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Gov Forms 1040

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Gov Forms 1040

Gov forms 1040 Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. Gov forms 1040 General RulesFiguring Installment Sale Income Reporting Installment Sale Income Other RulesElecting Out of the Installment Method Payments Received or Considered Received Escrow Account Depreciation Recapture Income Sale to a Related Person Like-Kind Exchange Contingent Payment Sale Single Sale of Several Assets Sale of a Business Unstated Interest and Original Issue Discount (OID) Disposition of an Installment Obligation Repossession Interest on Deferred Tax Reporting an Installment SaleRelated person. Gov forms 1040 Several assets. Gov forms 1040 Special situations. Gov forms 1040 Schedule D (Form 1040). Gov forms 1040 Form 4797. Gov forms 1040 How To Get Tax Help What Is an Installment Sale? An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. Gov forms 1040 The rules for installment sales do not apply if you elect not to use the installment method (see Electing Out of the Installment Method under Other Rules, later) or the transaction is one for which the installment method may not apply. Gov forms 1040 The installment sales method cannot be used for the following. Gov forms 1040 Sale of inventory. Gov forms 1040   The regular sale of inventory of personal property does not qualify as an installment sale even if you receive a payment after the year of sale. Gov forms 1040 See Sale of a Business under Other Rules, later. Gov forms 1040 Dealer sales. Gov forms 1040   Sales of personal property by a person who regularly sells or otherwise disposes of the same type of personal property on the installment plan are not installment sales. Gov forms 1040 This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. Gov forms 1040 However, the rule does not apply to an installment sale of property used or produced in farming. Gov forms 1040 Special rule. Gov forms 1040   Dealers of time-shares and residential lots can treat certain sales as installment sales and report them under the installment method if they elect to pay a special interest charge. Gov forms 1040 For more information, see section 453(l). Gov forms 1040 Stock or securities. Gov forms 1040   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. Gov forms 1040 You must report the entire gain on the sale in the year in which the trade date falls. Gov forms 1040 Installment obligation. Gov forms 1040   The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you. Gov forms 1040 General Rules If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method. Gov forms 1040 See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. Gov forms 1040 Sale at a loss. Gov forms 1040   If your sale results in a loss, you cannot use the installment method. Gov forms 1040 If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. Gov forms 1040 Unstated interest. Gov forms 1040   If your sale calls for payments in a later year and the sales contract provides for little or no interest, you may have to figure unstated interest, even if you have a loss. Gov forms 1040 See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Gov forms 1040 Figuring Installment Sale Income You can use the following discussions or Form 6252 to help you determine gross profit, contract price, gross profit percentage, and installment sale income. Gov forms 1040 Each payment on an installment sale usually consists of the following three parts. Gov forms 1040 Interest income. Gov forms 1040 Return of your adjusted basis in the property. Gov forms 1040 Gain on the sale. Gov forms 1040 In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. Gov forms 1040 You do not include in income the part that is the return of your basis in the property. Gov forms 1040 Basis is the amount of your investment in the property for installment sale purposes. Gov forms 1040 Interest Income You must report interest as ordinary income. Gov forms 1040 Interest is generally not included in a down payment. Gov forms 1040 However, you may have to treat part of each later payment as interest, even if it is not called interest in your agreement with the buyer. Gov forms 1040 Interest provided in the agreement is called stated interest. Gov forms 1040 If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Gov forms 1040 See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Gov forms 1040 Adjusted Basis and Installment Sale Income (Gain on Sale) After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if it were made up of two parts. Gov forms 1040 A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). Gov forms 1040 Figuring adjusted basis for installment sale purposes. Gov forms 1040   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. Gov forms 1040 When you have completed the worksheet, you will also have determined the gross profit percentage necessary to figure your installment sale income (gain) for this year. Gov forms 1040 Worksheet A. Gov forms 1040 Figuring Adjusted Basis and Gross Profit Percentage 1. Gov forms 1040 Enter the selling price for the property   2. Gov forms 1040 Enter your adjusted basis for the property     3. Gov forms 1040 Enter your selling expenses     4. Gov forms 1040 Enter any depreciation recapture     5. Gov forms 1040 Add lines 2, 3, and 4. Gov forms 1040  This is your adjusted basis for installment sale purposes   6. Gov forms 1040 Subtract line 5 from line 1. Gov forms 1040 If zero or less, enter -0-. Gov forms 1040  This is your gross profit     If the amount entered on line 6 is zero, stop here. Gov forms 1040 You cannot use the installment method. Gov forms 1040   7. Gov forms 1040 Enter the contract price for the property   8. Gov forms 1040 Divide line 6 by line 7. Gov forms 1040 This is your gross profit percentage   Selling price. Gov forms 1040   The selling price is the total cost of the property to the buyer and includes any of the following. Gov forms 1040 Any money you are to receive. Gov forms 1040 The fair market value (FMV) of any property you are to receive (FMV is discussed in Property Used As a Payment under Other Rules, later). Gov forms 1040 Any existing mortgage or other debt the buyer pays, assumes, or takes (a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property). Gov forms 1040 Any of your selling expenses the buyer pays. Gov forms 1040   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Gov forms 1040 Adjusted basis for installment sale purposes. Gov forms 1040   Your adjusted basis is the total of the following three items. Gov forms 1040 Adjusted basis. Gov forms 1040 Selling expenses. Gov forms 1040 Depreciation recapture. Gov forms 1040 Adjusted basis. Gov forms 1040   Basis is your investment in the property for installment sale purposes. Gov forms 1040 The way you figure basis depends on how you acquire the property. Gov forms 1040 The basis of property you buy is generally its cost. Gov forms 1040 The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Gov forms 1040   While you own property, various events may change your original basis. Gov forms 1040 Some events, such as adding rooms or making permanent improvements, increase basis. Gov forms 1040 Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Gov forms 1040 The result is adjusted basis. Gov forms 1040   For more information on how to figure basis and adjusted basis, see Publication 551. Gov forms 1040 For more information regarding your basis in property you inherited from someone who died in 2010 and whose executor filed Form 8939, Allocation of Increase In Basis for Property Acquired From a Decedent, see Publication 4895. Gov forms 1040 Selling expenses. Gov forms 1040   Selling expenses relate to the sale of the property. Gov forms 1040 They include commissions, attorney fees, and any other expenses paid on the sale. Gov forms 1040 Selling expenses are added to the basis of the sold property. Gov forms 1040 Depreciation recapture. Gov forms 1040   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Gov forms 1040 See Depreciation Recapture Income under Other Rules, later. Gov forms 1040 Gross profit. Gov forms 1040   Gross profit is the total gain you report on the installment method. Gov forms 1040   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Gov forms 1040 If the property you sold was your home, subtract from the gross profit any gain you can exclude. Gov forms 1040 See Sale of Your Home , later, under Reporting Installment Sale Income. Gov forms 1040 Contract price. Gov forms 1040   Contract price equals: The selling price, minus The mortgages, debts, and other liabilities assumed or taken by the buyer, plus The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes. Gov forms 1040 Gross profit percentage. Gov forms 1040   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Gov forms 1040 This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Gov forms 1040   The gross profit percentage generally remains the same for each payment you receive. Gov forms 1040 However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. Gov forms 1040 Example. Gov forms 1040 You sell property at a contract price of $6,000 and your gross profit is $1,500. Gov forms 1040 Your gross profit percentage is 25% ($1,500 ÷ $6,000). Gov forms 1040 After subtracting interest, you report 25% of each payment, including the down payment, as installment sale income from the sale for the tax year you receive the payment. Gov forms 1040 The remainder (balance) of each payment is the tax-free return of your adjusted basis. Gov forms 1040 Amount to report as installment sale income. Gov forms 1040   Multiply the payments you receive each year (less interest) by the gross profit percentage. Gov forms 1040 The result is your installment sale income for the tax year. Gov forms 1040 In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Gov forms 1040 A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Gov forms 1040 For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. Gov forms 1040 Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. Gov forms 1040 You then must refigure the gross profit percentage for the remaining payments. Gov forms 1040 Refigure your gross profit using Worksheet B. Gov forms 1040 You will spread any remaining gain over future installments. Gov forms 1040 Worksheet B. Gov forms 1040 New Gross Profit Percentage — Selling Price Reduced 1. Gov forms 1040 Enter the reduced selling  price for the property   2. Gov forms 1040 Enter your adjusted  basis for the  property     3. Gov forms 1040 Enter your selling  expenses     4. Gov forms 1040 Enter any depreciation  recapture     5. Gov forms 1040 Add lines 2, 3, and 4. Gov forms 1040   6. Gov forms 1040 Subtract line 5 from line 1. Gov forms 1040  This is your adjusted  gross profit   7. Gov forms 1040 Enter any installment sale  income reported in  prior year(s)   8. Gov forms 1040 Subtract line 7 from line 6   9. Gov forms 1040 Future installments   10. Gov forms 1040 Divide line 8 by line 9. Gov forms 1040  This is your new gross profit percentage*   * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Gov forms 1040 Example. Gov forms 1040 In 2011, you sold land with a basis of $40,000 for $100,000. Gov forms 1040 Your gross profit was $60,000. Gov forms 1040 You received a $20,000 down payment and the buyer's note for $80,000. Gov forms 1040 The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. Gov forms 1040 Your gross profit