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Taxmap/pubs/p537-002.htm#TXMP446cf739 Other Rules

The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. The following topics are discussed.

• Electing out of the installment method.
• Payments received, including those considered received.
• An escrow account.
• Depreciation recapture income.
• A sale to a related person.
• A like-kind exchange.
• A contingent payment sale.
• A single sale of several assets.
• The sale of a business.
• Unstated interest and original interest discount.
• Disposition of an installment obligation.
• A repossession.

Taxmap/pubs/p537-002.htm#TXMP5ec0589d Electing Out of the   Installment Method

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.

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. Notes, mortgages, and land contracts are examples of obligations that are included at FMV.

You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. 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).

Taxmap/pubs/p537-002.htm#TXMP7c661f52
Example.

You sold a parcel of land for $50,000. 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. The buyer gave you a note for $40,000. The note had an FMV of $40,000. You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. The land cost $25,000 and you owned it for more than one year. You decide to elect out of the installment method and report the entire gain in the year of sale.

Gain realized:
Selling price			$50,000
Minus:	Property's adj. 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. basis	$25,000
	Commission	3,000	28,000
Gain recognized			$22,000

The recognized gain of $22,000 is long-term capital gain. 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. The interest on the note is ordinary income and is reported as interest income each year.

Taxmap/pubs/p537-002.htm#TXMP2b05d8be How to elect out.

To make this election, do not report your sale on Form 6252. Instead, report it on Schedule D (Form 1040) or Form 4797, whichever applies.

Taxmap/pubs/p537-002.htm#TXMP58c32007 When to elect out.

Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place.

Taxmap/pubs/p537-002.htm#TXMP62993dc1 Automatic six-month extension.

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). Write "Filed pursuant to section 301.9100-2" at the top of the amended return and file it where the original return was filed.

Taxmap/pubs/p537-002.htm#TXMP7f9e3ed1 Revoking the election.

Once made, the election can be revoked only with IRS approval. A revocation is retroactive. You will not be allowed to revoke the election if either of the following applies.

• One of the purposes is to avoid federal income tax.
• The tax year in which any payment was received has closed.

Taxmap/pubs/p537-002.htm#TXMP05fff125 Payments Received or Considered Received

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.

In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. 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. See Mortgage less than basis for an exception to this rule.

Taxmap/pubs/p537-002.htm#TXMP7d1f95e2 Buyer Pays Seller's Expenses

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. Include these expenses in the selling and contract prices when figuring the gross profit percentage.

Taxmap/pubs/p537-002.htm#TXMP7a4ee09e Buyer Assumes Mortgage

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.

Taxmap/pubs/p537-002.htm#TXMP4ca1f6ab Mortgage less than basis.

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. It is actually a recovery of your basis. The selling price minus the mortgage equals the contract price.

Taxmap/pubs/p537-002.htm#TXMP1ec325a8
Example.

You sell property with an adjusted basis of $19,000. You have selling expenses of $1,000. 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).

The selling price is $25,000 ($15,000 + $10,000). Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). The contract price is $10,000 ($25,000 − $15,000 mortgage). Your gross profit percentage is 50% ($5,000 ÷ $10,000). You report half of each $2,000 payment received as gain from the sale. You also report all interest you receive as ordinary income.

Taxmap/pubs/p537-002.htm#TXMP0c2b825d Mortgage more than basis.

If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. You are also relieved of the obligation to repay the amount borrowed. The part of the mortgage greater than your basis is treated as a payment received in the year of sale.

To figure the contract price, subtract the mortgage from the selling price. This is the total amount you will receive directly from the buyer. Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). The contract price is then the same as your gross profit from the sale.

If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage will always be 100%.

Taxmap/pubs/p537-002.htm#TXMP393fe4aa
Example.

The selling price for your property is $9,000. The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Your adjusted basis in the property is $4,400. You have selling expenses of $600, for a total installment sale basis of $5,000. The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). This amount is included in the contract price and treated as a payment received in the year of sale. 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%. Report 100% of each payment as gain from the sale. 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.

Taxmap/pubs/p537-002.htm#TXMP59a0a1d1 Mortgage Canceled

Mortgage Canceled

If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. You are considered to receive a payment equal to the outstanding canceled debt.

