When a taxpayer sells property in a contract that calls for payments to be made in more than one year, he or she generally reports the income on the installment basis. This means that he computes the taxable income for each year by multiplying the amount received that year by the percentage of the total sales price that will result in profit.
Example: A retiring bankruptcy attorney sells the painting on his office wall, which he paid $10,000 for to another lawyer for $20,000. The price will be paid over four years at $5,000 a year. Each year the seller will recognize $2,500 of taxable income.
The installment sale method applies only to gains and not to losses. It also requires that the seller recognize certain depreciation recapture and unrealized receivables in the year of sale, and only spread out the balance of the gain to future years.
There are a number of transactions for which the method cannot be used. Dealers in property may not use the installment method except for certain dealers in time shares or residential lots. Nor can relatives or controlled partnerships use it on certain sales of depreciable property. Stock or securities trades on an established security market may not be sold under the installment method, but closely held stocks, partnership interests or small businesses are eligible for the treatment.
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