percentage is 60%. Gov forms 1040 You reported a gain of $12,000 on each payment received in 2011 and 2012. Gov forms 1040 In 2013, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2013, 2014, and 2015 are reduced to $15,000 for each year. Gov forms 1040 The new gross profit percentage, 46. Gov forms 1040 67%, is figured on Example—Worksheet B. Gov forms 1040 You will report a gain of $7,000 (46. Gov forms 1040 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. Gov forms 1040 Example — Worksheet B. Gov forms 1040 New Gross Profit Percentage — Selling Price Reduced 1. Gov forms 1040 Enter the reduced selling  price for the property 85,000 2. Gov forms 1040 Enter your adjusted  basis for the  property 40,000   3. Gov forms 1040 Enter your selling  expenses -0-   4. Gov forms 1040 Enter any depreciation  recapture -0-   5. Gov forms 1040 Add lines 2, 3, and 4. Gov forms 1040 40,000 6. Gov forms 1040 Subtract line 5 from line 1. Gov forms 1040  This is your adjusted  gross profit 45,000 7. Gov forms 1040 Enter any installment sale  income reported in  prior year(s) 24,000 8. Gov forms 1040 Subtract line 7 from line 6 21,000 9. Gov forms 1040 Future installments 45,000 10. Gov forms 1040 Divide line 8 by line 9. Gov forms 1040  This is your new gross profit percentage* 46. Gov forms 1040 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Gov forms 1040 Reporting Installment Sale Income Generally, you will use Form 6252 to report installment sale income from casual sales of real or personal property during the tax year. Gov forms 1040 You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. Gov forms 1040 See Schedule D (Form 1040) and Form 4797 , later. Gov forms 1040 If the property was your main home, you may be able to exclude part or all of the gain. Gov forms 1040 See Sale of Your Home , later. Gov forms 1040 Form 6252 Use Form 6252 to report an installment sale in the year it takes place and to report payments received, or considered received because of related party resales, in later years. Gov forms 1040 Attach it to your tax return for each year. Gov forms 1040 Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. Gov forms 1040 Which parts to complete. Gov forms 1040   Which part to complete depends on whether you are filing the form for the year of sale or a later year. Gov forms 1040 Year of sale. Gov forms 1040   Complete lines 1 through 4, Part I, and Part II. Gov forms 1040 If you sold property to a related party during the year, also complete Part III. Gov forms 1040 Later years. Gov forms 1040   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. Gov forms 1040   If you sold a marketable security to a related party after May 14, 1980, and before January 1, 1987, complete Form 6252 for each year of the installment agreement, even if you did not receive a payment. Gov forms 1040 (After December 31, 1986, the installment method is not available for the sale of marketable securities. Gov forms 1040 ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Gov forms 1040 Complete Part III unless you received the final payment during the tax year. Gov forms 1040   If you sold property other than a marketable security to a related party after May 14, 1980, complete Form 6252 for the year of sale and for 2 years after the year of sale, even if you did not receive a payment. Gov forms 1040 Complete lines 1 through 4 and Part II for any year during this 2-year period in which you receive a payment from the sale. Gov forms 1040 Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. Gov forms 1040 Schedule D (Form 1040) Enter the gain figured on Form 6252 (line 26) for personal-use property (capital assets) on Schedule D (Form 1040), as a short-term gain (line 4) or long-term gain (line 11). Gov forms 1040 If your gain from the installment sale qualifies for long-term capital gain treatment in the year of sale, it will continue to qualify in later tax years. Gov forms 1040 Your gain is long-term if you owned the property for more than 1 year when you sold it. Gov forms 1040 Form 4797 An installment sale of property used in your business or that earns rent or royalty income may result in a capital gain, an ordinary gain, or both. Gov forms 1040 All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. Gov forms 1040 For trade or business property held for more than 1 year, enter the amount from line 26 of Form 6252 on Form 4797, line 4. Gov forms 1040 If the property was held 1 year or less or you have an ordinary gain from the sale of a noncapital asset (even if the holding period is more than 1 year), enter this amount on Form 4797, line 10, and write “From Form 6252. Gov forms 1040 ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. Gov forms 1040 See Publication 523 for information about excluding the gain. Gov forms 1040 If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. Gov forms 1040 Seller-financed mortgage. Gov forms 1040   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. Gov forms 1040   When you report interest income received from a buyer who uses the property as a personal residence, write the buyer's name, address, and social security number (SSN) on line 1 of Schedule B (Form 1040A or 1040), Interest and Ordinary Dividends. Gov forms 1040   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. Gov forms 1040   If either person fails to include the other person's SSN, a $50 penalty will be assessed. Gov forms 1040 Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. Gov forms 1040 The following topics are discussed. Gov forms 1040 Electing out of the installment method. Gov forms 1040 Payments received or considered received. Gov forms 1040 Escrow account. Gov forms 1040 Depreciation recapture income. Gov forms 1040 Sale to a related person. Gov forms 1040 Like-kind exchange. Gov forms 1040 Contingent payment sale. Gov forms 1040 Single sale of several assets. Gov forms 1040 Sale of a business. Gov forms 1040 Unstated interest and original issue discount. Gov forms 1040 Disposition of an installment obligation. Gov forms 1040 Repossession. Gov forms 1040 Interest on deferred tax. Gov forms 1040 Electing Out of the Installment Method If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you do not receive all the sale proceeds in that year. Gov forms 1040 To figure the amount of gain to report, use the fair market value (FMV) of the buyer's installment obligation that represents the buyer's debt to you. Gov forms 1040 Notes, mortgages, and land contracts are examples of obligations that are included at FMV. Gov forms 1040 You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. Gov forms 1040 If you use the cash method of accounting, the FMV of the obligation will never be considered to be less than the FMV of the property sold (minus any other consideration received). Gov forms 1040 Example. Gov forms 1040 You sold a parcel of land for $50,000. Gov forms 1040 You received a $10,000 down payment and will receive the balance over the next 10 years at $4,000 a year, plus 8% interest. Gov forms 1040 The buyer gave you a note for $40,000. Gov forms 1040 The note had an FMV of $40,000. Gov forms 1040 You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. Gov forms 1040 The land cost $25,000, and you owned it for more than one year. Gov forms 1040 You decide to elect out of the installment method and report the entire gain in the year of sale. Gov forms 1040 Gain realized:     Selling price $50,000 Minus: Property's adj. Gov forms 1040 basis $25,000     Commission 3,000 28,000 Gain realized $22,000 Gain recognized in year of sale:   Cash $10,000 Market value of note 40,000 Total realized in year of sale $50,000 Minus: Property's adj. Gov forms 1040 basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. Gov forms 1040 You include the entire gain in income in the year of sale, so you do not include in income any principal payments you receive in later tax years. Gov forms 1040 The interest on the note is ordinary income and is reported as interest income each year. Gov forms 1040 How to elect out. Gov forms 1040   To make this election, do not report your sale on Form 6252. Gov forms 1040 Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. Gov forms 1040 When to elect out. Gov forms 1040   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Gov forms 1040 Automatic six-month extension. Gov forms 1040   If you timely file your tax return without making the election, you still can make the election by filing an amended return within 6 months of the due date of your return (excluding extensions). Gov forms 1040 Write “Filed pursuant to section 301. Gov forms 1040 9100-2” at the top of the amended return and file it where the original return was filed. Gov forms 1040 Revoking the election. Gov forms 1040   Once made, the election can be revoked only with IRS approval. Gov forms 1040 A revocation is retroactive. Gov forms 1040 You will not be allowed to revoke the election if either of the following applies. Gov forms 1040 One of the purposes is to avoid federal income tax. Gov forms 1040 The tax year in which any payment was received has closed. Gov forms 1040 Payments Received or Considered Received You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale. Gov forms 1040 In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Gov forms 1040 These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. Gov forms 1040 However, as discussed later, the buyer's assumption of your debt is treated as a recovery of your basis rather than as a payment in many cases. Gov forms 1040 Buyer Pays Seller's Expenses If the buyer pays any of your expenses related to the sale of your property, it is considered a payment to you in the year of sale. Gov forms 1040 Include these expenses in the selling and contract prices when figuring the gross profit percentage. Gov forms 1040 Buyer Assumes Mortgage If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply. Gov forms 1040 Mortgage not more than basis. Gov forms 1040   If the buyer assumes a mortgage that is not more than your installment sale basis in the property, it is not considered a payment to you. Gov forms 1040 It is considered a recovery of your basis. Gov forms 1040 The contract price is the selling price minus the mortgage. Gov forms 1040 Example. Gov forms 1040 You sell property with an adjusted basis of $19,000. Gov forms 1040 You have selling expenses of $1,000. Gov forms 1040 The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 12% interest) in each of the next 4 years). Gov forms 1040 The selling price is $25,000 ($15,000 + $10,000). Gov forms 1040 Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Gov forms 1040 The contract price is $10,000 ($25,000 − $15,000 mortgage). Gov forms 1040 Your gross profit percentage is 50% ($5,000 ÷ $10,000). Gov forms 1040 You report half of each $2,000 payment received as gain from the sale. Gov forms 1040 You also report all interest you receive as ordinary income. Gov forms 1040 Mortgage more than basis. Gov forms 1040   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Gov forms 1040 The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Gov forms 1040   To figure the contract price, subtract the mortgage from the selling price. Gov forms 1040 This is the total amount (other than interest) you will receive directly from the buyer. Gov forms 1040 Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Gov forms 1040 The contract price is then the same as your gross profit from the sale. Gov forms 1040    