Download Instructions and Background for Installment Sale Agreement, also

Instructions and Background for Installment Sale Agreement, also known as a “Contract
for Deed” or “Land Contract”
An Installment Sale Agreement is commonly used by a Seller of property who is interested in
acting as a lender to the purchaser of their property. Through a Installment Sale Agreement, the
Seller also acts like a mortgage company. This option has pros and cons for both Buyer and
Seller.
The pro for you as a buyer is that you get built in financing typically with no credit check and a
small or no downpayment. It is also quick and easy compared to a commercial lender.
The Seller does not receive the total sales price for the property at the time of executing the
installment sale agreement, but rather receives payments. The Seller does retain ownership of the
property until the Contract terms are met. Since the Seller receives periodic payments, the Seller
can view these payments as steady income. Since the Seller is the lender, the Seller receives the
total purchase price plus interest.
An Installment Sale Agreement assists a buyer with no credit history or poor credit history in
obtaining financing to purchase the property. By not using the traditional financing method of a
bank or mortgage company, the Buyer can acquire a property without going through the
traditional hoops involved with commercial lenders.
The Buyer must be cautious when entering into a Installment Sale Agreement to ensure that the
Seller is the actual owner of the property and has authority to sell the property. The Buyer should
order a title search to verify ownership and liens against the property.
Upon the fulfillment of the terms of the Contract the Seller will need to execute a deed
transferring ownership of the property to the Buyer.
The IRS allows the seller to defer gains on sales of property through an installment sale
agreement. This arrangement permits sellers to declare a prorated portion of their profits over
several years, as long as the proper paperwork is completed during the year of the sale. See IRS
publication 537.
How the Installment Sale Method Works
Declaring gains under an installment sale is theoretically simple. The taxation of installment sales
has a prorated portion of each payment is considered a return of principal. The only stipulations
are that the property being sold cannot be a publicly traded security of any kind, and the taxpayer
cannot be a dealer of the sold property in any sense.
Reporting Installment Sale Income
Installment sale income can be broken down into three separate categories: gain, principal and
interest. Each of these categories is treated seperately.
Capital Gain
Seller must declare the gain each year as being either long or short term depending upon whether
the gain was long or short term in the year of the sale. Long-term gains are taxed at a lower rate,
while short-term gains are taxed as ordinary income. The gain from an installment sale is reported
on IRS Form 6252 and then carried to the Schedule D on Form 1040.
Interest
Taxpayers with installment sale income must also charge interest to the buyer at a rate that is the
lower of the applicable federal rate (or 9% compounded semiannually). The buyer will pay
interest on the unpaid installments until the balance has been remanded. The interest is reported
separately as ordinary interest income on Schedule B. (Note: If the interest is not reported
separately, then the IRS will consider part of the sale proceeds to be interest.)
Principal
Part of each installment sale is considered by the IRS to be a tax-free return of principal. This
amount can be determined by calculating the exclusion ratio. Divide the amount of actual gain by
the sale price, that gives you the exclusion ratio. Simply multiply this ratio by the amount of the
installment: This is the amount that is to be excluded from tax because it is designated as
principal.
Mortgages and Contract Price
If the buyer of the property assumes a mortgage or some other promissory note with the purchase,
the cost basis of the property must be reduced by the amount of the mortgage/note.