Tax Planning Opportunities and Installment Sales

Internal Revenue Service form 6252 recordstaxpayer friend wishes to sell a piece of land that
installment sales. An installment sale allows for awill carry a significant long-term capital gain upon
taxpayer to recognize income over a period ofits sale. Upon studying the installment sale method,
time as income is actually collected. Typically, thishe decides to hold the note on the transaction
income will be long-term capital gain (property heldand will charge the buyer 9% annual interest. If
for more than a year) and will yield the mostthe note is for ten years, the taxpayer will report
favorable of tax rates, 5% or 15%. In addition tolong-term capital gain income on the principal he
postponing the collection of income, the installmentreceives from the note payments. The earlier
note will also have interest associated with theyears will be more in the form of interest income
transaction giving the seller an additional financialwith smaller amounts going towards principal. This
benefit. Is the installment sale method always theinterest will provide investment interest income
best way to go? Of course not my friends. Thethat will be offset by any carry-over of
one thing that we who practice tax have comeinvetsment interest expense. This interest income
to learn is never say always, and never sayprovides an additional return on this transaction
never.and will be further enhanced by offsetting it
If I were to sell a capital asset (normally a pieceagainst invesment interest expense carryover. On
of real estate or a business interest), I mightthe capital gains side, the long-term capital gain will
consider the installment method of accounting forbe netted against the capital loss carry-forwards,
income tax purposes under the following twofirst against the long-term losses and then against
scenarios. Number one, if I am selling a businessthe short-term losses. The idea with capital gain
interest, I might have no choice but to hold paperand loss netting is to have any remaining gain
(take back of a note) as the buyer may not beleftover be long-term capital gain because of the
able to get adequate financing (beware of sellingmore favorable tax consequences. If during the
business interests and consult some one whoinstallment period, the taxpayer recognizes any
knows). In the other instance, I might be fineshort-term gains (subject to the taxpayer's top
finacially and have access to other larger blocksmarginal income tax rate as high as 35%), there
of funds and can afford to receive installmentswill be more opportunity to shelter the short-term
over time. By entering into an installmentgains first. If our taxpayer hadn't elected to use
agreement, I will want to make sure that mythe installment method, he would have used his
note is properly secured in case the buyercapital losses to offset income that would have
defaults and I will want to review the possiblebeen taxed at 5% and 15% rates as opposed to
income tax attributes.the higher marginal income tax rates. The
Suppose that our favorite taxpayer has ainstallment method allows for the prolonging of
carryover of capital losses consisting of bothcapital losses to be carried over and thus,
long-term and short-term capital losses. Inoffsetting gains that would be taxed at much
addition, this taxpayer has investment interesthigher rates.
expenses that has been carried over for yearsAs always, carefully consider your strategy and
because he has not had enough investmentknow your tax returns as it may contain
income to make use of the deduction. Ourcarryovers that you can use to your advantage.