received in the year of sale. You report the entire gain in the year of sale.
If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. The recapture income is also included in Part I of Form 6252. However, the gain equal to the recapture income is reported in full in the year of the sale. Only the gain greater than the recapture income is reported on the installment method. For more information on depreciation recapture, see chapter 3 of Pub. 544. The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. Determining gross profit is discussed under General Rules, earlier.
If you sell depreciable property to a related person and the sale is an installment sale, you may not be able to report the sale using the installment method. If you sell property to a related person and the related person disposes of the property before you receive all payments with respect to the sale, you may have to treat the amount realized by the related person as received by you when the related person disposes of the property. These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition, later.
If you sell depreciable property to certain related persons, you generally can’t report the sale using the installment method. Instead, all payments to be received are considered received in the year of sale. However, see Exception below. Depreciable property for this rule is any property the purchaser can depreciate. Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. In the case of contingent payments for which the FMV can’t be reasonably determined, your basis in the property is recovered proportionately. The purchaser can’t increase the basis of the property acquired in the sale before the seller includes a like amount in income.
Generally, a special rule applies if you sell or exchange property to a related person on the installment method (first disposition) who then sells, exchanges, or gives away the property (second disposition) under the following circumstances.
See Exception, later.
Example 1. In 2020, Vasyl Green sold farm land to his son Adrian for $500,000, which was to be paid in five equal payments over 5 years, plus adequate stated interest on the balance due. His installment sale basis for the farmland was $250,000 and the property wasn’t subject to any outstanding liens or mortgages. His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). He received $100,000 in 2020 and included $50,000 in income for that year ($100,000 × 0.50). Adrian made no improvements to the property and sold it to Alfalfa Inc. in 2021 for $600,000 after making the payment for that year. The amount realized from the second disposition is $600,000. Vasyl figures his installment sale income for 2021 as follows. Vasyl won’t include in his installment sale income any principal payments he receives on the installment obligation for 2022, 2023, and 2024 because he’s already reported the total payments of $500,000 from the first disposition ($100,000 in 2020 and $400,000 in 2021).
Example 2. Assume the facts are the same as Example 1, except that Adrian sells the property for only $400,000. The gain for 2021 is figured as follows. Vasyl receives a $100,000 payment in 2022 and another in 2023. They aren’t taxed because he treated the $200,000 from the disposition in 2021 as a payment received and paid tax on the installment sale income. In 2024, he receives the final $100,000 payment. He figures the installment sale income he must recognize in 2024 as follows.
Exception. This rule doesn’t apply to a second disposition, and any later transfer, if you can show to the satisfaction of the IRS that neither the first disposition (to the related person) nor the second disposition had as one of its principal purposes the avoidance of federal income tax. Generally, an involuntary second disposition will qualify under the nontax avoidance exception, such as when a creditor of the related person forecloses on the property or the related person declares bankruptcy. The nontax avoidance exception also applies to a second disposition that’s also an installment sale if the terms of payment under the installment resale are substantially equal to or longer than those for the first installment sale. However, the exception doesn’t apply if the resale terms permit significant deferral of recognition of gain from the first sale. In addition, any sale or exchange of stock to the issuing corporation isn’t treated as a first disposition. An involuntary conversion isn’t treated as a second disposition if the first disposition occurred before the threat of conversion. A transfer after the death of the person making the first disposition or the related person's death, whichever is earlier, isn’t treated as a second disposition.
If you trade business or investment real property solely for other business or investment real property of a like kind, you can postpone reporting the gain from the trade. These trades are known as like-kind exchanges. The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. A trade is not a like-kind exchange if the property you trade or the property you receive is property you hold primarily for sale to customers. You don’t have to report any part of your gain if you receive only like-kind property. However, if you also receive money or other property (boot) in the exchange, you must report your gain to the extent of the money and the FMV of the other property received. For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Pub. 544.
Installment payments. If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine the installment sale income each year.