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. Gov forms 1040 Example. Gov forms 1040 The selling price for your property is $9,000. Gov forms 1040 The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Gov forms 1040 Your adjusted basis in the property is $4,400. Gov forms 1040 You have selling expenses of $600, for a total installment sale basis of $5,000. Gov forms 1040 The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Gov forms 1040 This amount is included in the contract price and treated as a payment received in the year of sale. Gov forms 1040 The contract price is $4,000: Selling price $9,000 Minus: Mortgage (6,000) Amount actually received $3,000 Add difference:   Mortgage $6,000   Minus: Installment sale basis 5,000 1,000 Contract price $4,000       Your gross profit on the sale is also $4,000: Selling price $9,000 Minus: Installment sale basis (5,000) Gross profit $4,000 Your gross profit percentage is 100%. Gov forms 1040 Report 100% of each payment (less interest) as gain from the sale. Gov forms 1040 Treat the $1,000 difference between the mortgage and your installment sale basis as a payment and report 100% of it as gain in the year of sale. Gov forms 1040 Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. Gov forms 1040 You are considered to receive a payment equal to the outstanding canceled debt. Gov forms 1040 Example. Gov forms 1040 Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. Gov forms 1040 On April 4, 2013, she bought the land for $70,000. Gov forms 1040 At that time, $30,000 of her loan to you was outstanding. Gov forms 1040 She agreed to forgive this $30,000 debt and to pay you $20,000 (plus interest) on August 1, 2013, and $20,000 on August 1, 2014. Gov forms 1040 She did not assume an existing mortgage. Gov forms 1040 She canceled the $30,000 debt you owed her. Gov forms 1040 You are considered to have received a $30,000 payment at the time of the sale. Gov forms 1040 Buyer Assumes Other Debts If the buyer assumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of sale. Gov forms 1040 If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Gov forms 1040 Compare the debt to your installment sale basis in the property being sold. Gov forms 1040 If the debt is less than your installment sale basis, none of it is treated as a payment. Gov forms 1040 If it is more, only the difference is treated as a payment. Gov forms 1040 If the buyer assumes more than one debt, any part of the total that is more than your installment sale basis is considered a payment. Gov forms 1040 These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . Gov forms 1040 However, they apply only to the following types of debt the buyer assumes. Gov forms 1040 Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Gov forms 1040 Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Gov forms 1040 If the buyer assumes any other type of debt, such as a personal loan or your legal fees relating to the sale, it is treated as if the buyer had paid off the debt at the time of the sale. Gov forms 1040 The value of the assumed debt is then considered a payment to you in the year of sale. Gov forms 1040 Property Used As a Payment If you receive property other than money from the buyer, it is still considered a payment in the year received. Gov forms 1040 However, see Like-Kind Exchange , later. Gov forms 1040 Generally, the amount of the payment is the property's FMV on the date you receive it. Gov forms 1040 Exception. Gov forms 1040   If the property the buyer gives you is payable on demand or readily tradable, the amount you should consider as payment in the year received is: The FMV of the property on the date you receive it if you use the cash method of accounting, The face amount of the obligation on the date you receive it if you use the accrual method of accounting, or The stated redemption price at maturity less any original issue discount (OID) or, if there is no OID, the stated redemption price at maturity appropriately discounted to reflect total unstated interest. Gov forms 1040 See Unstated Interest and Original Issue Discount (OID) , later. Gov forms 1040 Debt not payable on demand. Gov forms 1040   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. Gov forms 1040 This is true even if the debt is guaranteed by a third party, including a government agency. Gov forms 1040 Fair market value (FMV). Gov forms 1040   This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of all the necessary facts. Gov forms 1040 Third-party note. Gov forms 1040   If the property the buyer gives you is a third-party note (or other obligation of a third party), you are considered to have received a payment equal to the note's FMV. Gov forms 1040 Because the FMV of the note is itself a payment on your installment sale, any payments you later receive from the third party are not considered payments on the sale. Gov forms 1040 The excess of the note's face value over its FMV is interest. Gov forms 1040 Exclude this interest in determining the selling price of the property. Gov forms 1040 However, see Exception under Property Used As a Payment, earlier. Gov forms 1040 Example. Gov forms 1040 You sold real estate in an installment sale. Gov forms 1040 As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. Gov forms 1040 The FMV of the third-party note at the time of the sale was $30,000. Gov forms 1040 This amount, not $50,000, is a payment to you in the year of sale. Gov forms 1040 The third-party note had an FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable return of capital. Gov forms 1040 The remaining 40% is interest taxed as ordinary income. Gov forms 1040 Bond. Gov forms 1040   A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. Gov forms 1040 For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. Gov forms 1040    If you receive a government or corporate bond for a sale before October 22, 2004, and the bond has interest coupons attached or can be readily traded in an established securities market, you are considered to have received payment equal to the bond's FMV. Gov forms 1040 However, see Exception under Property Used As a Payment, earlier. Gov forms 1040 Buyer's note. Gov forms 1040   The buyer's note (unless payable on demand) is not considered payment on the sale. Gov forms 1040 However, its full face value is included when figuring the selling price and the contract price. Gov forms 1040 Payments you receive on the note are used to figure your gain in the year received. Gov forms 1040 Installment Obligation Used as Security (Pledge Rule) If you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation. Gov forms 1040 This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. Gov forms 1040 It does not apply to the following dispositions. Gov forms 1040 Sales of property used or produced in farming. Gov forms 1040 Sales of personal-use property. Gov forms 1040 Qualifying sales of time-shares and residential lots. Gov forms 1040 The net debt proceeds are the gross debt minus the direct expenses of getting the debt. Gov forms 1040 The amount treated as a payment is considered received on the later of the following dates. Gov forms 1040 The date the debt becomes secured. Gov forms 1040 The date you receive the debt proceeds. Gov forms 1040 A debt is secured by an installment obligation to the extent that payment of principal or interest on the debt is directly secured (under the terms of the loan or any underlying arrangement) by any interest in the installment obligation. Gov forms 1040 For sales after December 16, 1999, payment on a debt is treated as directly secured by an interest in an installment obligation to the extent an arrangement allows you to satisfy all or part of the debt with the installment obligation. Gov forms 1040 Limit. Gov forms 1040   The net debt proceeds treated as a payment on the pledged installment obligation cannot be more than the excess of item (1) over item (2), below. Gov forms 1040 The total contract price on the installment sale. Gov forms 1040 Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. Gov forms 1040 Installment payments. Gov forms 1040   The pledge rule accelerates the reporting of the installment obligation payments. Gov forms 1040 Do not report payments received on the obligation after it has been pledged until the payments received exceed the amount reported under the pledge rule. Gov forms 1040 Exception. Gov forms 1040   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. Gov forms 1040 The debt was outstanding on December 17, 1987. Gov forms 1040 The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. Gov forms 1040   A refinancing as a result of the creditor's calling of the debt is treated as a continuation of the original debt so long as a person other than the creditor or a person related to the creditor provides the refinancing. Gov forms 1040   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Gov forms 1040 Any excess is treated as a payment on the installment obligation. Gov forms 1040 Escrow Account In some cases, the sales agreement or a later agreement may call for the buyer to establish an irrevocable escrow account from which the remaining installment payments (including interest) are to be made. Gov forms 1040 These sales cannot be reported on the installment method. Gov forms 1040 The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. Gov forms 1040 When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. Gov forms 1040 Example. Gov forms 1040 You sell property for $100,000. Gov forms 1040 The sales agreement calls for a down payment of $10,000 and payment of $15,000 in each of the next 6 years to be made from an irrevocable escrow account containing the balance of the purchase price plus interest. Gov forms 1040 You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. Gov forms 1040 You report the entire gain in the year of sale. Gov forms 1040 Escrow established in a later year. Gov forms 1040   If you make an installment sale and in a later year an irrevocable escrow account is established to pay the remaining installments plus interest, the amount placed in the escrow account represents payment of the balance of the installment obligation. Gov forms 1040 Substantial restriction. Gov forms 1040   If an escrow arrangement imposes a substantial restriction on your right to receive the sale proceeds, the sale can be reported on the installment method, provided it otherwise qualifies. Gov forms 1040 For an escrow arrangement to impose a substantial restriction, it must serve a bona fide purpose of the buyer, that is, a real and definite restriction placed on the seller or a specific economic benefit conferred on the buyer. Gov forms 1040 Depreciation Recapture Income If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Gov forms 1040 Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Gov forms 1040 Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. Gov forms 1040 The recapture income is also included in Part I of Form 6252. Gov forms 1040 However, the gain equal to the recapture income is reported in full in the year of the sale. Gov forms 1040 Only the gain greater than the recapture income is reported on the installment method. Gov forms 1040 For more information on depreciation recapture, see chapter 3 in Publication 544. Gov forms 1040 The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. Gov forms 1040 Determining gross profit is discussed under General Rules , earlier. Gov forms 1040 Sale to a Related Person If you sell depreciable