An installment sale can provide a useful tool to potentially defer taxes owed on the sale of capital assets. This is because, in most cases, taxes are owed on the actual funds received from the sale rather than the full amount. This assumes that the seller receives at least one payment after the tax year during which the sale occurs. It also requires the seller to fill out Form 6252 for each year of that payment.
But installment sales aren’t allowed in all cases or for all people, like the following:
Sale that Generates a Loss. The IRS is adamant that “installment method rules don’t apply to sales that result in a loss.” This is where the seller needs to know the adjusted bases of that property before determining its eligibility for the installment sales method.
Sale by Dealers. No, this doesn’t mean that a broker isn’t allowed to help a seller dispose of a real estate asset through an installment sale. What it does mean is that the SELLER can’t be a dealer. In other words, if the individual holds property in the ordinary course of their trade or business, they can’t use the installment sale method.
Sale of Inventory. Another thing tied to the ordinary course of trade or business is inventory. Inventory refers to raw materials used to produce goods, as well as goods available for sale. But inventory can’t be sold through the installment sale method.
Sale of Investment Securities. A seller wishing to sell stock or securities can’t do so through the installment sale method. This falls under the list of “ineligible transactions.”
Sale to Related Parties . . . But. In most cases, the IRS doesn’t allow special installment sale tax treatment if an asset goes to a related party. But in this case, there is a potential “out.” Specifically, if the seller disposes of depreciable property to a related party and can prove that no significant tax deferral benefits are involved, the IRS might allow it. That is, if certain conditions are met. In this case, the seller has to specifically prove, to the IRS’s satisfaction, that avoiding federal taxes isn’t the goal of the installment sale.
In many cases, installment sales can be a useful strategy in certain situations. But sellers need to understand the conditions under which installment sales might wave that red flag at the IRS. Before becoming involved with an installment sale, be sure to follow guidance from a tax attorney or professional.