J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

5.22 Figuring the Taxable Part of Installment Payments

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).

EXAMPLE

On December 14, 2012, you sell unmortgaged real estate for $100,000. The property had an adjusted basis of $56,000. Selling expenses are $4,000. You are to receive installment payments of $25,000 in 2012, 2013, 2014, and 2015 plus interest at 5%, compounded semiannually. The gross profit percentage of 40% is figured as follows:

In 2012, you report a profit of $10,000 (40% of $25,000 payment) on Form ...