[00:00:00] Hi, everyone. This is the how to lower your tax bill 
[00:00:10] podcast. I'm your host, Terrence Hutchins. I'm, a financial and tax advisor in the Dallas Fort worth area. And the goal of this podcast is to help you listeners get 
[00:00:20] educated on different tax strategies. That you can implement to improve your tax situation immediately? Each episode, we'll break down useful tax tips you can use to save 
[00:00:30] money no matter what your personal or business income situation. Because our motto is keep more of what you earn. So let's get into today's [00:00:40] episode. All right. So thanks for tuning in to another how to lawyer tax bill podcast. This week, we're going to be talking about installment sales. So I'm going to tell you guys 
[00:00:50] what is an installment sale, why you should consider it, how installment sales are taxed. We're going to go into the different types of installment sales.We're going to talk about a few special situations 
[00:01:00] that are related to the installment sales. We'll give you some tips and then we'll talk to a tax court case that specifically went through an installment sale in the past. So first, what 
[00:01:10] is an installment sale? simply it just means that you sold something that you received a payment for in more than one tax year.
So if you own the property, you decided you want to sell that 
[00:01:20] property and you didn't receive all the money for it this year, then you would effectively have an installment sale. why you would intentionally do this is for a few reasons. Number 
[00:01:30] one, you get to defer the tax. So, if I receive a payment this year, and I receive a payment next year, that means that I got to defer a portion of the tax that would have all been 
[00:01:40] owed this year.
I get to defer a portion of it to next year. year after or when I receive future payments. So I can actually reduce my total tax out of pocket, which 
[00:01:50] could help me because maybe I'm able to avoid being at the top capital gain tax rate. For example, for 2025, the top capital tax rate is at 20 [00:02:00] percent if you are over $600,000. So if I have a greater than $600,000 gain I'm going to pay 20 percent tax on it versus I would potentially pay 15 percent if I got below 
[00:02:10] that. Plus if it's not for a business asset. So I'm not selling a business property that I own or I'm not a real estate professional is selling a property. Then I would 
[00:02:20] actually pay an extra 3. 8 on top of that.so I could go from paying 23. 8 percent to potentially. 15 percent depending on my 
[00:02:30] circumstance. there is a way to reduce the amount of tax I pay total plus deferring it, which means I have more money now that can be deployed into other stuff. My tax year in the future might be different. 
[00:02:40] So let's say next year, I have a big tax loss coming up from another investment, or maybe I decide to do a cost segregation study on a property that I purchased. I have a big tax 
[00:02:50] loss well, that can help alleviate maybe the gain I have, so I'm not as rushed to do the 1031. If I fail the 1031 exchange, where I thought I was going to have the next property 
[00:03:00] identified or closed on, and I didn't, I can spread the gain out over two years as a result, I can also command maybe a higher price for my property. So if I go to a 
[00:03:10] buyer and they don't have to go to a bank to qualify, then I could even negotiate a higher price for my property because for them, they don't have to come up with as much money up front and they 
[00:03:20] can pay me monthly as a result.
Then I can negotiate a higher price as result of that exchange. I see some people that are trying to get out of the real 
[00:03:30] estate game. Or trying to downsize their portfolio when they're older. They can do this to say hey I can get a stable income.
And not to pay all the tax if I just want to sell my properties all at once. So it [00:03:40] does give you some flexibility from that vantage point on why you would consider doing an installment agreement. if you have an installment agreement, you have to think, okay, the payments that I receive are going to be broken up 
[00:03:50] into three different buckets.  
 One, you're going to have the return of your basis. So if I bought a property at a certain value, I'm not going to pay tax on that again, outside of [00:04:00] the depreciation, which we'll get into in a minute. Then I have the actual gain on the property. So let's say I buy a property for $500,000. I sell it for a million.
I have a 
[00:04:10] $500,000 gain. I would normally pay tax on that gain all in the first year, but because I'm doing an installment sale, I can spread that gain out over the length of my installment payments. If I do 
[00:04:20] an installment sale that is greater than $150,000, then I have to charge interest on the future payments that I get.
So if I say, Hey, I'm going to sale you this property for a million 
[00:04:30] dollars You need to give me 20 percent up front and then the other 80 percent we can spread out over 10 years or whatever the terms are of the agreement. That $800,000 that I'm deferring, 
[00:04:40] the IRS makes me charge interest on it. So either I decide I'm going to have a set interest rate that I'm going to charge my buyer or when they pay me the amount that I 
[00:04:50] commanded. So let's say in that case, $800,000 over 10 years is $80,000 a year. If I don't charge them interest, then the IRS is going to assume a portion of those payments is interest. 