property to a related person and the sale is an installment sale, you may not be able to report the sale using the installment method. Gov forms 1040 If you sell property to a related person and the related person disposes of the property before you receive all payments with respect to the sale, you may have to treat the amount realized by the related person as received by you when the related person disposes of the property. Gov forms 1040 These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. Gov forms 1040 Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Gov forms 1040 Instead, all payments to be received are considered received in the year of sale. Gov forms 1040 However, see Exception , below. Gov forms 1040 Depreciable property for this rule is any property the purchaser can depreciate. Gov forms 1040 Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. Gov forms 1040 In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. Gov forms 1040 The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. Gov forms 1040 Exception. Gov forms 1040   You can use the installment method to report a sale of depreciable property to a related person if no significant tax deferral benefit will be derived from the sale. Gov forms 1040 You must show to the satisfaction of the IRS that avoidance of federal income tax was not one of the principal purposes of the sale. Gov forms 1040 Related person. Gov forms 1040   Related persons include the following. Gov forms 1040 A person and all controlled entities with respect to that person. Gov forms 1040 A taxpayer and any trust in which such taxpayer (or his spouse) is a beneficiary, unless that beneficiary's interest in the trust is a remote contingent interest. Gov forms 1040 Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of that estate. Gov forms 1040 Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. Gov forms 1040   For information about which entities are controlled entities, see section 1239(c). Gov forms 1040 Sale and Later Disposition Generally, a special rule applies if you sell or exchange property to a related person on the installment method (first disposition) who then sells, exchanges, or gives away the property (second disposition) under the following circumstances. Gov forms 1040 The related person makes the second disposition before making all payments on the first disposition. Gov forms 1040 The related person disposes of the property within 2 years of the first disposition. Gov forms 1040 This rule does not apply if the property involved is marketable securities. Gov forms 1040 Under this rule, you treat part or all of the amount the related person realizes (or the FMV if the disposed property is not sold or exchanged) from the second disposition as if you received it at the time of the second disposition. Gov forms 1040 See Exception , later. Gov forms 1040 Related person. Gov forms 1040   Related persons include the following. Gov forms 1040 Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. Gov forms 1040 A partnership or estate and a partner or beneficiary. Gov forms 1040 A trust (other than a section 401(a) employees trust) and a beneficiary. Gov forms 1040 A trust and an owner of the trust. Gov forms 1040 Two corporations that are members of the same controlled group as defined in section 267(f). Gov forms 1040 The fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts. Gov forms 1040 A tax-exempt educational or charitable organization and a person (if an individual, including members of the individual's family) who directly or indirectly controls such an organization. Gov forms 1040 An individual and a corporation when the individual owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation. Gov forms 1040 A fiduciary of a trust and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation. Gov forms 1040 The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Gov forms 1040 Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. Gov forms 1040 An S corporation and a corporation that is not an S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation. Gov forms 1040 A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership. Gov forms 1040 An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. Gov forms 1040 Example 1. Gov forms 1040 In 2012, Harvey Green sold farm land to his son Bob for $500,000, which was to be paid in five equal payments over 5 years, plus adequate stated interest on the balance due. Gov forms 1040 His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. Gov forms 1040 His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). Gov forms 1040 He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. Gov forms 1040 50). Gov forms 1040 Bob made no improvements to the property and sold it to Alfalfa Inc. Gov forms 1040 , in 2013 for $600,000 after making the payment for that year. Gov forms 1040 The amount realized from the second disposition is $600,000. Gov forms 1040 Harvey figures his installment sale income for 2013 as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $500,000 Subtract: Sum of payments from Bob in 2012 and 2013 - 200,000 Amount treated as received because of second disposition $300,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $400,000 Multiply by gross profit % × . Gov forms 1040 50 Installment sale income for 2013 $200,000 Harvey will not include in his installment sale income any principal payments he receives on the installment obligation for 2014, 2015, and 2016 because he has already reported the total payments of $500,000 from the first disposition ($100,000 in 2012 and $400,000 in 2013). Gov forms 1040 Example 2. Gov forms 1040 Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. Gov forms 1040 The gain for 2013 is figured as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $400,000 Subtract: Sum of payments from Bob in 2012 and 2013 − 200,000 Amount treated as received because of second disposition $200,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $300,000 Multiply by gross profit % × . Gov forms 1040 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. Gov forms 1040 They are not taxed because he treated the $200,000 from the disposition in 2013 as a payment received and paid tax on the installment sale income. Gov forms 1040 In 2016, he receives the final $100,000 payment. Gov forms 1040 He figures the installment sale income he must recognize in 2016 as follows: Total payments from the first disposition received by the end of 2016 $500,000 Minus the sum of:     Payment from 2012 $100,000   Payment from 2013 100,000   Amount treated as received in 2013 200,000   Total on which gain was previously recognized  − 400,000 Payment on which gain is recognized for 2016  $100,000 Multiply by gross profit % × . Gov forms 1040 50 Installment sale income for 2016 $ 50,000 Exception. Gov forms 1040   This rule does not apply to a second disposition, and any later transfer, if you can show to the satisfaction of the IRS that neither the first disposition (to the related person) nor the second disposition had as one of its principal purposes the avoidance of federal income tax. Gov forms 1040 Generally, an involuntary second disposition will qualify under the nontax avoidance exception, such as when a creditor of the related person forecloses on the property or the related person declares bankruptcy. Gov forms 1040   The nontax avoidance exception also applies to a second disposition that is also an installment sale if the terms of payment under the installment resale are substantially equal to or longer than those for the first installment sale. Gov forms 1040 However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. Gov forms 1040   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. Gov forms 1040 An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. Gov forms 1040 A transfer after the death of the person making the first disposition or the related person's death, whichever is earlier, is not treated as a second disposition. Gov forms 1040 Like-Kind Exchange If you trade business or investment property solely for the same kind of property to be held as business or investment property, you can postpone reporting the gain. Gov forms 1040 These trades are known as like-kind exchanges. Gov forms 1040 The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. Gov forms 1040 You do not have to report any part of your gain if you receive only like-kind property. Gov forms 1040 However, if you also receive money or other property (boot) in the exchange, you must report your gain to the extent of the money and the FMV of the other property received. Gov forms 1040 For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. Gov forms 1040 Installment payments. Gov forms 1040   If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine the installment sale income each year. Gov forms 1040 The contract price is reduced by the FMV of the like-kind property received in the trade. Gov forms 1040 The gross profit is reduced by any gain on the trade that can be postponed. Gov forms 1040 Like-kind property received in the trade is not considered payment on the installment obligation. Gov forms 1040 Example. Gov forms 1040 In 2013, George Brown trades personal property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. Gov forms 1040 He also receives an installment note for $800,000 in the trade. Gov forms 1040 Under the terms of the note, he is to receive $100,000 (plus interest) in 2014 and the balance of $700,000 (plus interest) in 2015. Gov forms 1040 George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Gov forms 1040 His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). Gov forms 1040 The contract price is $800,000 ($1,000,000 − $200,000). Gov forms 1040 The gross profit percentage is 75% ($600,000 ÷ $800,000). Gov forms 1040 He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. Gov forms 1040 He reports $75,000 gain for 2014 (75% of $100,000 payment received) and $525,000 gain for 2015 (75% of $700,000 payment received). Gov forms 1040 Deferred exchanges. Gov forms 1040   A deferred exchange is one in which you transfer property you use in business or hold for investment and receive like-kind property later that you will use in business or hold for investment. Gov forms 1040 Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. Gov forms 1040 If certain rules are met, these funds will not be considered a payment until you have the right to receive the funds or, if earlier, the end of the exchange period. Gov forms 1040 See Regulations section 1. Gov forms 1040 1031(k)-1(j)(2) for these rules. Gov forms 1040 Contingent Payment Sale A contingent payment sale is one in which the total selling price cannot be determined by the end of the tax year of sale. Gov forms 1040 This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. Gov forms 1040 If the selling price cannot be determined by the end of the tax year, you must use different rules to figure the contract price and the gross profit percentage than those you use for an installment sale with a fixed selling price. Gov forms 1040 For rules on using the installment method for a contingent payment sale, see Regulations section 15a. Gov forms 1040 453-1(c). Gov forms 1040 Single Sale of Several Assets If you sell different types of assets in a single sale, you must identify each asset to determine whether you can use the installment method to report the sale of that asset. Gov forms 1040 You also have to allocate part of the selling