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Understanding Tax Terms: Installment Sales

7/26/2021

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If you use an installment sale to help sell property, you can benefit from tax deferral and possibly lower your overall tax bill. But you need to watch out for certain tax traps if you do.

Installment sale defined
Generally, you create an installment sale when you receive payments for sold property in the tax year of the sale and at least one other tax year. For instance, if you sell real estate for a profit in 2021 and receive payments in 2021 through 2026, your real estate transaction is an installment sale.

Tax implications
An installment sale creates a tax event in each year you receive payments. In the above example, part of your gain is taxable in 2021 and each year through 2026.
Note that property held longer than one year qualifies for favorable capital gains tax treatment. The current tax rate on long-term capital gains is from 0 to 20 percent, compared with the top ordinary income tax bracket of 37 percent.
You also have the ability to pay all the tax due on the sale up-front, to avoid paying tax on the installments in future years. In some cases you'll reduce your overall tax bill this way, though it may require some help with tax planning.

Benefits of an installment sale
With an installment sale, you may be able to lower your total tax on the sale of the property by spreading this income out over several years. In addition, the buyer will often pay a rate of interest to you higher than a typical bank loan for the remainder of the amount due.

Installment sale tax traps
Related parties caution. If you sell property to a related party and the property is then disposed of within two years, in most cases all the remaining tax comes due immediately. The tax law definition of related parties is more expansive than you might think. It includes:
  • Spouses
  • Children
  • Grandchildren
  • Siblings
  • Parents
  • A partnership or corporation in which you have a controlling interest
  • An estate or trust you’re connected to​

To avoid this major tax surprise, consider stipulating in the contract that the property can’t be disposed of within two years.
Depreciation recapture potential. Also be cautious if you took any depreciation on the property in prior years. In some circumstances you will owe extra tax related to that depreciation when you sell the property.

Gains not losses. Be aware that installment sale treatment is only available for gains, not losses. Other special rules may apply, so reach out if you need advice specific to your situation.

Of course, tax discussions now in Congress might impact how installment sales and long-term capital gains are taxed in the future. If you're planning an installment sale, consider reaching out for a consultation to discuss the tax implications.

"Tax Tips" are published to provide current tax information, tax-cutting suggestions, and tax reminders. If you would like more information on anything in "Tax Tips," or if you'd like to be on our mailing list to receive other tax information from time to time, please contact our office.
 
The tax information contained in this site is of a general nature and should not be acted upon in your specific situation without further details and/or professional assistance.
 
We are trusted CPA advisors servicing Burr Ridge, Hinsdale, Willowbrook, Darien, Naperville, and all Chicagoland area. 
Do you need assistance with your business and/or personal tax returns? Would you like to have a trusted source for your accounting, allowing you additional time to focus on increasing your business? Do you use QuickBooks, or plan to in the future, for your accounting? We include these in all our service packages, customized to fit your personal or business needs.  
Do you need assistance with your business and/or personal tax returns? Would you like to have a trusted source for your accounting, allowing you additional time to focus on increasing your business? Do you use QuickBooks, or plan to in the future, for your accounting? We include these in all our service packages, customized to fit your personal or business needs.  
 
We are currently accepting new clients. Your initial consultation is free, so you have nothing to lose and everything to gain. Our experienced staff is available to help you streamline your accounting, giving you more free time for yourself. Set up an appointment today by calling (630) 320-3720 or email us at [email protected]. 
 
For more free resources, such as Tax Organizers, and Record Retention Schedules, access our website www.monarchaccountinggroup.com.

Mia Verc, CPA;  Janice Papais, CPA
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145 Tower Drive, Suite 10
Burr Ridge, IL 60527-7836
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  • Home
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