Example. In 2021, Renata Brown trades real property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. She also receives an installment note for $800,000 in the trade. Under the terms of the note, she’s to receive $100,000 (plus interest) in 2022 and the balance of $700,000 (plus interest) in 2023. Renata's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Her gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). The contract price is $800,000 ($1,000,000 − $200,000). The gross profit percentage is 75% ($600,000 ÷ $800,000). She reports no gain in 2021 because the like-kind property she receives isn’t treated as a payment for figuring gain. She reports $75,000 gain for 2022 (75% of $100,000 payment received) and $525,000 gain for 2023 (75% of $700,000 payment received).
A contingent payment sale is one in which the total selling price can’t be determined by the end of the tax year of sale. This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. If the selling price can’t be determined by the end of the tax year, you must use different rules to figure the contract price and the gross profit percentage than those you use for an installment sale with a fixed selling price. For rules on using the installment method for a contingent payment sale, see Regulations section 15a.453-1(c).
If you sell different types of assets in a single sale, you must identify each asset to determine whether you can use the installment method to report the sale of that asset. You also have to allocate part of the selling price to each asset. If you sell assets that constitute a trade or business, see Sale of a Business, later. Unless an allocation of the selling price has been agreed to by both parties in an arm's-length transaction, you must allocate the selling price to an asset based on its FMV. If the buyer assumes a debt, or takes the property subject to a debt, you must reduce the FMV of the property by the debt. This becomes the net FMV. A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. However, if an asset is sold at a loss, its disposition can’t be reported on the installment method. It must be reported separately. The remaining assets sold at a gain are reported together.
Example. You sold three separate and unrelated parcels of real property (A, B, and C) under a single contract calling for a total selling price of $130,000. The total selling price consisted of a cash payment of $20,000, the buyer's assumption of a $30,000 mortgage on parcel B, and an installment obligation of $80,000 payable in eight annual installments, plus interest at 8% a year. Your installment sale basis for each parcel was $15,000. Your net gain was $85,000 ($130,000 − $45,000). You report the gain on the installment method. The sales contract didn’t allocate the selling price or the cash payment received in the year of sale among the individual parcels. The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. You should allocate the cash payment of $20,000 received in the year of sale and the note receivable on the basis of their proportionate net FMVs. The allocation is figured as follows. You can’t report the sale of parcel C on the installment method because the sale results in a loss. You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. However, if parcel C was held for personal use, the loss isn’t deductible. You allocate the installment obligation of $80,000 to the properties sold based on their proportionate net FMVs (90% to parcels A and B, 10% to parcel C).
The installment sale of an entire business for one overall price under a single contract isn’t the sale of a single asset.
To determine whether any of the gain on the sale of the business can be reported on the installment method, you must allocate the total selling price and the payments received in the year of sale between each of the following classes of assets.
Residual method. Except for assets exchanged under the like-kind exchange rules, both the buyer and seller of a business must use the residual method to allocate the sale price to each business asset sold. This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b). A group of assets constitutes a trade or business if goodwill or going concern value could, under any circumstances, attach to the assets or if the use of the assets would constitute an active trade or business under section 355. The residual method provides for the consideration to be reduced first by cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). The consideration remaining after this reduction must be allocated among the various business assets in a certain order. For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their FMVs on the purchase date in the following order.
If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. For example, if an asset is described in both (4) and (6), include it in (4).
A partner who sells a partnership interest at a gain may be able to report the sale on the installment method. The sale of a partnership interest is treated as the sale of a single capital asset. The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. (The term “unrealized receivables” includes income arising from compensation for services and depreciation recapture income, discussed earlier.) The gain allocated to the unrealized receivables and the inventory can’t be reported under the installment method. The gain allocated to the other assets can be reported under the installment method. For more information on the treatment of unrealized receivables and inventory, see Pub. 541.
