An installment agreement is one in which you have an agreement with the buyer to receive more than one payment, and some of the payments are made in the year in which you sell the property and other payments are made in the following year (or years). It’s considered an installment sale only if you sold your property for a gain.
Certain types of sales don’t qualify as installment sales, though, including:
The sale of inventory items
Sales made by dealers in the type of property being sold
The sale of stocks or other investment securities
As the seller, you aren’t required to report an installment sale using the installment method. However, you might want to do so because you can spread the tax over all the years in which installment payments are being made instead of paying the tax on your gain all in one year.
An installment sale transaction is reported on Form 4562 and is carried forward each year in which payments are being made until the property is completely paid for.
Each payment that the buyer pays you consists of three parts:
Interest income
Return of your basis
Gain on the sale
For each year that you receive a payment (or payments), you must include in income both the interest that you receive and a portion of the gain.
You need to consider a part of each payment that you receive as interest, whether or not the agreement you reached with the buyer included interest. The interest part doesn’t apply to any down payments, but all payments after that should have an interest component. The interest portion is taxed as ordinary income and isn’t subject to any special tax rates.
Enter the interest portion directly on the Form 1099-INT/OID worksheet in TaxCut. For more information on the interest income that you need to report, see IRS Publication 537, Installment Sales.
After you’ve calculated the interest portion of your payment, you treat the rest of the payment as being made up of two parts:
A tax-free return of your adjusted basis in the property
Your gain (referred to as installment sale income on Form 6252)
Once you’ve calculated these amounts, you need to figure a "gross profit percentage." TaxCut calculates this amount for you after you’ve entered all the pertinent information about the property you sold.
You’ll need the following information to complete the form:
Selling price. This is the price that you and the buyer agreed to plus any selling expenses the buyer paid.
Adjusted basis. Your adjusted basis includes any selling expenses that you paid
Depreciation. This is the amount of depreciation that you took on the property. You need this amount to calculate the gain from the sale. Your basis in the property is adjusted down by the amount of depreciation that you took in prior years. Often, the depreciation portion is taxed differently than the rest of your gain. This process is called depreciation recapture. For more information on depreciation recapture, see Publication 537, Installment Sales.
TaxCut uses the information above and the total payments received during the year to calculate how much of each year’s payment is taxable as a capital gain and how much is taxable as some kind of depreciation recapture.