price to each asset. Gov forms 1040 If you sell assets that constitute a trade or business, see Sale of a Business , later. Gov forms 1040 Unless an allocation of the selling price has been agreed to by both parties in an arm's-length transaction, you must allocate the selling price to an asset based on its FMV. Gov forms 1040 If the buyer assumes a debt, or takes the property subject to a debt, you must reduce the FMV of the property by the debt. Gov forms 1040 This becomes the net FMV. Gov forms 1040 A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. Gov forms 1040 However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. Gov forms 1040 It must be reported separately. Gov forms 1040 The remaining assets sold at a gain are reported together. Gov forms 1040 Example. Gov forms 1040 You sold three separate and unrelated parcels of real property (A, B, and C) under a single contract calling for a total selling price of $130,000. Gov forms 1040 The total selling price consisted of a cash payment of $20,000, the buyer's assumption of a $30,000 mortgage on parcel B, and an installment obligation of $80,000 payable in eight annual installments, plus interest at 8% a year. Gov forms 1040 Your installment sale basis for each parcel was $15,000. Gov forms 1040 Your net gain was $85,000 ($130,000 − $45,000). Gov forms 1040 You report the gain on the installment method. Gov forms 1040 The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. Gov forms 1040 The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. Gov forms 1040 The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. Gov forms 1040 You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Gov forms 1040 Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. Gov forms 1040 You should allocate the cash payment of $20,000 received in the year of sale and the note receivable on the basis of their proportionate net FMV. Gov forms 1040 The allocation is figured as follows:   Parcels   A and B Parcel C FMV $120,000 $10,000 Minus: Mortgage assumed 30,000 -0- Net FMV $ 90,000 $10,000 Proportionate net FMV:     Percentage of total 90% 10% Payments in year of sale:     $20,000 × 90% $18,000   $20,000 × 10%   $2,000 Excess of parcel B mortgage over installment sale basis 15,000 -0- Allocation of payments  received (or considered  received) in year of sale $ 33,000 $ 2,000 You cannot report the sale of parcel C on the installment method because the sale results in a loss. Gov forms 1040 You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. Gov forms 1040 However, if parcel C was held for personal use, the loss is not deductible. Gov forms 1040 You allocate the installment obligation of $80,000 to the properties sold based on their proportionate net FMVs (90% to parcels A and B, 10% to parcel C). Gov forms 1040 Sale of a Business The installment sale of an entire business for one overall price under a single contract is not the sale of a single asset. Gov forms 1040 Allocation of Selling Price To determine whether any of the gain on the sale of the business can be reported on the installment method, you must allocate the total selling price and the payments received in the year of sale between each of the following classes of assets. Gov forms 1040 Assets sold at a loss. Gov forms 1040 Real and personal property eligible for the installment method. Gov forms 1040 Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. Gov forms 1040 Inventory. Gov forms 1040   The sale of inventories of personal property cannot be reported on the installment method. Gov forms 1040 All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Gov forms 1040   If inventory items are included in an installment sale, you may have an agreement stating which payments are for inventory and which are for the other assets being sold. Gov forms 1040 If you do not, each payment must be allocated between the inventory and the other assets sold. Gov forms 1040   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Gov forms 1040 Use your basis in the inventory to figure the cost of goods sold. Gov forms 1040 Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. Gov forms 1040 Residual method. Gov forms 1040   Except for assets exchanged under the like-kind exchange rules, both the buyer and seller of a business must use the residual method to allocate the sale price to each business asset sold. Gov forms 1040 This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. Gov forms 1040   The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. Gov forms 1040 This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b). Gov forms 1040   A group of assets constitutes a trade or business if goodwill or going concern value could, under any circumstances, attach to the assets or if the use of the assets would constitute an active trade or business under section 355. Gov forms 1040   The residual method provides for the consideration to be reduced first by cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). Gov forms 1040 The consideration remaining after this reduction must be allocated among the various business assets in a certain order. Gov forms 1040   For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order. Gov forms 1040 Certificates of deposit, U. Gov forms 1040 S. Gov forms 1040 Government securities, foreign currency, and actively traded personal property, including stock and securities. Gov forms 1040 Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. Gov forms 1040 However, see Regulations section 1. Gov forms 1040 338-6(b)(2)(iii) for exceptions that apply to debt instruments issued by persons related to a target corporation, contingent debt instruments, and debt instruments convertible into stock or other property. Gov forms 1040 Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of business. Gov forms 1040 All other assets except section 197 intangibles. Gov forms 1040 Section 197 intangibles except goodwill and going concern value. Gov forms 1040 Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Gov forms 1040   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. Gov forms 1040 For example, if an asset is described in both (4) and (6), include it in (4). Gov forms 1040 Agreement. Gov forms 1040   The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market value of any of the assets. Gov forms 1040 This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Gov forms 1040 Reporting requirement. Gov forms 1040   Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets. Gov forms 1040 Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. Gov forms 1040 The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Gov forms 1040 Sale of Partnership Interest A partner who sells a partnership interest at a gain may be able to report the sale on the installment method. Gov forms 1040 The sale of a partnership interest is treated as the sale of a single capital asset. Gov forms 1040 The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. Gov forms 1040 (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. Gov forms 1040 ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. Gov forms 1040 The gain allocated to the other assets can be reported under the installment method. Gov forms 1040 For more information on the treatment of unrealized receivables and inventory, see Publication 541. Gov forms 1040 Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. Gov forms 1040 You received a $100,000 down payment and the buyer's note for $120,000. Gov forms 1040 The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. Gov forms 1040 The total selling price is $220,000. Gov forms 1040 Your selling expenses are $11,000. Gov forms 1040 The selling expenses are divided among all the assets sold, including inventory. Gov forms 1040 Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). Gov forms 1040 The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. Gov forms 1040 Asset FMV Claimed Basis Inventory $ 10,000 -0- $ 8,000 Land 42,000 -0- 15,000 Building 48,000 $9,000 36,000 Machine A 71,000 27,200 63,800 Machine B 24,000 12,960 22,040 Truck 6,500 18,624 5,376   $201,500 $67,784 $150,216         Under the residual method, you allocate the selling price to each of the assets based on their FMV ($201,500). Gov forms 1040 The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. Gov forms 1040 The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis, and the gain for each asset are shown in the following chart. Gov forms 1040   Sale  Price Sale   Exp. Gov forms 1040 Adj. Gov forms 1040   Basis Gain Inventory $ 10,000 $ 500 $ 8,000 $ 1,500 Land 42,000 2,100 15,000 24,900 Building 48,000 2,400 36,000 9,600 Mch. Gov forms 1040 A 71,000 3,550 63,800 3,650 Mch. Gov forms 1040 B 24,000 1,200 22,040 760 Truck 6,500 325 5,376 799 Goodwill 18,500 925 -0- 17,575   $220,000 $11,000 $150,216 $58,784 The building was acquired in 2005, the year the business began, and it is section 1250 property. Gov forms 1040 There is no depreciation recapture income because the building was depreciated using the straight line method. Gov forms 1040 All gain on the truck, machine A, and machine B is depreciation recapture income since it is the lesser of the depreciation claimed or the gain on the sale. Gov forms 1040 Figure depreciation recapture in Part III of Form 4797. Gov forms 1040 The total depreciation recapture income reported in Part II of Form 4797 is $5,209. Gov forms 1040 This consists of $3,650 on machine A, $799 on the truck, and $760 on machine B (the gain on each item because it was less than the depreciation claimed). Gov forms 1040 These gains are reported in full in the year of sale and are not included in the installment sale computation. Gov forms 1040 Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. Gov forms 1040 The selling prices of the truck and machines are also removed from the total selling price because gain on these items is reported in full in the year of sale. Gov forms 1040 The selling price equals the contract price for the installment sale ($108,500). Gov forms 1040 The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. Gov forms 1040   Selling  Price Install- ment  Sale  Basis Gross  Profit Land $ 42,000 $17,100 $24,900 Building 48,000 38,400 9,600 Goodwill 18,500 925 17,575 Total $108,500 $56,425 $52,075         The gross profit percentage (gross profit ÷ contract price) for the installment sale is 48% ($52,075 ÷ $108,500). Gov forms 1040 The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. Gov forms 1040 95 Building— $9,600 ÷ $108,500 8. Gov forms 1040 85 Goodwill— $17,575 ÷ $108,500 16. Gov forms 1040 20 Total 48. Gov forms 1040 00 The sale includes assets sold on the installment method and assets for which the gain is reported in full in the year of sale, so payments must be allocated between the installment part of the sale and the part reported in the year of sale. Gov forms 1040 The selling price for the installment sale is $108,500. Gov forms 1040 This is 49. Gov forms 1040 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). Gov forms 1040 The selling price of assets not reported on the installment method is $111,500. Gov forms 1040 This is 50. Gov forms 1040 7% ($111,500 ÷ $220,000) of the total selling price. Gov forms 1040 Multiply principal payments by 49. Gov forms 1040 3% to determine the part of the payment for the installment sale. Gov forms 1040 The balance, 50. Gov forms 1040 7%, is for the part reported in the year of the sale. Gov forms 1040 The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. Gov