Taxmap/pubs/p537-002.htm#TXMP6d8cfa55
Example.

Mary Jones loaned you $45,000 in 2000 in exchange for a note mortgaging a tract of land you owned. On April 4, 2004, she bought the land for $70,000. At that time, $30,000 of her loan to you was outstanding. She agreed to forgive this $30,000 debt and to pay you $20,000 (plus interest) on August 1, 2004, and $20,000 on August 1, 2005. She did not assume an existing mortgage. She canceled the $30,000 debt you owed her. You are considered to have received a $30,000 payment at the time of the sale.

Taxmap/pubs/p537-002.htm#TXMP77845523 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.

If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Compare the debt to your installment sale basis in the property being sold. If the debt is less than your installment sale basis, none of it is treated as a payment. If it is more, only the difference is treated as a payment. 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. These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage. However, they apply only to the following types of debt the buyer assumes.

• Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes.
• Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased.

If the buyer assumes any other type of debt, such as a personal loan, it is treated as if the buyer had paid off the debt at the time of the sale. The value of the assumed debt is then considered a payment to you in the year of sale.

Taxmap/pubs/p537-002.htm#TXMP0ed88b55 Property Used As a Payment

Property Used As a Payment

If you receive property rather than money from the buyer, it is still considered a payment in the year received. However, see Like-Kind Exchange, later.

Generally, the amount of the payment is the property's FMV on the date you receive it.

Taxmap/pubs/p537-002.htm#TXMP1f6eaf59 Exception.

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 receipts and disbursements 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. See Unstated Interest and Original Issue Discount (OID), later.

Taxmap/pubs/p537-002.htm#TXMP59491dcc Fair market value (FMV).

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 who both have a reasonable knowledge of all the necessary facts.

Taxmap/pubs/p537-002.htm#TXMP17b1253e Third-party note.

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. Because 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. However, see Exception under Property Used As a Payment, above.

Taxmap/pubs/p537-002.htm#TXMP4b66c526
Example.

You sold real estate in an installment sale. As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. The FMV of the third-party note at the time of the sale was $30,000. This amount, not $50,000, is a payment to you in the year of sale. 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. The remaining 40% is ordinary income.

Taxmap/pubs/p537-002.htm#TXMP71b230bb Bond.

A bond or other evidence of debt you receive from the buyer that is payable on demand is treated as a payment in the year you receive it. 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. However, see Exception under Property Used As a Payment, earlier.

For sales on or after October 22, 2004, any bond or other evidence of debt you receive from the buyer that has interest coupons attached that can be readily traded on an established securities market is treated as a payment in the year you receive it. For more information on the amount you should treat as a payment, see Exception, earlier.

Taxmap/pubs/p537-002.htm#TXMP34571e55 Buyer's note.

The buyer's note (unless payable on demand) is not considered payment on the sale. However, its full face value is included when figuring the selling price and the contract price. Payments you receive on the note are used to figure your gain in the year received.

Taxmap/pubs/p537-002.htm#TXMP3289fdab Guarantee

Any evidence of debt you receive from the buyer that is not payable on demand is not considered a payment, even if it is guaranteed by a third party, including a government agency.

Taxmap/pubs/p537-002.htm#TXMP030b39cd 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. This is known as the pledge rule and it applies if the selling price of the property is over $150,000. It does not apply to the following dispositions.

• Sales of property used or produced in farming.
• Sales of personal-use property.
• Qualifying sales of time-shares and residential lots.

The net debt proceeds are the gross debt minus the direct expenses of getting the debt. The amount treated as a payment is considered received on the later of the following dates.

• The date the debt becomes secured.
• The date you receive the debt proceeds.

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. For sales after December 16, 1999, if you have the right to transfer an installment obligation in payment of a loan, the loan is considered directly secured.

Taxmap/pubs/p537-002.htm#TXMP429ad83b Limit.

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.

1. The total contract price on the installment sale.
2. Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment.

Taxmap/pubs/p537-002.htm#TXMP580bf48c Installment payments.

The pledge rule accelerates the reporting of the installment obligation payments. 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.