[00:05:00] So effectively, I'm going to have less money come back to me to report because the interest that I'm going to report is actually going to be considered income.So instead of me paying capital gains on the 
[00:05:10] payments that I receive, I'm going to pay an income on a portion of it. So that's a very important distinction that you have to charge interest at the minimum rate that the IRS requires, which currently is somewhere in the low [00:05:20] 4 percent range. Let's get into the eight different types of installment agreements. Now, some of these are pretty straightforward. I wouldn't even call them types per se, but they're kind of 
[00:05:30] just broken out into these eight categories. Number one, if you have a loss on your property, then that's not an installment sale.
In fact, that wouldn't make any sense to even want to do an installment sale because you'd want to just go 
[00:05:40] ahead and take the loss up front. All right. So if I have a loss on a property then that's not going to be a installment sale. I'm just going to take the loss and just for your tips, the loss is either going to be considered an 
[00:05:50] ordinary loss or capital loss.
So we'll get into stuff like that in the future. But ideally, ordinary losses are better, especially if they're business related properties. You can elect out of [00:06:00] installment sale, which just means you're going to report the gain all in the year. All right. So you don't really have to do anything for that.
You just have to report the gain all in that year. And that's effectively opting, [00:06:10] opting out of the installment sale. Now, if you report all the gain, you can't come back after the fact. It's actually, I didn't really want to do that unless you get special IRS approval, which they really not be 
[00:06:20] motivated at all to give you that because they want their money sooner instead of spreading it out. So if you want to do this, you better do it in the first year because you really can't undo it. once again, I said, if 
[00:06:30] you have an installment agreement under $150,000, you don't have to charge interest. So if the sale price is below $150,000, then you don't have to charge interest.
However. 
[00:06:40] If it's greater than $5,000,000, then you actually have to pay interest to the IRS. So interestingly enough, if I have, let's say 
[00:06:50] 6,000,000 worth of property, and I want to do an installment agreement. The IRS is going to now make me pay them interest to defer it because they know that they're not getting all the 
[00:07:00] tax that you would have gotten up front.
So they're actually going to charge me interest on my installment agreement. All right now important to note that let's say I had a six million dollar property If I'm 
[00:07:10] married, I can actually go to my buyer and say, Hey, look, you're going to make this transaction with me and my wife. So we're going to split up our property into 3 million and 3 million instead of 
[00:07:20] 6, That gets me below the 5,000,000 threshold, which means that we don't have to pay interest to the IRS.
So if you have a big property like that and you want to do an installment agreement, that would be a good strategy to 
[00:07:30] avoid that extra interest payment. Because at that level, that interest payment is actually going to be pretty big. when you have depreciation recapture, so if you have a property that you were depreciating, you actually have 
[00:07:40] to pay tax on the depreciation amount in the first year of sale.
 even if you say, okay, let's say going back to my million dollar property, if I had depreciated that 
[00:07:50] property at a $100,000, I have to report that a $100,000 as depletion recapture in the first year, which is considered ordinary, which is either gonna be taxed at my tax bracket, 
[00:08:00] which if it's greater than 25%, I'm gonna only pay 25% and if my tax bracket is lower than 25%, then I'm gonna pay at my tax bracket.
So if I'm in a 22% tax bracket 
[00:08:10] and I have a hundred thousand dollars of depreciation to recapture, I'm gonna pay a hundred thousand dollars at the 22%. I have to pay that in the first year. So that's why if you do a installment and 
[00:08:20] sell, you want to get at least a down payment large enough to compensate for the extra tax you're going to have to pay relative to the depreciation recapture because even if you only got a $50,000 down payment [00:08:30] and you had a $100,000 of depreciation, you would have to still report $100,000 of depreciation recapture in that first year. 
