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Installment Sale Essencials
An installment sale is a sale where the seller receives at least one payment after the tax year in which the sale occurs. For example, an investor who is selling property for $5 million in 2010 receives $1 million in cash at the closing and a note from the buyer agreeing to pay the remaining $4 million over the next four years, plus interest at the rate of 6% per annum.
The two main advantages of an installment sale is that it may facilitate a sale if the buyer cannot find third party financing, and it allows the seller to defer paying tax on a portion of the gain because the gain is spread out over the term of the installment note. There are a few important things to remember when structuring an installment sale transaction.
What is taxed and how is it taxed?
The interest portion is taxed as ordinary income. Even if the note does not provide for interest, the tax laws may re-characterize some of the payments as interest.