Definition
Contract Price (Tax)
In an installment sale, the contract price (tax) refers to the selling price minus any existing mortgages assumed by the buyer. This is a critical calculation for the seller when determining the taxable portion of their income from the sale. The contract price helps to establish the gross profit and the gain to be reported to the IRS.
Examples
-
Example One: Simple Transaction
- Selling Price: $200,000
- Assumed Mortgage: $120,000
- Received in Year of Sale: $10,000 in cash and a $70,000 second mortgage
Contract Price Calculation:
\[
\text{Selling Price} - \text{Assumed Mortgage} = \text{Contract Price}
\]
\[
$200,000 - $120,000 = $80,000
\]
-
Example Two: Adjusted Tax Basis Consideration
- Selling Price: $100,000
- Assumed Mortgage: $60,000
- Received in Year of Sale: $5,000 in cash and a $35,000 second mortgage
- Adjusted Tax Basis in the Land: $65,000
Contract Price Calculation:
The contract price here needs to account for the adjusted tax basis. Since the adjusted tax basis ($65,000) exceeds the existing mortgage ($60,000), the excess ($5,000) is treated as a payment in the year of sale and reduces the contract price.
\[
\text{Selling Price} - \text{Assumed Mortgage} - \text{Excess} = \text{Contract Price}
\]
\[
$100,000 - $60,000 - $5,000 = $35,000
\]
Frequently Asked Questions
What is an installment sale?
An installment sale is a method of selling property whereby you receive at least one payment after the tax year of the sale. Installment sales can offer tax advantages since they allow sellers to spread their taxable gain over several years.
How does the adjusted tax basis affect the contract price?
The adjusted tax basis may reduce the contract price calculation if it exceeds the assumed mortgage. This excess is viewed as an initial year payment and thus reduces the gain that needs to be reported.
What is the impact of an assumed mortgage on an installment sale?
An assumed mortgage decreases the contract price by the amount of the mortgage, impacting the taxable gain and reducing immediate tax liabilities.
Are there any limitations on what qualifies as an installment sale?
Yes, properties such as inventory, stocks and securities, and certain installment obligations from sales to dealers are not eligible for installment sale reporting.
Installment Sale
An installment sale involves the seller receiving at least one payment after the tax year of the sale. This method can spread the taxable gain over multiple years, thereby often reducing tax liability in any single year.
Adjusted Tax Basis
The adjusted tax basis of property is the original cost of property, adjusted for various items such as improvements or depreciation. This figure is essential in calculating gain or loss from the sale of the property.
Online Resources
- IRS Installment Sales
- Real Estate Tax Center (IRS)
- Investopedia: Installment Sale
References
- IRS Publication 537, Installment Sales
- IRS Publication 544, Sales and Other Dispositions of Assets
Suggested Books for Further Studies
- “Tax Strategies for the Small Business Owner” by Russell Fox
- “J.K. Lasser’s Your Income Tax” by J.K. Lasser Institute
- “Real Estate Taxation: A Practitioner’s Guide” by David. F Windish
Contract Price (Tax) Fundamentals Quiz
### How is the contract price for tax purposes calculated in an installment sale?
- [ ] Selling price minus cash received.
- [ ] Selling price minus buyer's second mortgage.
- [x] Selling price minus existing mortgages assumed by the buyer.
- [ ] Selling price minus the down payment.
> **Explanation:** The contract price in an installment sale is determined by subtracting the existing mortgages assumed by the buyer from the selling price.
### If a seller’s adjusted tax basis exceeds the assumed mortgage, what effect does this have on the contract price?
- [ ] It increases the contract price.
- [x] It reduces the contract price.
- [ ] It has no effect.
- [ ] It doubles the contract price.
> **Explanation:** When the adjusted tax basis exceeds the assumed mortgage, the excess is considered a payment in the year of sale and reduces the contract price.
### What happens to the excess adjusted tax basis in the year of sale if it surpasses an assumed mortgage?
- [ ] It is ignored.
- [ ] It is added to the selling price.
- [ ] It is deducted as a loss.
- [x] It reduces the contract price as payment.
> **Explanation:** Excess adjusted tax basis in the year of sale when surpassing an assumed mortgage reduces the contract price.
### In an installment sale with a $150,000 selling price and $50,000 assumed mortgage, what is the contract price?
- [ ] $200,000
- [ ] $150,000
- [x] $100,000
- [ ] $50,000
> **Explanation:** The contract price is calculated as the selling price minus the existing assumed mortgage. Here, it will be $150,000 - $50,000 = $100,000.
### Which term refers to the cash and note received in a year for tax purposes in an installment sale?
- [x] Contract price
- [ ] Selling price
- [ ] Fair market value
- [ ] Adjusted basis
> **Explanation:** In an installment sale, the contract price refers to the total of cash and notes received in the year after adjusting for existing mortgages.
### An installment sale involves a selling price of $200,000 and assumed first mortgage of $75,000. The seller receives $25,000 cash and a $100,000 note. What is the contract price?
- [x] $125,000
- [ ] $200,000
- [ ] $100,000
- [ ] $75,000
> **Explanation:** The contract price in an installment sale is calculated as the selling price minus the assumed mortgage, which is $200,000 - $75,000 = $125,000.
### How does receiving multiple payments over different years affect an installment sale?
- [ ] It increases initial tax liability.
- [ ] It requires immediate tax payment on the full amount.
- [x] It allows spreading tax liability over several years.
- [ ] It necessitates transaction recalculation every year.
> **Explanation:** An installment sale payment spread over multiple years allows the seller to distribute the tax liability over those years, potentially lowering annual tax burdens.
### Who is eligible to use the installment sale method for tax purposes?
- [ ] Only corporations.
- [ ] All sellers regardless of sold property type.
- [ ] Only sellers of commercial real estate.
- [x] Sellers who receive payments after the tax year of the sale.
> **Explanation:** The installment sale method is available to sellers who receive at least one payment after the tax year in which the sale was made.
### In an installment sale, what decreases the contract price?
- [ ] Adjusted tax basis less than selling price.
- [x] Existing mortgages assumed by the buyer.
- [ ] Total of all payments received.
- [ ] Improvement costs added to the adjusted basis.
> **Explanation:** Existing mortgages taken over by the buyer decrease the contract price calculation.
### If a seller receives a $50,000 first mortgage and assumes $60,000 second mortgage in an installment sale, how much total mortgage is accounted in the contract price calculation if the selling price is $120,000?
- [ ] $60,000
- [ ] $50,000
- [ ] $20,000
- [x] $110,000
> **Explanation:** Both mortgages are added into the calculation; thus $50,000 (first mortgage) + $60,000 (second mortgage) = $110,000.
$$$$
