Installment sales
An installment sale spreads gain recognition across the years payments are received, matching tax to cash flow and potentially keeping the taxpayer in lower brackets.
Gross profit percentage = Gross profit ÷ Contract price. Each principal payment received is multiplied by this percentage to determine recognized gain.
EXAMPLE: Property with a basis of $300,000 is sold for $500,000, payable $100,000 per year for five years. Gross profit is $200,000, so the gross profit percentage is 40%. Each $100,000 payment produces $40,000 of recognized gain (plus separately stated interest).
What can't use the installment method
- Inventory and dealer dispositions
- Publicly traded securities
- Depreciation recapture under §1245/§1250 — recapture is recognized entirely in the year of sale, even if no cash is received that year
- Losses — the installment method applies only to gains
Related-party traps
- §267 loss disallowance — losses on sales between related parties are disallowed entirely. The buyer may later use the disallowed loss to offset gain on a subsequent sale to an unrelated party.
- Installment sale to a related party — if the related buyer resells within two years, the original seller must accelerate remaining gain
- §1239 — gain on the sale of depreciable property to a related party is ordinary income, not capital gain
EXAMPLE (§267): A father sells stock with a $50,000 basis to his daughter for $30,000. The $20,000 loss is disallowed. If she later sells it to an unrelated buyer for $60,000, her realized gain is $30,000 but she may use the father's disallowed $20,000 loss, recognizing only $10,000.
Like-kind exchange planning
§1031 now applies only to real property. Key planning points: avoid receiving boot (including net debt relief), respect the 45-day identification and 180-day completion deadlines, and use a qualified intermediary so the taxpayer never has actual or constructive receipt of proceeds.
EXAM TIP: Combining strategies is where TCP questions live — e.g., an installment sale of appreciated real estate plus the fact that depreciation recapture accelerates into year one. Compute recapture first, then apply the installment method to the remaining gain.