Reporting income on the installment method to defer taxes isn’t always the best strategy. For instance, say an investment property you bought years ago has appreciated. You decide to sell, agreeing to accept a down payment now, with the balance of the sales price due over the next two years. When you file your tax return, you can report the income from the sale over the agreement term. This strategy spreads the tax on the gain over the same time period.
But there may be circumstances when you’d be better off electing to recognize the gain in the year of sale and pay tax currently. In addition, there are cases when the installment method is not available, such as if you regularly sell the same type of property on an installment plan. You could be considered a dealer, meaning you’re unable to use the tax break except in special situations.
Sales of business inventory items are also generally ineligible, as are stocks traded on an exchange. Another example of a sale that doesn’t qualify for installment treatment is selling your property at a loss. Assuming the loss is deductible, you’d have to recognize the full amount in the year of sale.
When the sale does qualify for the installment method, you may still elect out. Reasons to consider doing so include the availability of capital or net operating losses that offset the gain, or credits that reduce the tax. An expectation of higher income in the future – which would put you in a higher tax bracket – may also make reporting the full gain in the year of sale a good idea.
Other items to consider include passive activity losses you’ve been unable to use in prior years and depreciation recapture. Special rules apply to both.
Understanding the tax implications before you sell can save money. Give us a call. We’re ready to help you analyze the pros and cons of reporting your sale on the installment method.