Sponsor Highlight: Understanding Tax Phrases – Installment Fee

Nancy Ekrem

If you use an installment purchase to sell real estate, you can benefit from a tax deferral and possibly reduce your overall tax burden. But you need to be aware of certain tax traps when doing this.

Installment purchase defined

As a rule, you create an installment purchase if you receive payments for properties sold in the tax year of the sale and in at least one additional tax year. For example, if you sell a property at a profit in 2021 and receive payments from 2021 to 2026, your property transaction will be an installment purchase.

Tax implications

An installment purchase creates a tax event every year that you receive payments. In the example above, part of your profit will be taxable in 2021 and each year through 2026.

Note that properties held for more than a year qualify for advantageous capital gains tax treatment. The current tax rate for long-term capital gains is 0 to 20 percent, compared to the top ordinary income tax bracket of 37 percent.

You also have the option to prepay any taxes due on the sale to avoid tax on the installments in future years. In some cases, doing this will reduce your overall tax bill, although it may require some help with tax planning.

Advantages of an installment purchase

With an installment purchase, you may be able to lower your total tax on the sale of the property by spreading that income over several years. In addition, the buyer often pays you a higher interest rate on the remaining balance than a typical bank loan.

Hire purchase tax traps

Related parties beware. If you sell a property to a related party and the property is then sold within two years, in most cases the remaining taxes are due immediately. The tax definition of related parties is broader than you might think. It contains:

  • Spouse
  • children
  • Grandchildren
  • siblings
  • parents
  • A partnership or corporation in which you have a majority stake
  • An estate or trust that you are associated with

To avoid this big tax surprise, you should state in the contract that the property cannot be sold within two years.

Impairment Potential. Also, be careful if you have made write-downs on the property in previous years. In certain circumstances, you will owe additional taxes related to this depreciation when you sell the property.

Don't win losses. Note that the treatment of installment sales is only possible for profits, not for losses. Other special rules may apply. So get in touch with us if you need advice specifically tailored to your situation.

Of course, the tax discussions now in Congress could have an impact on how installment sales and long-term capital gains will be taxed in the future. If you are planning to buy in installments, you should seek advice to discuss the tax implications.

– By Nancy J. Ekrem, CPA

Executive Partner

DME CPA group PC

Certified auditors & management consultants

[email protected]

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