forms 1040 When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Gov forms 1040 Only the part for the installment sale (49. Gov forms 1040 3%) is used in the installment sale computation. Gov forms 1040 The only payment received in 2013 is the down payment of $100,000. Gov forms 1040 The part of the payment for the installment sale is $49,300 ($100,000 × 49. Gov forms 1040 3%). Gov forms 1040 This amount is used in the installment sale computation. Gov forms 1040 Installment income for 2013. Gov forms 1040   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. Gov forms 1040 Income Land—22. Gov forms 1040 95% of $49,300 $11,314 Building—8. Gov forms 1040 85% of $49,300 4,363 Goodwill—16. Gov forms 1040 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. Gov forms 1040   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. Gov forms 1040 3% of the total payments you receive on the buyer's note during the year. Gov forms 1040 Unstated Interest and Original Issue Discount (OID) An installment sale contract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the principal payment. Gov forms 1040 Interest provided in the contract is called stated interest. Gov forms 1040 If an installment sale contract does not provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest. Gov forms 1040 If section 483 applies to the contract, this interest is called unstated interest. Gov forms 1040 If section 1274 applies to the contract, this interest is called original issue discount (OID). Gov forms 1040 An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). Gov forms 1040 Treatment of unstated interest and OID. Gov forms 1040   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Gov forms 1040 As a result, the buyer cannot deduct the unstated interest. Gov forms 1040 The seller must report the unstated interest as income. Gov forms 1040   Personal-use property is any property in which substantially all of its use by the buyer is not in connection with a trade or business or an investment activity. Gov forms 1040   If the debt is subject to the section 483 rules and is also subject to the below-market loan rules, such as a gift loan, compensation-related loan, or corporation-shareholder loan, then both parties are subject to the below-market loan rules rather than the unstated interest rules. Gov forms 1040 Rules for the seller. Gov forms 1040   If either section 1274 or section 483 applies to the installment sale contract, you must treat part of the installment sale price as interest, even though interest is not called for in the sales agreement. Gov forms 1040 If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. Gov forms 1040   Include the unstated interest in income based on your regular method of accounting. Gov forms 1040 Include OID in income over the term of the contract. Gov forms 1040   The OID includible in income each year is based on the constant yield method described in section 1272. Gov forms 1040 (In some cases, the OID on an installment sale contract also may include all or part of the stated interest, especially if the stated interest is not paid at least annually. Gov forms 1040 )   If you do not use the installment method to report the sale, report the entire gain under your method of accounting in the year of sale. Gov forms 1040 Reduce the selling price by any stated principal treated as interest to determine the gain. Gov forms 1040   Report unstated interest or OID on your tax return, in addition to stated interest. Gov forms 1040 Rules for the buyer. Gov forms 1040   Any part of the stated selling price of an installment sale contract treated by the buyer as interest reduces the buyer's basis in the property and increases the buyer's interest expense. Gov forms 1040 These rules do not apply to personal-use property (for example, property not used in a trade or business). Gov forms 1040 Adequate stated interest. Gov forms 1040   An installment sale contract generally provides for adequate stated interest if the contract's stated principal amount is at least equal to the sum of the present values of all principal and interest payments called for under the contract. Gov forms 1040 The present value of a payment is determined based on the test rate of interest, defined next. Gov forms 1040 (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. Gov forms 1040 ) In general, an installment sale contract provides for adequate stated interest if the stated interest rate (based on an appropriate compounding period) is at least equal to the test rate of interest. Gov forms 1040 Test rate of interest. Gov forms 1040   The test rate of interest for a contract is the 3-month rate. Gov forms 1040 The 3-month rate is the lower of the following applicable federal rates (AFRs). Gov forms 1040 The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the first month in which there is a binding written contract that substantially provides the terms under which the sale or exchange is ultimately completed. Gov forms 1040 The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the month in which the sale or exchange occurs. Gov forms 1040 Applicable federal rate (AFR). Gov forms 1040   The AFR depends on the month the binding
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Page Last Reviewed or Updated: 14-Mar-2014

The Gov Forms 1040

Gov forms 1040 2. Gov forms 1040   Entertainment Table of Contents Directly-Related Test Associated TestMeetings at conventions. Gov forms 1040 50% LimitExceptions to the 50% Limit What Entertainment Expenses Are Deductible?A meal as a form of entertainment. Gov forms 1040 Deduction may depend on your type of business. Gov forms 1040 Exception for events that benefit charitable organizations. Gov forms 1040 Food and beverages in skybox seats. Gov forms 1040 What Entertainment Expenses Are Not Deductible?Out-of-pocket expenses. Gov forms 1040 You may be able to deduct business-related entertainment expenses you have for entertaining a client, customer, or employee. Gov forms 1040 The rules and definitions are summarized in Table 2-1 . Gov forms 1040 You can deduct entertainment expenses only if they are both ordinary and necessary and meet one of the following tests. Gov forms 1040 Directly-related test. Gov forms 1040 Associated test. Gov forms 1040 Both of these tests are explained later. Gov forms 1040 An ordinary expense is one that is common and accepted in your trade or business. Gov forms 1040 A necessary expense is one that is helpful and appropriate for your business. Gov forms 1040 An expense does not have to be required to be considered necessary. Gov forms 1040 The amount you can deduct for entertainment expenses may be limited. Gov forms 1040 Generally, you can deduct only 50% of your unreimbursed entertainment expenses. Gov forms 1040 This limit is discussed later under 50% Limit. Gov forms 1040 Directly-Related Test To meet the directly-related test for entertainment expenses (including entertainment-related meals), you must show that: The main purpose of the combined business and entertainment was the active conduct of business, You did engage in business with the person during the entertainment period, and You had more than a general expectation of getting income or some other specific business benefit at some future time. Gov forms 1040 Business is generally not considered to be the main purpose when business and entertainment are combined on hunting or fishing trips, or on yachts or other pleasure boats. Gov forms 1040 Even if you show that business was the main purpose, you generally cannot deduct the expenses for the use of an entertainment facility. Gov forms 1040 See Entertainment facilities under What Entertainment Expenses Are Not Deductible? later in this chapter. Gov forms 1040 You must consider all the facts, including the nature of the business transacted and the reasons for conducting business during the entertainment. Gov forms 1040 It is not necessary to devote more time to business than to entertainment. Gov forms 1040 However, if the business discussion is only incidental to the entertainment, the entertainment expenses do not meet the directly-related test. Gov forms 1040 Table 2-1. Gov forms 1040 When Are Entertainment Expenses Deductible? General rule You can deduct ordinary and necessary expenses to entertain a client, customer, or employee if the expenses meet the directly-related test or the associated test. Gov forms 1040 Definitions Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation, and includes meals provided to a customer or client. Gov forms 1040 An ordinary expense is one that is common and accepted in your trade or business. Gov forms 1040 A necessary expense is one that is helpful and appropriate. Gov forms 1040 Tests to be met Directly-related test Entertainment took place in a clear business setting, or Main purpose of entertainment was the active conduct of business, and You did engage in business with the person during the entertainment period, and You had more than a general expectation of getting income or some other specific business benefit. Gov forms 1040   Associated test Entertainment is associated with your trade or business, and Entertainment is directly before or after a substantial business discussion. Gov forms 1040 Other rules You cannot deduct the cost of your meal as an entertainment expense if you are claiming the meal as a travel expense. Gov forms 1040 You cannot deduct expenses that are lavish or extravagant under the circumstances. Gov forms 1040 You generally can deduct only 50% of your unreimbursed entertainment expenses (see 50% Limit ). Gov forms 1040 You do not have to show that business income or other business benefit actually resulted from each entertainment expense. Gov forms 1040 Clear business setting. Gov forms 1040   If the entertainment takes place in a clear business setting and is for your business or work, the expenses are considered directly related to your business or work. Gov forms 1040 The following situations are examples of entertainment in a clear business setting. Gov forms 1040 Entertainment in a hospitality room at a convention where business goodwill is created through the display or discussion of business products. Gov forms 1040 Entertainment that is mainly a price rebate on the sale of your products (such as a restaurant owner providing an occasional free meal to a loyal customer). Gov forms 1040 Entertainment of a clear business nature occurring under circumstances where there is no meaningful personal or social relationship between you and the persons entertained. Gov forms 1040 An example is entertainment of business and civic leaders at the opening of a new hotel or play when the purpose is to get business publicity rather than to create or maintain the goodwill of the persons entertained. Gov forms 1040 Expenses not considered directly related. Gov forms 1040   Entertainment expenses generally are not considered directly related if you are not there or in situations where there are substantial distractions that generally prevent you from actively conducting business. Gov forms 1040 The following are examples of situations where there are substantial distractions. Gov forms 1040 A meeting or discussion at a nightclub, theater, or sporting event. Gov forms 1040 A meeting or discussion during what is essentially a social gathering, such as a cocktail party. Gov forms 1040 A meeting with a group that includes persons who are not business associates at places such as