Tax 4-5 Identify the rules relating to an installment sale. Flashcards
Installment Sales
The general rule for sales or exchanges of property is that all gain will be recognized as income in the year of the sale or exchange unless the tax law provides a specific exception. Receipt of a promissory note in
exchange for property is generally treated as a receipt of cash. Application of this general rule could produce some exceptionally harsh results because…
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as it often is necessary to allow the purchaser to spread payments over a period of time to expedite the sale of the property.
If all the gain had to be recognized in the year of sale, then taxes due in the year of sale could exceed the total amount of payments received. Such a result would put the seller in the impossible position of having to pay tax on the entire gain while having received only a fraction of the sale price.
Installment Sales
The _____ _____ treatment allows the seller to recognize the gain proportionately in each tax year in which payments are received. Interest, at a reasonable rate, should also be included in the contract.
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installment sale treatment
The installment sale treatment is automatic for any sale in which a payment on the purchase price is received in a year later than the year of sale.
Installment Sales
It is possible for the taxpayer to affirmatively elect out of installment sale treatment by making such an election when filing the tax return for the year of sale. To elect out of installment sale treatment, the seller simply reports the entire _____ in the year of disposition. Once the election out of installment reporting is made, the consent of the IRS is required to revoke the election.
Gain or Loss
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gain
A taxpayer may wish to elect out of installment sale treatment if there are expiring net operating losses or if the taxpayer has a large capital loss that she wishes to utilize. A taxpayer should also consider electing out of the installment sale method if she is in a lower tax bracket in the year of sale than during the years in which the installment payments will be received.
Installment Sales
_____ cannot be recognized on an installment sale basis. They must be recognized in the year the sale occurs. This is consistent with the treatment most
taxpayers desire.
Gains or Losses
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Losses
Installment Sales
Sales of certain types of property do not qualify for installment sale treatment. _____ securities, do not qualify for installment sale treatment. The gain or loss on the sale of these types of assets must be reported as of the execution of the sale (the trade date), not as of the settlement date.
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Publicly traded securities, such as stocks or bonds
Installment Sales
Explain why installment sale treatment cannot be used in each of the following situations.
Harry Hooper sold an apartment building on January 7th. The terms of the note call for 10% down and 10% of the principal to be paid annually. Interest is payable monthly. The purchaser pays off the entire note on December 20th of the year of the purchase.
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Installment sale treatment cannot be used unless a payment is received in a year later than the year of sale. In this example, all payments were received in the year of sale.
Installment Sales
Explain why installment sale treatment cannot be used in each of the following situations:
Jack Davis purchased a residential building lot for investment purposes over two years ago. Jack paid $5,000 for the lot. He recently sold the lot to Frank Lawder for $4,800.
(4-5, 73)
Installment sale treatment cannot be used for losses.
Installment Sales
Explain why installment sale treatment cannot be used in each of the following situations.
During the current year, Rudy Yarnovich sold publicly traded stock to his son, Stephen, for the fair market value of $150,000. Under the terms of the sale, Stephen paid 20% down and has made the first of nine
installment payments.
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Installment sale treatment cannot be used for a sale of stock traded on an established securities market.
Module Check
- Which one of the following statements is correct regarding the use of the installment sale method of accounting for income tax purposes?
a. It may be used only if the payments are to be received over at least a two-year period.
b. A taxpayer may not avoid the use of the installment sale method if there is an installment sale.
c. The installment sale method is available for use by most dealers.
d. Any cost recovery recapture is recognized in the year of the installment sale.
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d. Any cost recovery recapture is recognized in the year of the installment sale.
A requirement of the installment sale method is that any cost recovery recapture be recognized (taxed) in the year of the sale. Only the remaining gain (the gain in excess of the cost recovery recapture) is eligible for installment reporting.
a. is incorrect because “An installment sale is a sale in which a payment on the purchase price is received in a year later than the year of sale.”
b. is incorrect because “It is possible for the taxpayer to affirmatively elect out of installment sale treatment by making an election when filing the tax return for the year of sale.”
c. is incorrect because “The use of the installment sale method is not available for sales of property by dealers; dealers are required to recognize all gain from an installment sale in the year of sale, except for sales of farm property, certain timeshares, and residential lots.”
Module Check
- In which of the following situations may the installment method of accounting be used?
a. Bill sells IBM stock to his neighbor. Bill will receive one-half of the sale price this year, and one-half next year.
b. Mary sells a vacant lot to her friend for a loss. Mary will receive payments over four years.
c. Mike sells a classic convertible automobile to a co-worker for an $8,000 gain. The sales price will be paid to Mike in a lump sum next year.
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c. Mike sells a classic convertible automobile to a co-worker for an $8,000 gain. The sales price will be paid to Mike in a lump sum next year.
A casual sale of an asset does qualify for installment sale treatment. An installment sale is a sale in which a payment will be received in a year later than the installment sale.
a. is incorrect because “The sale of a publicly traded security does not qualify for installment sale treatment.
b. is incorrect because “A sale at a loss does not qualify for installment sale treatment.”