Now, if I decide I have a 
[00:08:40] installment sale, and I decide to sell that to someone else, then the gain I was deferring immediately becomes taxable in that year. All right. So if I sell a 
[00:08:50] property and then someone else wants to buy that installment note from me.Then the gain that I was deferring, I have to pay it all in that year. if I sell to a related party  and they 
[00:09:00] sell within two years, then I actually have to pay tax on that, gain. It essentially prevents me from trying to go to my buddy to say, Hey, I got this agreement with him and then he sells the 
[00:09:10] property and I'm basically trying to just defer tax.So if I have someone that's a relative, so my brother, my mom my sister, people like that, my literary descendants, 
[00:09:20] if I sell to a related party and they sell the property within two years, and I basically have to pay tax on the, on the sale proceeds in the year that they sell. Okay. If it's within those first two years.
 [00:09:30] I can't do this, for. house flippers. So house flippers can't do installment sales. I can't have bought a property, fixed it up, and then want to flip it, and then do it on an 
[00:09:40] installment note. That's not allowed in this case, because those properties are looked at more like inventory. And so inventory, we can't spread out the payments in that way, or at least defer the tax in 
[00:09:50] that way. I also can't do this when it comes to stocks, so I can't say, hey, I'm going to sell this stock to my buddy and then I'm going to defer the tax. I can't do that. 
[00:10:00] I can do it though on a business. And so that's where you have a few special circumstances because the sale price of your business could be a [00:10:10] little fluid depending on the deal terms that you have. So I'm just going to use a simple example. So traditionally, let's say I own a business. my basis in the business is $500,000 and I decide 
[00:10:20] I want to sell this business for a million dollars. Well, in that case, my gross profit percentage would be 50 percent because I take $500,000. I divide that by the 
[00:10:30] purchase price. I get 50%. So that means whatever payments I receive, half of them are going to be taxable. So it's kind of like an annuity in a sense, right? You think 
[00:10:40] about. How much did you put in? How much is the gain? And then you're kind of just going to split between, all right, how much is gained versus how much is the money that you put in?
A similar concept. if I get a 
[00:10:50] $100,000 payment, 50 percent of that is going to be taxable. The other 50 percent is going to be returned on a basis, and I spread it out. However, in this deal, I could basically say, hey, look, if 
[00:11:00] you meet certain criteria, so, hey, you buy this business from me, But your sales numbers jump through the roof or hey, I'm going to stay on and help you out And I'm helping you increase your sales, the 
[00:11:10] sale price could jump up to 1.2 million instead of a million. Well in that case I'm going to calculate my gross profit percentage as if I had sold it for [00:11:20] 1. 2 So instead of keep treating it as if it was sold at a million, I'm going to say, Hey, my gross profit percentage is actually not 50%. It's going to be, you know, the $700,000 over 
[00:11:30] the 1. 2. So it's going to be a little bit higher, closer to 60 percent range. Or I can say, Hey, look, you're going to pay me out over 10 years. So if we haven't determined a maximum sale 
[00:11:40] price, but I'm just going to receive a payment from you for 10 years minimum, basically, they're going to say, okay, you have $500,000 in basis. You guys agreed to a 10 
[00:11:50] year payout. So we're going to treat $50, 000 of the payments you receive as a return of basis.
So if one year I get, let's say I get $100,000, $50,000 is going to be my [00:12:00] basis. $50,000 is going to be taxed. The next year I received $110,000 because if I tie my purchase price to sales, let's say that, Hey, $50,000 is going to be my 
[00:12:10] basis. You pay me $110,000, $60,000 is going to be taxed. So these rules get a little convoluted, so that's why you're going to want to make sure you work with someone who's got some 
[00:12:20] experience and can know the ins and outs. There's one other obscure situation where if we don't determine the sale price. We don't determine the fixed period, which I don't know why you would do that the 
[00:12:30] IRS basically just says, okay We're gonna just spread out your payment your basis over 15 years.so Pretty obscure. So you probably won't really run into that but something there's no just to be 
[00:12:40] thorough on some of the rules So just to recap an installment sale is paid out over more than one tax year, this could happen if you have a, failed installment agreement or a failed 
[00:12:50] 1031 exchange, I should say.