cocktail lounges, country clubs, golf clubs, athletic clubs, or vacation resorts. Gov forms 1040 Associated Test Even if your expenses do not meet the directly-related test, they may meet the associated test. Gov forms 1040 To meet the associated test for entertainment expenses (including entertainment-related meals), you must show that the entertainment is: Associated with the active conduct of your trade or business, and Directly before or after a substantial business discussion (defined later). Gov forms 1040 Associated with trade or business. Gov forms 1040   Generally, an expense is associated with the active conduct of your trade or business if you can show that you had a clear business purpose for having the expense. Gov forms 1040 The purpose may be to get new business or to encourage the continuation of an existing business relationship. Gov forms 1040 Substantial business discussion. Gov forms 1040   Whether a business discussion is substantial depends on the facts of each case. Gov forms 1040 A business discussion will not be considered substantial unless you can show that you actively engaged in the discussion, meeting, negotiation, or other business transaction to get income or some other specific business benefit. Gov forms 1040   The meeting does not have to be for any specified length of time, but you must show that the business discussion was substantial in relation to the meal or entertainment. Gov forms 1040 It is not necessary that you devote more time to business than to entertainment. Gov forms 1040 You do not have to discuss business during the meal or entertainment. Gov forms 1040 Meetings at conventions. Gov forms 1040   You are considered to have a substantial business discussion if you attend meetings at a convention or similar event, or at a trade or business meeting sponsored and conducted by a business or professional organization. Gov forms 1040 However, your reason for attending the convention or meeting must be to further your trade or business. Gov forms 1040 The organization that sponsors the convention or meeting must schedule a program of business activities that is the main activity of the convention or meeting. Gov forms 1040 Directly before or after business discussion. Gov forms 1040   If the entertainment is held on the same day as the business discussion, it is considered to be held directly before or after the business discussion. Gov forms 1040   If the entertainment and the business discussion are not held on the same day, you must consider the facts of each case to see if the associated test is met. Gov forms 1040 Among the facts to consider are the place, date, and duration of the business discussion. Gov forms 1040 If you or your business associates are from out of town, you must also consider the dates of arrival and departure, and the reasons the entertainment and the discussion did not take place on the same day. Gov forms 1040 Example. Gov forms 1040 A group of business associates comes from out of town to your place of business to hold a substantial business discussion. Gov forms 1040 If you entertain those business guests on the evening before the business discussion, or on the evening of the day following the business discussion, the entertainment generally is considered to be held directly before or after the discussion. Gov forms 1040 The expense meets the associated test. Gov forms 1040 50% Limit In general, you can deduct only 50% of your business-related meal and entertainment expenses. Gov forms 1040 (If you are subject to the Department of Transportation's “hours of service” limits, you can deduct 80% of your business-related meal and entertainment expenses. Gov forms 1040 See Individuals subject to “hours of service” limits , later. Gov forms 1040 ) The 50% limit applies to employees or their employers, and to self-employed persons (including independent contractors) or their clients, depending on whether the expenses are reimbursed. Gov forms 1040 Figure A summarizes the general rules explained in this section. Gov forms 1040 The 50% limit applies to business meals or entertainment expenses you have while: Traveling away from home (whether eating alone or with others) on business, Entertaining customers at your place of business, a restaurant, or other location, or Attending a business convention or reception, business meeting, or business luncheon at a club. Gov forms 1040 Included expenses. Gov forms 1040   Expenses subject to the 50% limit include: Taxes and tips relating to a business meal or entertainment activity, Cover charges for admission to a nightclub, Rent paid for a room in which you hold a dinner or cocktail party, and Amounts paid for parking at a sports arena. Gov forms 1040 However, the cost of transportation to and from a business meal or a business-related entertainment activity is not subject to the 50% limit. Gov forms 1040 Figure A. Gov forms 1040 Does the 50% Limit Apply to Your Expenses? There are exceptions to these rules. Gov forms 1040 See Exceptions to the 50% Limit . Gov forms 1040 Please click here for the text description of the image. Gov forms 1040 Figure A. Gov forms 1040 Does the 50% limit apply to Your Expenses?TAs for Figure A are: Notice 87-23; Form 2106 instructions Application of 50% limit. Gov forms 1040   The 50% limit on meal and entertainment expenses applies if the expense is otherwise deductible and is not covered by one of the exceptions discussed later. Gov forms 1040   The 50% limit also applies to certain meal and entertainment expenses that are not business related. Gov forms 1040 It applies to meal and entertainment expenses you have for the production of income, including rental or royalty income. Gov forms 1040 It also applies to the cost of meals included in deductible educational expenses. Gov forms 1040 When to apply the 50% limit. Gov forms 1040   You apply the 50% limit after determining the amount that would otherwise qualify for a deduction. Gov forms 1040 You first have to determine the amount of meal and entertainment expenses that would be deductible under the other rules discussed in this publication. Gov forms 1040 Example 1. Gov forms 1040 You spend $200 for a business-related meal. Gov forms 1040 If $110 of that amount is not allowable because it is lavish and extravagant, the remaining $90 is subject to the 50% limit. Gov forms 1040 Your deduction cannot be more than $45 (50% × $90). Gov forms 1040 Example 2. Gov forms 1040 You purchase two tickets to a concert and give them to a client. Gov forms 1040 You purchased the tickets through a ticket agent. Gov forms 1040 You paid $200 for the two tickets, which had a face value of $80 each ($160 total). Gov forms 1040 Your deduction cannot be more than $80 (50% × $160). Gov forms 1040 Exceptions to the 50% Limit Generally, business-related meal and entertainment expenses are subject to the 50% limit. Gov forms 1040 Figure A can help you determine if the 50% limit applies to you. Gov forms 1040 Expenses not subject to 50% limit. Gov forms 1040   Your meal or entertainment expense is not subject to the 50% limit if the expense meets one of the following exceptions. Gov forms 1040 1 - Employee's reimbursed expenses. Gov forms 1040   If you are an employee, you are not subject to the 50% limit on expenses for which your employer reimburses you under an accountable plan. Gov forms 1040 Accountable plans are discussed in chapter 6. Gov forms 1040 2 - Self-employed. Gov forms 1040   If you are self-employed, your deductible meal and entertainment expenses are not subject to the 50% limit if all of the following requirements are met. Gov forms 1040 You have these expenses as an independent contractor. Gov forms 1040 Your customer or client reimburses you or gives you an allowance for these expenses in connection with services you perform. Gov forms 1040 You provide adequate records of these expenses to your customer or client. Gov forms 1040 (See chapter 5 . Gov forms 1040 )   In this case, your client or customer is subject to the 50% limit on the expenses. Gov forms 1040 Example. Gov forms 1040 You are a self-employed attorney who adequately accounts for meal and entertainment expenses to a client who reimburses you for these expenses. Gov forms 1040 You are not subject to the directly-related or associated test, nor are you subject to the 50% limit. Gov forms 1040 If the client can deduct the expenses, the client is subject to the 50% limit. Gov forms 1040 If you (as an independent contractor) have expenses for meals and entertainment related to providing services for a client but do not adequately account for and seek reimbursement from the client for those expenses, you are subject to the directly-related or associated test and to the 50% limit. Gov forms 1040 3 - Advertising expenses. Gov forms 1040   You are not subject to the 50% limit if you provide meals, entertainment, or recreational facilities to the general public as a means of advertising or promoting goodwill in the community. Gov forms 1040 For example, neither the expense of sponsoring a television or radio show nor the expense of distributing free food and beverages to the general public is subject to the 50% limit. Gov forms 1040 4 - Sale of meals or entertainment. Gov forms 1040   You are not subject to the 50% limit if you actually sell meals, entertainment, goods and services, or use of facilities to the public. Gov forms 1040 For example, if you run a nightclub, your expense for the entertainment you furnish to your customers, such as a floor show, is not subject to the 50% limit. Gov forms 1040 5 - Charitable sports event. Gov forms 1040   You are not subject to the 50% limit if you pay for a package deal that includes a ticket to a qualified charitable sports event. Gov forms 1040 For the conditions the sports event must meet, see Exception for events that benefit charitable organizations under What Entertainment Expenses Are Deductible?, later. Gov forms 1040 Individuals subject to “hours of service” limits. Gov forms 1040   You can deduct a higher percentage of your meal expenses while traveling away from your tax home if the meals take place during or incident to any period subject to the Department of Transportation's “hours of service” limits. Gov forms 1040 The percentage is 80%. Gov forms 1040   Individuals subject to the Department of Transportation's “hours of service” limits include the following persons. Gov forms 1040 Certain air transportation workers (such as pilots, crew, dispatchers, mechanics, and control tower operators) who are under Federal Aviation Administration regulations. Gov forms 1040 Interstate truck operators and bus drivers who are under Department of Transportation regulations. Gov forms 1040 Certain railroad employees (such as engineers, conductors, train crews, dispatchers, and control operations personnel) who are under Federal Railroad Administration regulations. Gov forms 1040 Certain merchant mariners who are under Coast Guard regulations. Gov forms 1040 What Entertainment Expenses Are Deductible? This section explains different types of entertainment expenses you may be able to deduct. Gov forms 1040 Entertainment. Gov forms 1040   Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation. Gov forms 1040 Examples include entertaining guests at nightclubs; at social, athletic, and sporting clubs; at theaters; at sporting events; on yachts; or on hunting, fishing, vacation, and similar trips. Gov forms 1040   Entertainment also may include meeting personal, living, or