Taxmap/pubs/p537-002.htm#TXMP3431a507 Exception.

The pledge rule does not apply to debt incurred after December 17, 1987, to refinance a debt under the following circumstances.

• The debt was outstanding on December 17, 1987.
• The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred.

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.

This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Any excess is treated as a payment on the installment obligation.

Taxmap/pubs/p537-002.htm#TXMP7ed6336b 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. These sales cannot be reported on the installment method. The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement.

Taxmap/pubs/p537-002.htm#TXMP007c1c4b
Example.

You sell property for $100,000. 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. You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. You report the entire gain in the year of sale.

Taxmap/pubs/p537-002.htm#TXMP659c0aa8 Escrow established in a later year.

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.

Taxmap/pubs/p537-002.htm#TXMP749dbb7a Substantial restriction.

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. 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.

Taxmap/pubs/p537-002.htm#TXMP79d2d53d Depreciation   Recapture Income

Depreciation, Recapture

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. Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. The recapture income is also included in Part I of Form 6252. However, the gain equal to the recapture income is reported in full in the year of the sale. Only the gain greater than the recapture income is reported on the installment method. For more information on depreciation recapture, see chapter 3 in Publication 544.

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. Determining gross profit is discussed under General Rules, earlier.

Taxmap/pubs/p537-002.htm#TXMP62868d79 Sale to a   Related Person

Sale to a Related Person

If you sell 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. 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. These rules are explained below under Sale of Depreciable Property and Sale and Later Disposition.

Taxmap/pubs/p537-002.htm#TXMP229c34f4 Related persons.

The definition of related persons depends on whether you sold depreciable property or the related person disposed of the property.

Taxmap/pubs/p537-002.htm#TXMP068c3370 Depreciable property.

For purposes of the sale of depreciable property rules, related persons include the following.

• A person and all entities that are controlled entities with respect to such person.
• A taxpayer and any trust in which such taxpayer (or his spouse) is a beneficiary, unless such beneficiary's interest in the trust is a remote contingent interest.
• Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of such estate.
• Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests.

For information about which entities are controlled entities, see section 1239(c) of the Internal Revenue Code.

Taxmap/pubs/p537-002.htm#TXMP30f29733 Later disposition.

For purposes of the sale and disposition rules, related persons include the following.

• Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants.
• A partnership or estate and a partner or beneficiary.
• A trust (other than a section 401(a) employees trust) and a beneficiary.
• A trust and an owner of the trust.
• Two corporations that are members of the same controlled group as defined in section 267(f) of the Internal Revenue Code.
• 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.
• 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.
• 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.
• 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.
• The grantor and fiduciary, and the fiduciary and beneficiary, of any trust.
• Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation.
• 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.
• 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.
• An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest.

Taxmap/pubs/p537-002.htm#TXMP6716671c Sale of Depreciable Property

Sale of Depreciable Property

If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Instead, all payments to be received are considered received in the year of sale. However, see Exception, later. Depreciable property for this rule is any property the purchaser can depreciate.

Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount.

In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income.

Taxmap/pubs/p537-002.htm#TXMP12446892 Exception.

The prohibition on using the installment method to report a sale of depreciable property to a related person will not apply if no significant tax deferral benefit will be derived from the sale. 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.

Taxmap/pubs/p537-002.htm#TXMP27d0aa9d Sale and Later Disposition

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.

• The related person makes the second disposition before making all payments on the first disposition.
• The related person disposes of the property within 2 years of the first disposition. This rule does not apply if the property involved is marketable securities.

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.

See Exception, later.

Taxmap/pubs/p537-002.htm#TXMP7ca27057
Example 1.

In 2003, 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. His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). He received $100,000 in 2003 and included $50,000 in income for that year ($100,000 × 0.50). Bob made no improvements to the property and sold it to Alfalfa Inc., in 2004 for $600,000 after making the payment for that year. The amount realized from the second disposition is $600,000. Harvey figures his installment sale income for 2004 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 2003 and 2004	- 200,000
Amount treated as received because of second disposition	$300,000
Add: Payment from Bob in 2004	+ 100,000
Total payments received and treated as received for 2004	$400,000
Multiply by gross profit %	× .50
Installment sale income for 2004	$200,000

Harvey will not include in his installment sale income any principal payments he receives on the installment obligation for 2005, 2006, and 2007 because he has already reported the total payments of $500,000 from the first disposition ($100,000 in 2003 and $400,000 in 2004).