So let's just say that you're at the year and you're not 100 percent sure if you're going to be able to close out this agreement or you find out, Hey, I'm actually not going to do this 
[00:13:00] property. Well, what I would do is instead of closing out that property the next year, I'd say, Hey, go ahead and send me part of the money this year. And send me the other part next year 
[00:13:10] so that I could basically spread out the tax over two tax years. So you have a 1031 that's kind of coming up on the end of the year and you feel like you're not gonna be able to close it, you might wanna get your intermediary to go ahead and 
[00:13:20] send you part of those proceeds so you can go ahead and treat those as taxable and then spread out the tax over two years. You can actually combine a 1031 and 
[00:13:30] an installment sale. So for example, if I have a property and I'm gonna receive two different items. So let's say I'm going to sell this property and I'm going to receive another 
[00:13:40] property plus cash in exchange, that cash I receive I can actually spread that out over multiple payments. That's the installment part. But then the property that I 
[00:13:50] receive, that's going to be the 1031 component. So I can defer the tax based on the value of the property. I receive the cash. I receive or the boot that can be spread 
[00:14:00] out over multiple payments. Thanks. That's going to be the installment sale, component. Remember you have to have interest. If you have depreciation, you're going to pay that depreciation expense in the first 
[00:14:10] year. This is actually going to be reported on form 6252 and if you have a business, you're also going to report that under 8594. So, a If it's a rental property, let's 
[00:14:20] say, you're going to report that under 4797 and form 6252.
If it's a business, you're going to report it under 6252 and 8594. so let's [00:14:30] look at a specific tax court case that dealt with an installment sale. This court case was police versus commissioner. And this 
[00:14:40] case is where they sold a restaurant. Now, when you sell a restaurant, you're going to have multiple components a lot of times.
And in their case, the sale price was 
[00:14:50] $210,000. $120,000 of that was the building and the real estate. $90,000 was the equipment and furniture inside. and they determined, okay, our gross profit percentage is this, theirs 
[00:15:00] was 46%, and they were going to basically get a 35, 000 down payment. Plus principal payments we're going to start in year one. So what they did is they said, okay, we 
[00:15:10] receive roughly $39,000 in year one, which is the down payment plus the first installment payment. They want it to only report that as 
[00:15:20] a capital gain of the 46 percent based on the gross profit percentage. Well the IRS said, look, that. Equipment and stuff that you own, that is 
[00:15:30] depreciation. That is what's called 1245 property. So that 1245 property, you need to pay tax on that first. Then you can spread out the rest of your 
[00:15:40] payments. So that's why I meant when I said before, hey, if you have depreciation expense, the IRS wants you to pay tax on that first.
Because the IRS looks at that as, hey, we gave you a 
[00:15:50] tax deduction to reduce your income in previous years. So since that, tax deduction reduced your income and now you're basically selling this property, we want you to pay 
[00:16:00] tax as if it was income that you're receiving on the amount that was attributed to the tax deduction that you previously had. So they want to kind of match the 
[00:16:10] deduction with the payment that you're getting. So if I have something that's depreciated, I gotta report that first, then I can spread out the rest of my payments upon the traditional installment 
[00:16:20] agreement. So this couple, they effectively said, Hey look, we want to attribute the payments to where we can only pay a portion of our income to be considered capital 
[00:16:30] gain and a portion of it to be considered ordinary. So they wanted to say our depreciation was $10,000. Our gain was $10,000 and now we're getting payments over 10 years. We 
[00:16:40] want to be able to say, hey, half of the tax we pay as income, half of it is capital gain. IRS says, no, no, no, you need to report all of that amount that's attributed to 
[00:16:50] your depreciation in the first year.  
So they went to tax court, the IRS won in this case. So they basically had to pay tax at the higher rate. So if you have 
[00:17:00] depreciation, you want to make sure that the installment agreement makes sense because you are going to have to pay that depreciation recapture in the first year. So that's why you have to make sure you negotiate a 
[00:17:10] big enough down payment to factor in the taxes that you're going to owe and basically look at your future years or the future years of the.
installment agreement payment to make 
[00:17:20] sure that the tax savings makes sense as far as, doing the agreement to begin with. Because you're not going to really save money in taxes by doing the installment sale, 
[00:17:30] you really want to determine does it make sense at all to do
 and whether you'd be better off just getting your money and investing that money versus having to wait to get those payments. Because one other [00:17:40] thing, if this person defaults on that agreement, now you're going to have to either probably lose money on the, on the installment sale. but you will then have to pay the tax if you 
[00:17:50] repossess the property. So there's certain things that just can get a little complicated if you do have the installment sale. And so. It is a strategy that you have. It can certainly lower your tax 
[00:18:00] bill, but you want to make sure that you look, you take a multi-year approach to determine if it's going to be good for you. Because as we always say, our motto is keep more of what you 
[00:18:10] earn. So, thanks for listening and we'll be back with you next week.