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, 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 of $51,000; and $10,000 of personal exemptions.
The negative taxable income does not create a net operating loss (NOL) because the Jacksons do not have enough nonbusiness 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 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 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 Conversions and Recapture 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 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.
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|Author:||Ellentuck, Albert B.|
|Publication:||The Tax Adviser|
|Date:||Jul 1, 1995|
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