On June 4, 2021, you sold the machine shop you’d operated since 2013. You received a $100,000 down payment and the buyer's note for $120,000. The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2022. The total selling price is $220,000. Your selling expenses are $11,000. The selling expenses are divided among all the assets sold, including inventory. Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows. Under the residual method, you allocate the selling price to each of the assets based on their FMV ($201,500). The remaining $18,500 ($220,000 – $201,500) is allocated to your section 197 intangible goodwill. The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis, and the gain for each asset are shown in the following chart. The building was acquired in 2013, the year the business began, and it’s section 1250 property. There’s no depreciation recapture income because the building was depreciated using the straight line method. All gain on the truck, machine A, and machine B is depreciation recapture income since it’s the lesser of the depreciation claimed or the gain on the sale. Figure depreciation recapture in Part III of Form 4797. The total depreciation recapture income reported in Part II of Form 4797 is $5,209. This consists of $3,650 on machine A, $799 on the truck, and $760 on machine B (the gain on each item because it was less than the depreciation claimed). These gains are reported in full in the year of sale and aren’t included in the installment sale computation. Of the $220,000 total selling price, the $10,000 for inventory assets can’t be reported using the installment method. The selling prices of the truck and machines are also removed from the total selling price because gain on these items is reported in full in the year of sale. The selling price equals the contract price for the installment sale ($108,500). The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. The gross profit percentage (gross profit ÷ contract price) for the installment sale is 48% ($52,075 ÷ $108,500). The gross profit percentage for each asset is figured as follows. The sale includes assets sold on the installment method and assets for which the gain is reported in full in the year of sale, so payments must be allocated between the installment part of the sale and the part reported in the year of sale. The selling price for the installment sale is $108,500. This is 49.3% of the total selling price of $220,000 ($108,500 ÷ $220,000). The selling price of assets not reported on the installment method is $111,500. This is 50.7% ($111,500 ÷ $220,000) of the total selling price. Multiply principal payments by 49.3% (0.493) to determine the part of the payment for the installment sale. The balance, 50.7%, is for the part reported in the year of the sale. The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Only the part for the installment sale (49.3%) is used in the installment sale computation. The only payment received in 2021 is the down payment of $100,000. The part of the payment for the installment sale is $49,300 ($100,000 × 49.3% (0.493)). This amount is used in the installment sale computation.
An installment sale contract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the principal payment. Interest provided in the contract is called stated interest. If an installment sale contract doesn’t provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest. If section 483 applies to the contract, this interest is called unstated interest. If section 1274 applies to the contract, this interest is called OID. An installment sale contract doesn’t provide for adequate stated interest if the stated interest rate is lower than the test rate. See Test rate of interest, later.
Treatment of unstated interest and OID. Generally, if a buyer gives a debt in consideration for personal-use property, the unstated interest rules under section 483 and the OID rules under section 1274 don’t apply to the buyer. As a result, the buyer can’t deduct the unstated interest or OID. The seller must report the unstated interest or OID as income. Personal-use property is any property in which substantially all of its use by the buyer isn’t in connection with a trade or business or an investment activity. If the debt is subject to the section 483 rules and is also subject to the below-market loan rules, such as a gift loan, compensation-related loan, or corporation-shareholder loan, then both parties are subject to the below-market loan rules rather than the unstated interest rules.
Rules for the seller. If either section 1274 or section 483 applies to the installment sale contract, you must treat part of the installment sale price as interest, even though interest isn’t called for in the sales agreement. If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest or OID. Include the unstated interest in income based on your regular method of accounting. Include OID in income over the term of the contract. The OID includible in income each year is based on the constant yield method described in section 1272. (In some cases, the OID on an installment sale contract may also include all or part of the stated interest, especially if the stated interest isn’t paid at least annually.) If you don’t use the installment method to report the sale, report the entire gain under your method of accounting in the year of sale. Reduce the selling price by any stated principal treated as interest to determine the gain. Report unstated interest or OID on your tax return, in addition to stated interest.
