When selling a property that was not your primary residence and taking back a mortgage using Seller Financing, you may qualify for tax savings with installment sale tax treatment. This means that you do not have to pay the capital gains tax all at once, but rather over a period of time as you receive payments from the buyer.
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An installment sale occurs when you sell a property and receive payments from the buyer over a period of time, rather than receiving the full payment upfront. This is commonly seen in Seller Financing. By spreading out the payments, the seller can potentially reduce their immediate tax liability.
How Does Installment Sale Tax Treatment Work?
Installment sale tax treatment allows sellers to defer the payment of capital gains tax on the profit made from the sale of the property. Instead of paying the full tax amount in the year of the sale, the tax liability is spread out over the duration of the installment period.
Let’s consider an example to understand this better. Assume you purchased a property for $40,000 and after several years, you have depreciated it to $32,500. You decide to sell the property for $50,000 and take back a mortgage from the buyer.
Since you are not receiving the full amount of money upfront, you are not required to pay the capital gains tax immediately. Instead, you will report the sale on Tax Form 6252 and pay the tax as you receive the installment payments.
Example Computations:
| Gross sales price | $50,000 |
| Commission | 2,500 |
| Adjusted basis | 32,500 |
| Loan balance | 20,000 |
| Buyer assumes loan | 20,000 |
| Seller takes back second mortgage | 17,000 |
| Down payment | 13,000 |
| Mortgage payments in 1st year are $750 of which $500 is interest. Then balance of $250 is recovery of principal | |
| Down payment | 13,000 |
| + recovery of principal | 250 |
| TOTAL TO PRINCIPAL | 13,250 |
| Gross sales price | 50,000 |
| Less commission | 2,500 |
| = Net sales price | 47,500 |
| Less adjusted basis | 32,500 |
| = Realized gain | $15,000 |
| Gross sales price | 50,000 |
| Less mortgage assumed | 20,000 |
| = Contract price | 30,000 |
| Profit ratio = Realized gain / Contract Price | |
| thus 15,000 / 30,000 | = 0.5 |
| Recognized gain in first year = Profit ratio X Principal payments received | |
| thus 0.5 x 13,250 | = $6,625 |
Reporting the Sale on Tax Form 6252
Tax Form 6252, also known as the “Installment Sale Income” form, is used to report the sale of property under installment sale tax treatment. This form helps you calculate the amount of gain to report each year and determine the tax liability associated with the installment payments received.
When filling out Form 6252, you will need to provide details such as the buyer’s name, the total selling price, the adjusted basis of the property, and the terms of the installment agreement. The form will guide you through the calculation of the gain to report each year and the corresponding tax amount.
It’s important to note that if you sell the property within a year of purchasing it, you may not qualify for installment sale tax treatment. In such cases, you would report the sale as a regular capital gain on Schedule D of your tax return.
Benefits of Installment Sale Tax Treatment
Opting for installment sale tax treatment can provide several benefits for sellers:
- Tax Deferral: By spreading out the tax payments over time, sellers can defer their tax liability and potentially reduce their immediate tax burden.
- Income Planning: Installment sales allow sellers to plan their income more effectively, as they can control the timing and amount of the payments received.
- Interest Earnings: Sellers who receive installment payments also have the opportunity to earn interest on the outstanding balance, potentially increasing their overall return on the sale.
It’s important to consult with a tax professional or accountant to fully understand the implications of installment sale tax treatment and to ensure compliance with tax laws and reporting requirements.
DISCLAIMER: We are not attorneys and we cannot advise you regarding your particular circumstances. You must always obtain competent legal counsel and financial advice. We believe this information to be accurate, but please check with a qualified real estate attorney in your state before making any decision based on this information.