family needs of individuals, such as providing meals, a hotel suite, or a car to customers or their families. Gov forms 1040 A meal as a form of entertainment. Gov forms 1040   Entertainment includes the cost of a meal you provide to a customer or client, whether the meal is a part of other entertainment or by itself. Gov forms 1040 A meal expense includes the cost of food, beverages, taxes, and tips for the meal. Gov forms 1040 To deduct an entertainment-related meal, you or your employee must be present when the food or beverages are provided. Gov forms 1040    You cannot claim the cost of your meal both as an entertainment expense and as a travel expense. Gov forms 1040    Meals sold in the normal course of your business are not considered entertainment. Gov forms 1040 Deduction may depend on your type of business. Gov forms 1040   Your kind of business may determine if a particular activity is considered entertainment. Gov forms 1040 For example, if you are a dress designer and have a fashion show to introduce your new designs to store buyers, the show generally is not considered entertainment. Gov forms 1040 This is because fashion shows are typical in your business. Gov forms 1040 But, if you are an appliance distributor and hold a fashion show for the spouses of your retailers, the show generally is considered entertainment. Gov forms 1040 Separating costs. Gov forms 1040   If you have one expense that includes the costs of entertainment and other services (such as lodging or transportation), you must allocate that expense between the cost of entertainment and the cost of other services. Gov forms 1040 You must have a reasonable basis for making this allocation. Gov forms 1040 For example, you must allocate your expenses if a hotel includes entertainment in its lounge on the same bill with your room charge. Gov forms 1040 Taking turns paying for meals or entertainment. Gov forms 1040   If a group of business acquaintances takes turns picking up each others' meal or entertainment checks primarily for personal reasons, without regard to whether any business purposes are served, no member of the group can deduct any part of the expense. Gov forms 1040 Lavish or extravagant expenses. Gov forms 1040   You cannot deduct expenses for entertainment that are lavish or extravagant. Gov forms 1040 An expense is not considered lavish or extravagant if it is reasonable considering the facts and circumstances. Gov forms 1040 Expenses will not be disallowed just because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs, or resorts. Gov forms 1040 Allocating between business and nonbusiness. Gov forms 1040   If you entertain business and nonbusiness individuals at the same event, you must divide your entertainment expenses between business and nonbusiness. Gov forms 1040 You can deduct only the business part. Gov forms 1040 If you cannot establish the part of the expense for each person participating, allocate the expense to each participant on a pro rata basis. Gov forms 1040 Example. Gov forms 1040 You entertain a group of individuals that includes yourself, three business prospects, and seven social guests. Gov forms 1040 Only 4/11 of the expense qualifies as a business entertainment expense. Gov forms 1040 You cannot deduct the expenses for the seven social guests because those costs are nonbusiness expenses. Gov forms 1040 Trade association meetings. Gov forms 1040   You can deduct entertainment expenses that are directly related to and necessary for attending business meetings or conventions of certain exempt organizations if the expenses of your attendance are related to your active trade or business. Gov forms 1040 These organizations include business leagues, chambers of commerce, real estate boards, trade associations, and professional associations. Gov forms 1040 Entertainment tickets. Gov forms 1040   Generally, you cannot deduct more than the face value of an entertainment ticket, even if you paid a higher price. Gov forms 1040 For example, you cannot deduct service fees you pay to ticket agencies or brokers or any amount over the face value of the tickets you pay to scalpers. Gov forms 1040 Exception for events that benefit charitable organizations. Gov forms 1040   Different rules apply when the cost of a ticket to a sports event benefits a charitable organization. Gov forms 1040 You can take into account the full cost you pay for the ticket, even if it is more than the face value, if all of the following conditions apply. Gov forms 1040 The event's main purpose is to benefit a qualified charitable organization. Gov forms 1040 The entire net proceeds go to the charity. Gov forms 1040 The event uses volunteers to perform substantially all the event's work. Gov forms 1040    The 50% limit on entertainment does not apply to any expense for a package deal that includes a ticket to such a charitable sports event. Gov forms 1040 Example 1. Gov forms 1040 You purchase tickets to a golf tournament organized by the local volunteer fire company. Gov forms 1040 All net proceeds will be used to buy new fire equipment. Gov forms 1040 The volunteers will run the tournament. Gov forms 1040 You can deduct the entire cost of the tickets as a business expense if they otherwise qualify as an entertainment expense. Gov forms 1040 Example 2. Gov forms 1040 You purchase tickets to a college football game through a ticket broker. Gov forms 1040 After having a business discussion, you take a client to the game. Gov forms 1040 Net proceeds from the game go to colleges that qualify as charitable organizations. Gov forms 1040 However, since the colleges also pay individuals to perform services, such as coaching and recruiting, you can only use the face value of the tickets in determining your business deduction. Gov forms 1040 Skyboxes and other private luxury boxes. Gov forms 1040   If you rent a skybox or other private luxury box for more than one event at the same sports arena, you generally cannot deduct more than the price of a nonluxury box seat ticket. Gov forms 1040   To determine whether a skybox has been rented for more than one event, count each game or other performance as one event. Gov forms 1040 For example, renting a skybox for a series of playoff games is considered renting it for more than one event. Gov forms 1040 All skyboxes you rent in the same arena, along with any rentals by related parties, are considered in making this determination. Gov forms 1040   Related parties include: Family members (spouses, ancestors, and lineal descendants), Parties who have made a reciprocal arrangement involving the sharing of skyboxes, Related corporations, A partnership and its principal partners, and A corporation and a partnership with common ownership. Gov forms 1040 Example. Gov forms 1040 You pay $3,000 to rent a 10-seat skybox at Team Stadium for three baseball games. Gov forms 1040 The cost of regular nonluxury box seats at each event is $30 a seat. Gov forms 1040 You can deduct (subject to the 50% limit) $900 ((10 seats × $30 each) × 3 events). Gov forms 1040 Food and beverages in skybox seats. Gov forms 1040   If expenses for food and beverages are separately stated, you can deduct these expenses in addition to the amounts allowable for the skybox, subject to the requirements and limits that apply. Gov forms 1040 The amounts separately stated for food and beverages must be reasonable. Gov forms 1040 You cannot inflate the charges for food and beverages to avoid the limited deduction for skybox rentals. Gov forms 1040 What Entertainment Expenses Are Not Deductible? This section explains different types of entertainment expenses you generally may not be able to deduct. Gov forms 1040 Club dues and membership fees. Gov forms 1040   You cannot deduct dues (including initiation fees) for membership in any club organized for: Business, Pleasure, Recreation, or Other social purpose. Gov forms 1040 This rule applies to any membership organization if one of its principal purposes is either: To conduct entertainment activities for members or their guests, or To provide members or their guests with access to entertainment facilities, discussed later. Gov forms 1040   The purposes and activities of a club, not its name, will determine whether or not you can deduct the dues. Gov forms 1040 You cannot deduct dues paid to: Country clubs, Golf and athletic clubs, Airline clubs, Hotel clubs, and Clubs operated to provide meals under circumstances generally considered to be conducive to business discussions. Gov forms 1040 Entertainment facilities. Gov forms 1040   Generally, you cannot deduct any expense for the use of an entertainment facility. Gov forms 1040 This includes expenses for depreciation and operating costs such as rent, utilities, maintenance, and protection. Gov forms 1040   An entertainment facility is any property you own, rent, or use for entertainment. Gov forms 1040 Examples include a yacht, hunting lodge, fishing camp, swimming pool, tennis court, bowling alley, car, airplane, apartment, hotel suite, or home in a vacation resort. Gov forms 1040 Out-of-pocket expenses. Gov forms 1040   You can deduct out-of-pocket expenses, such as for food and beverages, catering, gas, and fishing bait, that you provided during entertainment at a facility. Gov forms 1040 These are not expenses for the use of an entertainment facility. Gov forms 1040 However, these expenses are subject to the directly-related and associated tests and to the 50% limit , all discussed earlier. Gov forms 1040 Expenses for spouses. Gov forms 1040   You generally cannot deduct the cost of entertainment for your spouse or for the spouse of a customer. Gov forms 1040 However, you can deduct these costs if you can show you had a clear business purpose, rather than a personal or social purpose, for providing the entertainment. Gov forms 1040 Example. Gov forms 1040 You entertain a customer. Gov forms 1040 The cost is an ordinary and necessary business expense and is allowed under the entertainment rules. Gov forms 1040 The customer's spouse joins you because it is impractical to entertain the customer without the spouse. Gov forms 1040 You can deduct the cost of entertaining the customer's spouse. Gov forms 1040 If your spouse joins the party because the customer's spouse is present, the cost of the entertainment for your spouse is also deductible. Gov forms 1040 Gift or entertainment. Gov forms 1040   Any item that might be considered either a gift or entertainment generally will be considered entertainment. Gov forms 1040 However, if you give a customer packaged food or beverages that you intend the customer to use at a later date, treat it as a gift. Gov forms 1040   If you give a customer tickets to a theater performance or sporting event and you do not go with the customer to the performance or event, you have a choice. Gov forms 1040 You can treat the tickets as either a gift or entertainment, whichever is to your advantage. Gov forms 1040   You can change your treatment of the tickets at a later date by filing an amended return. Gov forms 1040 Generally, an amended return must be filed within 3 years from the date the original return was filed or within 2 years from the time the tax was paid, whichever is later. Gov forms 1040   If you go with the customer to the event, you must treat the cost of the tickets as an entertainment expense. Gov forms 1040 You cannot choose, in this case, to treat the tickets as a gift. Gov forms 1040 Prev  Up  Next   Home   More Online Publications