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 under Other Rules, later, for information on recognizing the entire gain in the year of sale.

Installment obligation. The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you.

Stock or securities. You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. You must report the entire gain on the sale in the year in which the trade date falls.

Dealer sales. Sales of personal property by a person who regularly sells or otherwise disposes of the same type of property on the installment plan cannot be reported under the installment method. This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. However, the rule does not apply to an installment sale of property used or produced in farming.

Special rule. Dealers of time-shares and residential lots can report certain sales on the installment method if they elect to pay a special interest charge. For more information, see section 453(l) of the Internal Revenue Code.

Sale at a loss. If your sale results in a loss, you cannot use the installment method. If the loss is on an installment sale of business assets, you can deduct it only in the tax year of sale. You cannot deduct a loss on the sale of property owned for personal use.

Unstated interest. If your sale calls for payments in a later year and the sales contract provides for little or no interest, you may have to figure unstated interest, even if you have a loss. See Unstated Interest and Original Issue Discount, later.

Figuring Installment Income

Each payment on an installment sale usually consists of the following three parts.

1. Interest income.
2. Return of your adjusted basis in the property.
3. Gain on the sale.

In each year you receive a payment, you must include the interest part in income, as well as the part that is your gain on the sale. You do not include in income the part that is the return of your basis in the property. Basis is the amount of your investment in the property for tax purposes.

Interest income. 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 is not called interest in your agreement with the buyer. See Unstated Interest and Original Issue Discount, later.

Return of basis and gain on sale. The rest of each payment is treated as if it were made up of two parts. One part is a tax-free return of your adjusted basis in the property. The other part is your gain.

Figuring gain part of payment. To figure what part of any payment is gain, multiply the payment (less interest) by the gross profit percentage. Use the following worksheet to figure the gross profit percentage.

1)	Selling price
2)	Installment sale basis:
	Adjusted basis of property
	Selling expenses
	Depreciation recapture
3)	Gross profit (line 1 - line 2)
4)	Contract price
5)	Gross profit percentage (line 3 × line 4)

Selling price. The selling price is the total cost of the property to the buyer. It includes any money and the fair market value of any property you are to receive. Fair market value (FMV) is discussed later. It also includes any debt the buyer pays, assumes, or takes, to which the property is subject. The debt could be a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property. If the buyer pays any of your selling expenses, that amount is also included in the selling price. The selling price does not include interest, whether stated or unstated.

Installment sale basis. Three items comprise installment sale basis.

• Adjusted basis
• Selling expenses
• Depreciation recapture

Adjusted basis. Basis is the amount of your investment in the property for tax purposes. The way you figure basis depends on how you acquire the property. The basis of property you buy is generally its cost. The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently.

While you own personal-use property, various events may change your original basis. Some events, such as adding rooms or making permanent improvements, increase basis. Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. The result is adjusted basis.

For more information on how to figure basis and adjusted basis, see Publication 551.

Selling expenses. Selling expenses are any expenses that relate to the sale of the property. They include commissions, attorney fees, and any other expenses paid on the sale. Selling expenses are added to the basis of the sold property.

Depreciation recapture. If you took depreciation deductions on the asset, you may need to recapture part of the gain on the sale as ordinary income. See Depreciation Recapture Income, later.

Gross profit. Gross profit is the total gain you report on the installment method.

To figure your gross profit, subtract your installment sale basis from the selling price. If the property you sold was your home, subtract from the gross profit any gain you can exclude. See Sale of your home, later, under Reporting Installment Income.

Contract price. The contract price is the total of all principal payments you are to receive on the installment sale. It also includes payments you are considered to receive. See Payments Received, later.

If part of the selling price is paid in cash and you hold a mortgage payable from the buyer to you for the remainder, then the contract price includes both.

Gross profit percentage. A certain percentage of each payment (after subtracting interest) is reported as gain from the sale. It is called the "gross profit percentage" and is figured by dividing your gross profit from the sale by the contract price.

The gross profit percentage generally remains the same for each payment you receive. However, see the example under Selling price reduced, later, for a situation where the gross profit percentage changes.

Example. You sell property at a contract price of $2,000 and your gross profit is $500. Your gross profit percentage is 25% ($500 × $2,000). After subtracting interest, you report 25% of each payment, including the down payment, as gain from the sale for the tax year you receive the payment.

Amount to include in income. Each year as you receive payments on the installment sale, multiply the payments (less interest) by the gross profit percentage to determine the amount you must include in income for the tax year. In certain circumstances, you may be considered to have received a payment, even though you received nothing directly. A receipt of property or the assumption of a mortgage on the property sold may be considered a payment. For a detailed discussion, see Payments Received, later.

Selling price reduced. 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 the reduced sale price and then subtract the gain already reported. Spread the remaining gain over the future installments.

Example. In 1999, 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 12% interest, beginning in 2000. Your gross profit percentage is 60%. You reported a gain of $12,000 on each payment received in 1999 and 2000.

In 2001, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2001, 2002, and 2003 are reduced to $15,000 for each year.

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

1)	Reduced selling price		$85,000
2)	Minus: Basis		40,000
3)	Adjusted gross profit		$45,000
4)	Minus: Gain reported in 1999 & 2000		24,000
5)	Gain to be reported		$21,000
6)	Selling price to be received:
	Reduced selling price	$85,000
	Minus: Payments received in 1999 and 2000	40,000	$45,000
7)	New gross profit percentage (line 5 × line 6)		46.67%

You will report a gain of $7,000 (46.67% of $15,000) on each of the $15,000 installments due in 2001, 2002, and 2003.

Reporting Installment Income

Form 6252. Use Form 6252 to report an installment sale in the year it takes place and to report payments received in later years. Attach it to your tax return for each year.

Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and how much of each payment to include in income.

Form 6252 is divided into the following parts.

1. Part I, Gross Profit and Contract Price, is completed for the year of sale only.
2. Part II, Installment Sale Income, is completed for the year of sale and for any year you receive a payment or are considered to have received a payment.
3. Part III, Related Party Installment Sale Income, is completed if you sold the property to a related person, as discussed later under Sale to a Related Person.

Year of sale. Answer the questions at the beginning of the form and complete Part I and Part II. Line 3 asks whether you sold the property to a related party. If you answer "Yes," answer the question on line 4 and complete Part III.

Later years. Answer the questions at the beginning of the form and complete Part II for each year in which you receive a payment on the sale. If you sold the property to a related person, you may have to complete Part III also.

Schedule D (Form 1040). Enter the gain figured on Form 6252 (line 26) for personal-use property (capital assets) on Schedule D (Form 1040), Capital Gains and Losses. If your gain from 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 the property for more than one year when you sold it.

Form 4797. An installment sale of property used in your business or that earns rent or royalty income may result in a capital gain, an ordinary gain, or both. All or part of any gain from its disposition may be ordinary gain from depreciation recapture. Use Form 4797 to report these transactions and to determine the 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 the gain on the sale. See Publication 523 for information about excluding the gain. If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage.

Seller-financed mortgage. Special reporting procedures apply if you finance the sale of your home to an individual.

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) or Schedule 1 (Form 1040A).

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

If either person fails to include the other person's SSN, a $50 penalty will be assessed.

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