An installment agreement is one where you receive at least 1 payment after the end of the tax year in which the sale occurs. If you realize a gain on an installment sale, you may be able to report part of the gain when you receive each payment. This method of reporting gain is called the installment method.
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
A sale that results in a loss
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 1 year.
Generally, you'll use Form 6252 to report installment sale income from casual sales of real or personal property during the tax year. However, special rules may allow for exclusion of income or require reporting on other forms such as Schedule D (Form 1040) or Form 4797.
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) or are treated as receiving a payment, you must include in income both the interest 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 portion is taxed as ordinary income and isn’t subject to any special tax rates.
After you’ve calculated the interest portion of your payment, you treat the rest of the payment as being made up of 2 parts:
A tax-free return of your adjusted basis in the property
Your gain (referred to as installment sale income on Form 6252)
You’ll need the following information to complete the form:
Selling price. This is the total cost of the property to the buyer, including any selling expenses the buyer paid.
Adjusted basis. This is your investment in the property, modified by:
Any additions or subtractions to basis while you held the probably
Any selling expenses that you paid
Depreciation you recaptured. You could be subject to depreciation recapture when selling certain kinds of property that are eligible for depreciation methods other than straight-line depreciation. 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. Any depreciation recapture will be taxed as ordinary income and is not eligible for capital gain rates.
For more information on depreciation recapture, see Publication 537, Installment Sales.