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Property installment sale spreads out taxable gains

Q: I own a property in Washington state that is under contract to sell for $212,000. I owe $143,000 on the property and the loan will have to be paid for the buyer to get clear title. The buyer will pay me $19,000 and I will carry a note for the $50,000 balance. I believe the tax law allows me to match my tax payments to the cash received. Please confirm this. If I’m right, is the $143,000 used to pay the mortgage considered to be money received by me and therefore taxable? I bought the property for $160,000 so my gain is $52,000 minus my selling costs, so I don’t understand how I compute how much tax I pay if the loan is part of what I receive.

A: What you describe is called an installment sale. If you receive at least one payment in a year after the year of sale you can report your gain on this method, which allows you to generally match the cash received to the gain recognized.

The seller in an installment sale computes something called the “gross profit percentage.” This gross profit percentage is then multiplied by the payment received in each year to determine how much gain is reported for that year.

Fortunately, the payoff of the mortgage is not considered to be a payment made to you. But the mortgage does increase the gross profit percentage to make sure that the proper gain is reported.

The gross profit percentage is computed by dividing the gross profit by something called the “contract price.”

The gross profit is the sales price minus the cost of the property. You didn’t specify selling expenses so just to illustrate I’ll use the $212,000 selling price and the $160,000 cost.

The gross profit is then $52,000. The contract price is the selling price reduced by the mortgage paid off at closing. So the contract price in your situation is $69,000 ($212,000 minus $143,000).

The gross profit percentage is then 75.36 percent ($52,000/$69,000). Each payment received will be 75.36 percent gain and 24.64 percent recovery of your investment in the property.

When you receive the down payment of $19,000 you will multiple that payment by the gross profit percentage and report $14,318 of gain in the year of sale.

As you receive the remaining $50,000 you do the same calculation and report $37,682 of additional gain. In total, you report gain of $52,000. You will report interest on the note as income as it is received.

So the payoff of the mortgage will not cause you to report gain in the year of sale. You will use IRS Form 6252 to report your installment sale.

When you include selling costs the numbers will work out a bit differently than my example. I have also ignored any depreciation you may have claimed on the property since you did not mention it.

Q: I use my credit card for just about any expense that I can because I get airline miles. Is it always true that credit card interest is not deductible on your tax return?

A: No, there is no rule that relates to whether interest paid on credit card debt is or is not deductible. Interest is classified by the use of the borrowed funds, not by the means used to borrow the money.

Interest on funds borrowed and used for personal expenditures is not deductible. Most people use their credit card for personal expenses. The interest on the credit card debt is then nondeductible because of the use of the funds, not because a credit card was used to borrow.

If a credit card is used to purchase supplies for use in a business, the interest on that portion of the credit card debt is deductible as business interest. The same would be true if the card was used to pay for services related to the business.

A credit card could be used to pay education expenses such as tuition, and the interest may then be deductible as education interest (although there are limits to education interest deductions).

So your interest deduction is based on how you use loan proceeds, not how you choose to borrow.

James R. Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

 

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