If you’re thinking about selling property at a substantial profit, you should consider an installment sale. An installment sale lets you report your capital gains over a number of years and can often result in sizeable tax savings.
Take Fred Little, for example. Fred owns Adam, Up and Billem, a thriving lawn care firm. Adam, Up and Billem was created when Fred entered State College and spent his summer vacations mowing lawns to help pay for his tuition. Fred quickly built a reputation for reliability and soon hired several follow students to keep up with the demand for his services. By the time he finished his education, Fred had cultivated a growing firm.
Now Fred wasn’t the type to let an opportunity pass him by. When one of his customers told him that he was thinking of selling a piece of land, that Fred mowed, Fred decided to buy the land. This proved to be a good investment after several years. When Fred decided to sell the property it did not take long to find a buyer. When the property was sold Fred made a profit of $80,000.
Unfortunately, Fred didn’t realize that he had a silent partner who would reap a good portion of Fred’s profit. That silent partner was the federal and state taxing authorities. When Fred filed his federal and state tax returns, he discovered that, based on his $75,000 salary from Adam, Up and Billem, the joint tax return tax rates, personal exemptions if $6,200, and ignoring all other deductions, his federal income taxes totaled $20,256. And this did not include the state taxes.
A BETTER SOLUTION
Fred had a green thumb for the landscaping business, but he paid a costly price for not knowing about the advantages of an installment sale. An installment sale would have allowed Fred to use a special method of reporting his gain. Using that method, Fred’s taxes on the gain would have been deferred over a number of years and his current taxes would have been sharply reduced.
Under the method of reporting, the gross profit on the sale, when at least one payment is to be received after the year in which the sale is made, is prorated over the years in which payments are received rather than taxed in the year of the sale.
The taxable gain from an installment sale is determined by multiplying the installment sale receipts in the taxable year by the gross profit ration for the sale. Because the gain is spread over a number of years, the installment method will usually result in a lower total income tax.
Here’s what this would mean to Fred Little. If he had made an installment sale over four years and received payments of $50,000 each year, he would report only $20,000 of income from the sale on his tax return as shown here:
1. Gross profit ($200,000 selling price less $120,000 cost)…..$80,000
2. Gross profit ration ($80,000 gross profit divided by
$200,000 selling price)……………………………...............40%
3. Taxable income (40% of $50,000 per year)…………………$20,000
For Fred, this would produce significant tax savings. If he had sold his land and received payments of $50,000 a year for four years, he would report only $20,000 in gain on his tax return instead of $80,000. This would reduce his federal income tax from $20,256 to $11,256.
Deciding when and how to make an installment sale requires training and experience. Your accountant will be glad to give you the professional advice that is right for your situation.
CALL ON US
This publication is issued as a service to our clients and friends. This intellectual capital is of general nature and should not be acted upon without professional guidance. So if you know someone that is looking for a way to save taxes and avoid the IRS, call me at (702) 642-8953 or write me at isueirs@aol.com. No Exceptions. No Conditions, No Time limit. No IRS.
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