Taxmap/pubs/p537-002.htm#TXMP578f2396
Example 2.

Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. The gain for 2004 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 2003 and 2004	- 200,000
Amount treated as received because of second disposition	$200,000
Add: Payment from Bob in 2004	+ 100,000
Total payments received and treated as received for 2004	$300,000
Multiply by gross profit %	× .50
Installment sale income for 2004	$150,000

Harvey receives a $100,000 payment in 2005 and another in 2006. They are not taxed because he treated the $200,000 from the disposition in 2004 as a payment received and paid tax on the gain. In 2007, he receives the final $100,000 payment. He figures the gain he must recognize in 2007 as follows:

Total payments from the first disposition received by the end of 2007		$500,000
Minus the sum of:
Payment from 2003	$100,000
Payment from 2004	100,000
Amount treated as received in 2004	200,000
Total on which gain was previously recognized		- 400,000
Payment on which gain is recognized for 2007		$100,000
Multiply by gross profit %		× .50
Installment sale income for 2007		$ 50,000

Taxmap/pubs/p537-002.htm#TXMP6ebcac41 Exception.

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. 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.

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. However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale.

In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. 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.

Taxmap/pubs/p537-002.htm#TXMP4341b9e3 Like-Kind Exchange

Tax-Free 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. These trades are known as like-kind exchanges. The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up.

You do not have to report any part of your gain if you receive only like-kind property. 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.

For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544.

Taxmap/pubs/p537-002.htm#TXMP17a1069f Installment payments.

If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply.

• The contract price is reduced by the FMV of the like-kind property received in the trade.
• The gross profit is reduced by any gain on the trade that can be postponed.
• Like-kind property received in the trade is not considered payment on the installment obligation.

Taxmap/pubs/p537-002.htm#TXMP5e461e36
Example.

In 2004, George Brown trades personal property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. He also receives an installment note for $800,000 in the trade. Under the terms of the note, he is to receive $100,000 (plus interest) in 2005 and the balance of $700,000 (plus interest) in 2006.

George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). The contract price is $800,000 ($1,000,000 − $200,000). The gross profit percentage is 75% ($600,000 ÷ $800,000). He reports no gain in 2004 because the like-kind property he receives is not treated as a payment for figuring gain. He reports $75,000 gain for 2005 (75% of $100,000 payment received) and $525,000 gain for 2006 (75% of $700,000 payment received).

Taxmap/pubs/p537-002.htm#TXMP1f8ad5e0 Deferred exchanges.

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. Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. 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. See Regulations section 1.1031(k)-1(j)(2) for these rules.

Taxmap/pubs/p537-002.htm#TXMP15cb59a7 Contingent Payment Sale

Contingent Payment Sale

A contingent payment sale is one whose total selling price cannot be determined by the end of the tax year in which the sale takes place. This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years.

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.

For rules on using the installment method for a contingent payment sale, see Regulations section 15A.453-1(c).

Taxmap/pubs/p537-002.htm#TXMP7c4df17a Single Sale of Several Assets

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. You also have to allocate part of the selling price to each asset. If you sell assets that constitute a trade or business, see Sale of a Business, later.

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. 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. This becomes the net FMV.

A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. It must be reported separately. The remaining assets sold at a gain are reported together.

Taxmap/pubs/p537-002.htm#TXMP16153559
Example.

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. 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.

Your installment sale basis for each parcel was $15,000. Your net gain was $85,000 ($130,000 − $45,000). You report the gain on the installment method.

The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. The FMV of parcels A, B, and C were $60,000, $60,000 and $10,000, respectively.

The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels.

Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. 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. 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. You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. However, if parcel C was held for personal use, the loss is not deductible.

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).

Taxmap/pubs/p537-002.htm#TXMP70dde023 Sale of a Business

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.

