Real estate installment sales tax treatment

I f 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. 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 and receive payments in through , your real estate transaction is an installment sale.

An installment sale creates a tax event in each year you receive payments. In the above example, part of your gain is taxable in and each year through 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. A dealer is one who buys with the intent of reselling rather than for investment.

There is no magic formula for determining who is an investor and who is a dealer, but the IRS will balance a number of factors, See, e.

Tomlinson, F. Thus, the gains from the sale of real estate will be subject to self-employment tax, which is currently You will have to pay the back taxes due, plus interest. Consider a corporation for flipping properties to avoid the self-employment tax issue. An installment sale is defined under the Internal Revenue Code as a disposition of property wherein the seller receives one or more payments after the close the tax year in which the sale occurred.

Installment sales are reported on IRS form A seller may elect to report the gain from a wraparound transaction on the installment method. This is desirable because much of the profit made on a wrap is on paper, not in cash.

By using the installment method, the seller can spread out the tax on his profits over several years. But, if new rates are effective retroactive to January 1, which Congress can do , prospective planning is greatly hampered. For transactions involving installment sales or seller financing i. There is always some risk in spreading payments out over a longer period, though.

One risk is that a buyer mismanages the purchased business and within a couple of years is not able to make the remaining installment payments. Furthermore, the longer the payment period, the more interest that accrues on the outstanding balance.

Such greater interest expense may cause some buyers to demand lower total purchase prices. What about installment sales that have already occurred with payments remaining owing over the next few years? Assuming the gain is long-term capital gain, currently, the seller will pay no more than But beginning in , the same seller could be paying taxes at a rate of Such sellers may seek to accelerate the payments to occur in or to otherwise accelerate the gain recognition even though the payments will continue to be paid over a period of years.

By accelerating the payments or the gain recognition to , the seller will have a higher tax bill in , but will potentially save a vast sum in taxes overall.

A seller may not be able to control whether payments are accelerated, though, as it will require the buyer to agree and such buyer might simply be unable to pay off the outstanding balance all at once in Finally, a taxpayer can elect out of the installment method. While this requires a greater tax payment for the current tax year, electing out of the installment method for the tax year may save a seller a lot in taxes over time. She has owned such stock for many years. But if Samantha can withstand delivering her entire down payment received to the government, she will be much better off in the long run.