On the installment method, a portion of each payment other than interest represents part of your gain and is taxable. This taxable gain amount is based on the gross profit percentage or ratio, which is figured by dividing gross profit by the contract price. The contract price is the same as the selling price unless an adjustment is made for an existing mortgage assumed or “taken subject to” by the buyer. The term contract price is used in the computation to describe only payments that the seller receives or is considered to have received. Thus, it does not include the buyer’s assumption of an existing mortgage; see below for the mortgage adjustment to contract price. By following the line-by-line instructions to Form 6252, you get the gross profit percentage. Selling price, gross profit, and contract price are explained in the following paragraphs.
Interest equal to the applicable federal rate must generally be charged on a deferred payment sale. Otherwise, the IRS treats part of the sale price as interest (4.32).
Include cash, fair market value of property received from the buyer, the buyer’s notes (at face value), and any outstanding mortgage on the property that the buyer assumes or takes subject to. If, under the contract of sale, the buyer pays off an existing mortgage or assumes liability for any other liens on the property, such as taxes you owe, or pays the sales commissions, such payments are also included in the selling price.
Interest, including minimum interest imputed under the rules in 4.32, is not included in the selling price.
Notes of a third party given to you by the buyer are valued at fair market value.
Gross profit is the selling price less what the IRS calls installment sale basis, which is the total of adjusted basis of the property (5.20), selling expenses, such as brokers’ commissions and legal fees, and recaptured depreciation income, if any (44.1).
Divide the gross profit by the contract price to get the gross profit percentage. Each year, you multiply this percentage by your payments to determine the taxable amount under the installment method.
To figure the gross profit percentage first reduce the selling price by the amount of your existing mortgages that the buyer assumes or takes the property subject to. The reduced amount is the contract price. You then divide your gross profit by the contract price to get the gross profit percentage.
If the mortgage exceeds your installment sale basis (total of adjusted basis of the property, selling expenses, and depreciation recapture), you are required to report the excess as a payment received in the year of sale and also increase the contract price by that excess amount. Where the mortgage equals or exceeds your installment sale basis, the gross profit percentage will be 100%; see Example 3 below.
Selling price (including mortgage) | $90,000 |
Less: Mortgage | 60,000 |
$30,000 | |
Add: Excess of mortgage ($60,000) over installment sale basis ($50,000) | 10,000 |
Contract price | $40,000 |
Selling price | $90,000 |
Less: Installment sale basis | 50,000 |
Gross profit | $40,000 |
Gross profit percentage ($40,000 gross profit÷ $40,000 contract price) | 100% |
In a wraparound mortgage transaction, the buyer does not assume the seller’s mortgage or take the property subject to it, but instead makes payments that cover the seller’s outstanding mortgage liability. At one time, the IRS treated a wraparound mortgage transaction as an assumption of a mortgage by the buyer and required a reduction of the selling price by the mortgage to compute the contract price. The Tax Court rejected the IRS position, and the IRS acquiesced in the decision. Currently, the IRS does not require a reduction of selling price for a wraparound mortgage in the Form 6252 instructions or in Publication 537; see Example 4 above.
If the selling price is changed during the period payments are outstanding, the gross profit percentage is refigured on the new selling price. The adjusted profit ratio is then applied to payments received after the adjustment.
Payments include cash, the fair market value of property or services received, and payments on the buyer’s notes. Payments do not include receipt of the buyer’s notes or other evidence of indebtedness, unless payable on demand or readily tradable. “Readily tradable” means registered bonds, bonds with coupons attached, debentures, and other evidences of indebtedness of the buyer that are readily tradable in an established securities market. This rule is directed mainly at corporate acquisitions. A third-party guarantee (including a standby letter of credit) is not treated as a payment received on an installment obligation.
If the buyer has assumed or taken property subject to a mortgage that exceeds your installment sale basis (adjusted basis plus selling expenses plus depreciation recapture, if any), you include as a payment in the year of the sale the excess of the mortgage over the installment basis; see the Johnson Example below.
If, as security for a loan, you pledge an installment obligation from a sale of property of more than $150,000 (excluding farm property, personal-use property and timeshares and residential lots), the net loan proceeds must be treated as a payment on the installment obligation. The net loan proceeds are treated as received on the later of the date the loan is secured and the date you receive the loan proceeds. These pledging rules do not apply if the debt refinances a debt that was outstanding on December 17, 1987, and secured by the installment obligation until the refinancing. If the refinancing exceeds the loan principal owed immediately before the refinancing, the excess is treated as a payment on the installment obligation. See the Form 6252 instructions.
3.145.103.154