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Installment Sales

Exchange Basics

Installment Sales in Like-Kind Exchanges

It is not unusual for a taxpayer in a like-kind exchange to receive both like-kind property and an installment note in exchange for the taxpayer's relinquished property.

In other cases, it is not uncommon for a taxpayer to enter into a deferred exchange in connection with the sale of the taxpayer's relinquished property but fail to enter identify or acquire replacement property.

An installment sale is defined as a disposition of property where at least one payment is to be received after the close of the taxable year in which the disposition occurs. As a general rule, each year taxable gain is recognized in the amount of the "gross profit ratio."

The tax consequences of the receipt of an installment note in a like-kind exchanges will generally result in following consequences:

  1. Immediate taxation in the year of sale of the smaller of either:
    1. all of the potential depreciation recapture. or
    2. the amount of the installment note.
  2. The tax basis on the property sold will be allocated first to the replacement property and only the amount of basis in excess of the FMV of the replacement property will be allocated to the installment note. This often causes 100% of the principal payment of the note to be taxable.
  3. The receipt of like-kind property is not deemed to be a payment.

Fortunately, immediate taxation in the year of sale and thereafter can be avoided with several specific tax techniques.

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