Taxmap/pubs/p537-002.htm#TXMP2a3c1cdd Allocation of Selling Price

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.

• Property properly includible in income.
• Assets sold at a loss.
• Real property.

Taxmap/pubs/p537-002.htm#TXMP52434296 Inventory.

The sale of inventories of personal property cannot be reported on the installment method. All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years.

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. If you do not, each payment must be allocated between the inventory and the other assets sold.

Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Use your basis in the inventory to figure the cost of goods sold. Deduct the part of the selling expenses allocated to inventory as an ordinary business expense.

Taxmap/pubs/p537-002.htm#TXMP6774f8ef Residual method.

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. This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets.

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. 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) of the Internal Revenue Code.

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 of the Internal Revenue Code.

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). The consideration remaining after this reduction must be allocated among the various business assets in a certain order.

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.

1. Certificates of deposit, U.S. Government securities, foreign currency, and actively traded personal property, including stock and securities.
2. Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. However, see section 1.338-6(b)(2)(iii) of the regulations 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.
3. 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.
4. All other assets except section 197 intangibles.
5. Section 197 intangibles except goodwill and going concern value.
6. Goodwill and going concern value (whether or not they qualify as section 197 intangibles).

If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. For example, if an asset is described in both (4) and (6), include it in (4).

Taxmap/pubs/p537-002.htm#TXMP5e9a8432 Agreement.

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. This agreement is binding on both parties unless the IRS determines the amounts are not appropriate.

Taxmap/pubs/p537-002.htm#TXMP07f1f2aa Reporting requirement.

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. Use Form 8594 to provide this information. The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred.

Taxmap/pubs/p537-002.htm#TXMP4591eaa0 Sale of Partnership Interest

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. The sale of a partnership interest is treated as the sale of a single capital asset. The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. (The term unrealized receivables includes depreciation recapture income, discussed earlier.)

The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. The gain allocated to the other assets can be reported under the installment method.

For more information on the treatment of unrealized receivables and inventory, see Publication 541.

Taxmap/pubs/p537-002.htm#TXMP5118a2a8 Example — Sale of a Business

Example — Sale of a Business

On June 4, 2004, you sold the machine shop you had operated since 1996. You received a $100,000 down payment and the buyer's note for $120,000. The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2005. The total selling price is $220,000. Your selling expenses are $11,000. The selling expenses are divided among all the assets sold, including inventory.

Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price).

The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:

		Depre-ciation	Adjusted
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). The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill.

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.

	Sale Price	Sale Exp.	Adj. 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. A	71,000	3,550	63,800	3,650
Mch. 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 1996, the year the business began, and it is section 1250 property. There is no depreciation recapture income because the building was depreciated using the straight line method.

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. Figure depreciation recapture in Part III of Form 4797.

The total depreciation recapture income reported in Part II of Form 4797 is $5,209. 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). These gains are reported in full in the year of sale and are not included in the installment sale computation.

Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported on the installment method. 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.

The selling price equals the contract price for the installment sale ($108,500). The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart.

	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). The gross profit percentage for each asset is figured as follows:

Percentage
Land - $24,900 ÷ $108,500	22.95
Building - $9,600 ÷ $108,500	8.85
Goodwill - $17,575 ÷ $108,500	16.20
Total	48.00

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. The selling price for the installment sale is $108,500. This is 49.3% of the total selling price of $220,000 ($108,500 ÷ $220,000). The selling price of assets not reported on the installment method is $111,500. This is 50.7% ($111,500 ÷ $220,000) of the total selling price.

Multiply principal payments by 49.3% to determine the part of the payment for the installment sale. The balance, 50.7%, is for the part reported in the year of the sale.

The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Only the part for the installment sale (49.3%) is used in the installment sale computation.

The only payment received in 2004 is the down payment of $100,000. The part of the payment for the installment sale is $49,300 ($100,000 × 49.3%). This amount is used in the installment sale computation.

Taxmap/pubs/p537-002.htm#TXMP477af06b Installment income for 2004.

Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2004.

Income
Land - 22.95% of $49,300	$11,314
Building - 8.85% of $49,300	4,363
Goodwill - 16.2% of $49,300	7,987
Total installment income for 2004	$23,664

Taxmap/pubs/p537-002.htm#TXMP7e1f5d28 Installment income after 2004.

