The Coronavirus pandemic has had a dramatic impact on American businesses and the overall economy. As the crisis continues, businesses and individuals may increasingly find themselves in the position of needing more liquidity in an environment that doesn’t currently lend itself to selling off real property in traditional ways. Installment sales may be a good way to attract buyers looking to take advantage of the current environment to purchase if they do not have the means to cover the full purchase price upfront.
One interesting way to accomplish your liquidity goal is to review your current catalogue of real property and figure out what you would like to sell. Once you’ve identified the real property you’d like to put on the market — which can include items such as buildings or land — you may have better luck finding a ready buyer if you’re willing to execute the sale via an installment sale.
What Are Some of the Benefits of an Installment Sale?
An installment sale involves the sale of real property in such a way that the seller receives a promissory note from the buyer who opts to make multiple, regular payments with at least one payment occurring after the tax year in which the initial sale was made. As the seller, you receive interest on the full amount of the promissory note, in accordance with the stated interest in the agreement. If the interest is inadequate or not stated, the Applicable Federal Rate (AFR) published monthly by the IRS is used to compute the interest.
One of the primary benefits of an installment sale is that it gives the seller an opportunity to partially defer capital gains from the sale to future tax years.
By using an installment sale, the seller may benefit by:
- Partially deferring taxes while simultaneously improving cash flow
- Keeping income within a desired tax bracket by spreading that income across a longer period of time
- Restrict capital gains to a lower tax bracket
- Avoid higher net investment income taxes or alternative minimum taxes
- Keep a sale low enough that the seller can take advantage of additional tax deductions that may not be available if income is too high.
Generally, you are required to report an installment sale of real property on your tax return using the “installment method.” Installment payments include interest income, a return of your adjusted basis in the property, and the gain recognized on the sale. For each tax year in which you receive an installment payment, you must report both the interest and the gain as part of your income for those tax years.
Calculating taxable gain can be complex. The method involves multiplying the amount of the installment sale payments, excluding any interest, received during the tax year by the gross profit ratio for the sale.
For help determining whether you have real property that would best be sold using an installment sale or assistance with how to calculate your taxable gain on an installment sale you’ve already executed, consult with your Untracht Early advisor.