Section 1274 applies to a debt instrument issued for the sale or exchange of property if any payment under the instrument is due more than 6 months after the date of the sale or exchange and the instrument doesn’t provide for adequate stated interest. Section 1274, however, doesn’t apply to an installment sale contract that’s a cash method debt instrument (defined next) or that arises from the following transactions.
Land transfers between related persons. The section 483 rules (discussed next) apply to debt instruments issued in a land sale between related persons to the extent the sum of the following amounts doesn’t exceed $500,000.
The section 1274 rules, if otherwise applicable, apply to debt instruments issued in a sale of land to the extent the stated principal amount exceeds $500,000, or if any party to the sale is a nonresident alien. Related persons include an individual and the members of the individual's family and their spouses. Members of an individual's family include the individual's spouse, brothers and sisters (whole or half), ancestors, and lineal descendants. Membership in the individual's family can be the result of a legal adoption.
Section 483 generally applies to an installment sale contract that doesn’t provide for adequate stated interest and isn’t covered by section 1274. Section 483, however, generally doesn’t apply to an installment sale contract that arises from the following transactions.
Sections 1274 and 483 don’t apply under the following circumstances.
A disposition generally includes a sale, exchange, cancellation, bequest, distribution, or transmission of an installment obligation. An installment obligation is the buyer's note, deed of trust, or other evidence that the buyer will make future payments to you. If you’re using the installment method and you dispose of the installment obligation, generally you’ll have a gain or loss to report. It’s considered gain or loss on the sale of the property for which you received the installment obligation. If the original installment sale produced ordinary income, the disposition of the obligation will result in ordinary income or loss. If the original sale resulted in a capital gain, the disposition of the obligation will result in a capital gain or loss. If the original installment sale resulted in a section 1231 capital gain (or loss), the disposition of the obligation will result in either a long-term capital gain or an ordinary loss.
The following transactions generally aren’t dispositions.
If you repossess your property after making an installment sale, you must figure the following amounts.
The rules for figuring these amounts depend on the kind of property you repossess. The rules for repossessions of personal property differ from those for real property. Special rules may apply if you repossess property that was your main home before the sale. See Regulations section 1.1038-2 for further information. The repossession rules apply whether or not title to the property was ever transferred to the buyer. It doesn’t matter how you repossess the property, whether you foreclose or the buyer voluntarily surrenders the property to you. However, it isn’t a repossession if the buyer puts the property up for sale and you repurchase it. For the repossession rules to apply, the repossession must at least partially discharge (satisfy) the buyer's installment obligation to you. The discharged obligation must be secured by the property you repossess. This requirement is met if the property is auctioned off after you foreclose and you apply the installment obligation to your bid price at the auction.
If you repossess personal property, you may have a gain or a loss on the repossession. In some cases, you may also have a bad debt. To figure your gain or loss, subtract the total of your basis in the installment obligation and any repossession expenses you have from the FMV of the property. If you receive anything from the buyer besides the repossessed property, add its value to the property's FMV before making this calculation. How you figure your basis in the installment obligation depends on whether or not you reported the original sale on the installment method. The method you used to report the original sale also affects the character of your gain or loss on the repossession.
The rules for the repossession of real property allow you to keep essentially the same adjusted basis in the repossessed property you had before the original sale. You can recover this entire adjusted basis when you resell the property. This, in effect, cancels out the tax treatment that applied to you on the original sale and puts you in the same tax position you were in before that sale. As a result, the total payments you’ve received from the buyer on the original sale must be considered income to you. You report, as gain on the repossession, any part of the payments you haven’t yet included in income. These payments are amounts you previously treated as a return of your adjusted basis and excluded from income. However, the total gain you report is limited. See Limit on taxable gain, later. . 
