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

4.32 Minimum Interest on Seller-Financed Sales

The law requires minimum interest charges for seller-financed sales. If the minimum rate is not charged, the IRS imputes interest at the minimum applicable rate requiring both buyer and seller to treat part of the purchase price as interest even though it is not called interest in the sales contract. Generally, interest at the applicable federal rate (AFR) must be charged; see the chart at the end of this section for minimum required rates. For example, investment property is sold on the installment basis for $100,000 and the parties fail to charge adequate interest. Assume the IRS imputes interest of $5,000. For tax purposes, $95,000 is allocated to the sale of the property and the principal amount of the debt; the balance is imputed interest of $5,000, taxable to the seller and deductible by the buyer if allowed under the rules of Chapter 15.

Two statute classes.

The minimum or imputed interest rules are covered by two Internal Revenue Code statutes: Sections 1274 and 483. Under both, the same minimum interest rates apply but the timing of interest reporting is different, as discussed below.

Section 483 applies to any payment due more than six months after the date of sale under a contract which calls for some or all payments more than one year after the date of sale. If the sales price cannot exceed $3,000, Section 483 does not apply. Transactions within Section 483 are sales or exchanges of: (1) principal residences; (2) any property ...