Figuring Installment Income Each payment on an installment sale usually consists of thefollowing three parts. Interest income. Return of your adjusted basis in the property. Gain on the sale. In each year you receive a payment, you include the interestpart in income, as well as the part that is your gain on the sale. Youdo not include in income the part that is the return of your adjustedbasis in the property. Interest income.You must report interest as ordinary income. Interest is generallynot included in a down payment. However, you may have to treat part ofeach later payment as interest, even if it is not called interest inyour agreement with the buyer. See Unstated interest,later. Return of basis and gain on sale.The rest of each payment is treated as if it were made up of twoparts. One part is a tax-free return of your adjusted basis in theproperty. The other part is your gain. Pencil: Figuring gain part of payment. To figure what part ofany payment is gain, multiply the payment (less interest) by the grossprofit percentage. Use the following worksheet to figure the grossprofit percentage. 1) Selling price            2) Installment sale basis:  Adjusted basis of property             Selling expenses             Depreciation recapture                       3) Gross profit (line 1 - line 2)            4) Contract price            5) Gross profit percentage(line 3 line 4)            Selling price.The selling price is the total cost of the property to the buyer.It includes any money and the FMV of any property you are to receive.It also includes any debt the buyer pays, assumes, or takes, to whichthe property is subject. The debt could be a note, mortgage, or anyother liability, such as a lien, accrued interest, or taxes you owe onthe property. If the buyer pays any of your selling expenses for you,that amount is also included in the selling price. The selling pricedoes not include interest, whether stated or unstated. Installment sale basis.This chapter refers to the adjusted basis plus selling expenses anddepreciation recapture income as the installment sale basis. Adjusted basis.Basis is a way of measuring your investment in the property you areselling. The way you figure basis depends on how you first acquiredthe property. The basis of property you bought is generally its cost.The basis of property you inherited, received as a gift, builtyourself, or received in a tax-free exchange is figured differently.See chapter 7for information on determining basis. While you own personal-use property, various events may change youroriginal basis in the property. Some events, such as adding rooms ormaking permanent improvements, increase basis. Others, such asdeductible casualty losses or depreciation previously allowed orallowable, decrease basis. The result is adjusted basis. Selling expenses.Selling expenses are any expenses that relate to the sale of theproperty. They include commissions, attorney fees, and any otherexpenses paid on the sale. Selling expenses are added to the basis ofthe sold property. Depreciation recapture.If you took depreciation deductions on the asset, part of the gainon the sale of the asset may be recaptured as ordinary income. SeeSale of depreciable property, later. Gross profit.For an installment sale, gross profit is the total gain you reporton the installment method. To figure your gross profit, subtract your installment sale basisfrom the selling price. If the property you sold was your home,subtract from the gross profit any gain you can exclude. SeePublication 523 for information on excluding gain on the sale of yourhome. Contract price.The contract price is the total of all principal payments you areto receive on the installment sale. It includes payments you areconsidered to receive, even though you are not paid anything directly.See Payments Received, later. If part of the selling price is paid in cash and you hold amortgage payable from the buyer to you for the remainder, then thecontract price equals the selling price. Gross profit percentage.A certain percentage of each payment (after subtracting interest)is reported as gain from the sale. It is called the "gross profitpercentage" and is figured by dividing your gross profit from thesale by the contract price. The gross profit percentage generally remains the same for eachpayment you receive. However, see Selling price reduced,later, for an example of changing the gross profit percentage. Example.You sell property at a contract price of $200,000. The property hasan adjusted basis of $150,000. Your gross profit is $50,000. Yourgross profit percentage is 25% ($50,000 $200,000). Aftersubtracting interest, you report 25% of each payment, including thedown payment, as gain from the sale for the tax year you receive thepayment. Amount to include in income.Each year you receive a payment on the installment sale, multiplythe payment (after subtracting interest) by the gross profitpercentage to determine the amount you must include in income for thetax year. Sale of depreciable property.You cannot use the installment method to report any depreciationrecapture income up to the gain on the sale. Report any remaining gainon the installment method. However, you generally cannot report gain from the sale ofdepreciable property to a related person on the installment method.See Sale to Related Person in Publication 537. Figure your depreciation recapture income (including the section179 deduction and the section 179A deduction recapture) in Part III ofForm 4797. Report the depreciation recapture income in Part II of Form4797 as ordinary income in the year of sale. TaxTip: If you sell depreciable business property, prepare Form 4797 firstin order to figure the amount to enter on line 12 of Part I, Form6252. For more information on the section 179 deduction, see Section179 Deduction in chapter 8.For more information on the section179A deductions, see chapter 15 in Publication 535.For moreinformation on depreciation recapture, see Depreciation Recapturein chapter 11. Selling price reduced.If the selling price is reduced at a later date, the gross profiton the sale will also change. You must then refigure your gross profitpercentage for the remaining payments. Refigure your gross profitusing the reduced sale price and then subtract the gain alreadyreported. Spread the remaining gain over the remaining installments.You cannot go back and refigure the gain you reported in earlieryears. Example.In 1997, you sold land with a basis of $40,000 for $100,000. Yourgross profit was $60,000. You received a $20,000 down payment and thebuyer's note for $80,000. The note provides for four annual paymentsof $20,000 each, plus 12% interest, beginning in 1998. Your grossprofit percentage is 60%. You reported a gain of $12,000 on eachpayment received in 1997 and 1998. In 1999, you and the buyer agreedto reduce the purchase price to $85,000 and the payments for 1999,2000, and 2001 are reduced to $15,000 for each year. The new gross profit percentage, 46.67%, is figured as follows. Youwill report a gain of $7,000 (46.67% of $15,000) on each of the$15,000 installments due in 1999, 2000, and 2001. 1) Reduced selling price $85,000 2) Minus: Basis     40,000 3) Adjusted gross profit $45,000 4) discount hotels in RiminiMinus: Gain reported in 1997 & 1998     24,000 5) Moravske Toplice ReservierungenGain to be reported    $21,000 6) Selling price to be received:  Reduced selling price $85,000  Minus: Payments received in 1997 and1998     40,000    $45,000 7) New gross profit percentage(line 5 line 6) 46.67% Sale to related person.Special rules apply to an installment sale between related persons.Spouses, children, grandchildren, brothers, sisters, and parents areall considered related persons. A partnership or corporation in whichyou have an interest, or an estate or trust with which you have aconnection, can also be considered a related person. For information on these rules, see Sale to Related Personin Publication 537. Trading property for like-kind property.If you trade business or investment property for the same kind ofproperty, you can postpone reporting part of the gain. SeeLike-Kind Exchanges in chapter 10for a discussion oflike-kind property. If the trade includes an installment obligation, the followingrules apply. The contract price is reduced by the FMV of the like-kindproperty received in the trade. The gross profit is reduced by any gain on the trade thatcan be postponed. Like-kind property received in the trade is not consideredpayment on the installment obligation.