Electing out of installment sale reporting.
In the current year, Mark and Betty Jackson sold a lake lot for $55,000. Selling expenses totaled $4,000, and the Jacksons' basis in the land was $32,000.
The purchaser made a down payment of $10,000 and gave the Jacksons a note for the remaining $45,000. The note calls for five annual principal payments of $9,000 plus interest.
Using the installment method installment method
The accounting method of treating revenue from the sale of an asset on installments such that profits are recognized in proportion to the percentage of the sale price collected in a given accounting period. , the Jacksons will recognize gain in the current year, as calculated in the chart below.
Sales price $55,000 Original cost of lot $32,000 Selling expenses 4,000 Adjusted basis (36,000) Realized gain 19,000 Sales price 55,000 Debt assumed by purchaser -- Contract price 55,000 Payments received 10,000 Gross profit percentage (realized gain/contract price) 34.55% Gain recognized $ 3,455
The Jacksons started a new business that resulted in a substantial decrease in income. Including the $3,455 gain from the lake lot sale, their current income will be a negative amount of $16,000, based on adjusted gross income of $45,000; itemized deductions Itemized Deduction
A deduction from a taxpayer's taxable adjusted gross income that is made up of deductions for money spent on certain goods and services throughout the year. of $51,000; and $10,000 of personal exemptions Personal exemption
Amount of money a taxpayer can exclude from personal income for each member of the household in calculation of a tax obligation.
See exemption. .
The negative taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. does not create a net operating loss operating loss
The excess of operating expenses over revenue. As with operating income, operating losses exclude revenues and expenses from operations that are not considered a regular part of the business. Also called deficit. Compare operating income. (NOL NOL - Never Offline ) because the Jacksons do not have enough nonbusiness non·busi·ness
1. Unrelated to business or industry.
2. Unrelated to one's own business or employment. income to offset the nonbusiness expenses (i.e., itemized deductions). Thus, the Jacksons will not receive the full benefit of their itemized deductions.
The Jacksons expect an increase in income beginning in the following year, and expect their marginal tax rate Marginal Tax Rate
The amount of tax paid on an additional dollar of income. As income rises, so does the tax rate.
Many believe this discourages business investment because you are taking away the incentive to work harder. to be 28%.
Must the Jacksons use the installment method to report the gain from the lake lot sale? What can they do to take advantage of the itemized deductions that will otherwise be lost?
Generally, the installment method must be used to report gain from the sale of nondealer property if the seller receives one or more payments in a year subsequent to the year of sale. However, the seller can elect out of the installment method. If the seller makes the election, the entire gain is reported in the year of sale.
The tax adviser informs the Jacksons that if they elect out of the installment method, the entire $19,000 gain will be reported in the current year. Because of the amount of their itemized deductions, accelerating the gain will not incur any additional tax.
If the Jacksons do not elect out of the installment method for the sale of their lake lot, $3,455 of the $19,000 gain will be recognized in the current year and $15,545 will be recognized during the next five years as the payments are received. Tax at 28% on the $15,545 will be $4,353.
The tax adviser recommends that the Jacksons elect out of the installment method for the sale of their lake lot. The Jacksons will then recognize the entire $19,000 gain in the current year, but will not increase their tax liability because of the negative taxable income. Thus, making the election should save the Jacksons $4,353 of tax over the next five years.
Forms, elections and implementation
Installment sales Installment sale
The sale of an asset in exchange for a specified series of payments (the installments).
A sale in which the buyer is scheduled to make a series of payments over a period of time. generally are reported on Form 6252, Computation of Installment Sale Income. The election not to use the installment method is made by completing Part V of Schedule D or Part IV of Form 4797, Sales of Business Property (Also Involuntary involuntary adj. or adv. without intent, will, or choice. Participation in a crime is involuntary if forced by immediate threat to life or health of oneself or one's loved ones, and will result in dismissal or acquittal.
INVOLUNTARY. Conversions and Recapture recapture n. in income tax, the requirement that the taxpayer pay the amount of tax savings from past years due to accelerated depreciation or deferred capital gains upon sale of property. (See: income tax)
RECAPTURE, war. Amounts Under Sections 179 and 280F(b)(2)). If the election is made, the taxpayer should not complete Form 6252.
The election must be made by the due date (including extensions) of the return for the sale year. The IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. may permit a taxpayer to make the election after the due date of the return. However, permission will be given only if the Service concludes that the taxpayer had good cause for failing to make a timely election. For example, the later recharacterization of a lease as a sale will not justify a late election. In Rev. Rul. 90-46, the IRS denied permission to make a late election because it did not consider a subsequent change in circumstances or law to be good cause for failing to make a timely election out of installment reporting; however, the Service would grant permission for a late election out of installment reporting if the taxpayer originally clearly intended to elect out, but the election was not made because of an accountant's error.