Example. You sold a tract of land in January 2019 for $25,000. You accepted a $5,000 down payment, plus a $20,000 mortgage secured by the property and payable at the rate of $4,000 annually plus interest (9.5%). The payments began on January 1, 2020. Your adjusted basis in the property was $19,000 and you reported the transaction as an installment sale. Your selling expenses were $1,000. You figured your gross profit as follows. For this sale, the contract price equals the selling price. The gross profit percentage is 20% ($5,000 gross profit ÷ $25,000 contract price). In 2019, you included $1,000 in income (20% (0.20) × $5,000 down payment). In 2020, you reported a profit of $800 (20% (0.20) × $4,000 annual installment). In 2021, the buyer defaulted and you repossessed the property. You paid $500 in legal fees to get the property back. Your taxable gain on the repossession is figured as illustrated in Example—Worksheet D.
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Generally, you must pay interest on the deferred tax related to any obligation that arises during a tax year from the disposition of property under the installment method if both of the following apply.
How to figure interest on deferred tax. First, find the underpayment rate in effect for the month with or within which your tax year ends. The underpayment rate is published quarterly in the Internal Revenue Bulletin, available at IRS.gov/irb. Then compute the deferred tax liability. The deferred tax liability is equal to the balance of the unrecognized gain at the end of the tax year multiplied by your maximum tax rate (ordinary or capital gain, as appropriate) in effect for the tax year. Note, you will need to determine the gross profit percentage of the installment sale to calculate the amount of the gain that has not been recognized. Next you will need to compute the applicable percentage. The applicable percentage is the aggregate face amount of obligations outstanding as of the close of the tax year in excess of $5,000,000 divided by the aggregate face amount of obligations outstanding as of the close of the tax year. To determine the interest on the deferred tax you owe, multiply your deferred tax liability by the applicable percentage by the underpayment rate.
Section 453A Example. Below is an example of the computation. ABC, Inc., a calendar year taxpayer, sold intellectual property with a $0 basis to an unrelated party on November 15, 2017, for $15 million on the installment method (a payment is due after the year of sale). ABC, Inc., incurred $500,000 of expenses related to the sale. The installment sale contract requires the following payments.
Computation Under Section 453A
For information on interest on dealer sales of timeshares and residential lots under the installment method, see section 453(l).
If you have a capital gain, you can invest that gain into a QOF and elect to defer part or all of the gain that is otherwise includible in income. The gain is deferred until you sell or exchange the investment or December 21, 2026, whichever is earlier. You may also be able to permanently exclude gain from the sale or exchange of an investment in a QOF if the investment is held for at least 10 years. For information about what types of gains entitle you to elect these special rules, see the Instructions for Schedule D for your tax return. Report the eligible gain on the form and in the manner otherwise instructed. See the Instructions for Form 8949 on how to report your election to defer eligible gains invested in a QOF.
For all years. Complete lines 1 through 4, Part I, and Part II. If you sold property to a related party during the year, also complete Part III. Complete Form 6252 for each year of the installment agreement, including the year of final payment, even if a payment wasn’t received during the year. If you sold a marketable security to a related party after May 14, 1980, and before 1987, complete Form 6252 for each year of the installment agreement, even if you didn’t receive a payment. (After 1986, the installment method isn’t available for the sale of marketable securities.) Complete lines 1 through 4. Complete Part III for each year except for the year in which you receive the final payment. If you sold property other than a marketable security to a related party after May 14, 1980, complete Form 6252 for the year of the sale and for the 2 years after the year of sale, even if you didn’t receive a payment in those years. Complete lines 1 through 4. Complete Part II for each of the 2 years after the year of sale in which you receive a payment. Complete Part III for each of the 2 years after the year of the sale unless you received the final payment during the year. If the related person to whom you sold your property disposes of it, you may have to immediately report the rest of your gain in Part III. See Sale and Later Disposition, earlier, for more information.
Seller-financed mortgage. If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. When you report interest income received from a buyer who uses the property as a personal residence, write the buyer's name, address, and social security number (SSN) on line 1 of Schedule B (Form 1040). When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 8b of Schedule A (Form 1040). If either person fails to include the other person's SSN, a penalty will be assessed.
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Which method of payment gives the buyer credit by postponing the time for payment?
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