You figure installment income for years after 2004 by applying the same gross profit percentages to 49.3% of the total payments you receive on the buyer's note during the year.

Taxmap/pubs/p537-002.htm#TXMP749b2910 Unstated Interest and Original Issue Discount (OID)

Unstated Interest and Original Issue Discount

Note. Section references are to the Internal Revenue Code and regulation references are to the Income Tax Regulations under the Code.

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. Interest provided in the contract is called stated interest.

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. If section 483 applies to the contract, this interest is called unstated interest. If section 1274 applies to the contract, this interest is called original issue discount (OID).

An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later).

Taxmap/pubs/p537-002.htm#TXMP393e4be4 Treatment of unstated interest and OID.

Generally, the unstated interest rules do not apply to a debt given in consideration for a sale or exchange of personal-use property. 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.

Taxmap/pubs/p537-002.htm#TXMP6dd9ccbc Rules for the seller.

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. If either section applies, you must reduce the stated selling price of the property and increase your interest income by this interest.

Include the unstated interest in income based on your regular method of accounting. Include OID in income over the term of the contract.

The OID includible in income each year is based on the constant yield method described in section 1272. (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.)

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. Reduce the selling price by any stated principal treated as interest to determine the gain.

Report unstated interest or OID on your tax return, in addition to stated interest.

Taxmap/pubs/p537-002.htm#TXMP539f9b36 Rules for the buyer.

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. These rules do not apply to personal-use property (for example, property not used in a trade or business).

Taxmap/pubs/p537-002.htm#TXMP54a8a810 Adequate stated interest.

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. The present value of a payment is determined based on the test rate of interest, defined next. (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value.) 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.

Taxmap/pubs/p537-002.htm#TXMP6ceed6df Test rate of interest.

The test rate of interest for a contract is the 3-month rate. The 3-month rate is the lower of the following applicable federal rates (AFRs).

• 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.
• 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.

Taxmap/pubs/p537-002.htm#TXMP7f97a286 Applicable federal rate (AFR).

The AFR depends on the month the binding contract for the sale or exchange of property is made and the term of the instrument. For an installment obligation, the term of the instrument is its weighted average maturity, as defined in Regulations section 1.1273-1(e)(3). The AFR for each term is shown below.

• For a term of 3 years or less, the AFR is the federal short-term rate.
• For a term of over 3 years, but not over 9 years, the AFR is the federal mid-term rate.
• For a term of over 9 years, the AFR is the federal long-term rate.

The applicable federal rates are published monthly in the Internal Revenue Bulletin (IRB). You can get this information by contacting an IRS office. IRBs are also available on the IRS web site at www.irs.gov.

Taxmap/pubs/p537-002.htm#TXMP71551835 Seller financed sales.

For sales or exchanges of property (other than new section 38 property, which includes most tangible personal property) involving seller financing of $4,381,300 or less, the test rate of interest cannot be more than 9%, compounded semiannually. For seller financing over $4,381,300 and for all sales or exchanges of new section 38 property, the test rate of interest is 100% of the AFR.

For information on new section 38 property, see section 48(b) of the Internal Revenue Code, as in effect before the enactment of Public Law 101-508.

Taxmap/pubs/p537-002.htm#TXMP62f1f030 Certain land transfers between related persons.

In the case of certain land transfers between related persons (described later), the test rate is no more than 6 percent, compounded semiannually.

Taxmap/pubs/p537-002.htm#TXMP16211fe9 Internal Revenue Code sections 1274 and 483.

If an installment sale contract does not provide for adequate stated interest, generally either section 1274 or section 483 will apply to the contract. These sections recharacterize part of the stated principal amount as interest. Whether either of these sections applies to a particular installment sale contract depends on several factors, including the total selling price and the type of property sold.

Taxmap/pubs/p537-002.htm#TXMP24b28d13 Determining whether section 1274 or section 483 applies.

For purposes of determining whether either section 1274 or section 483 applies to an installment sale contract, all sales or exchanges that are part of the same transaction (or related transactions) are treated as a single sale or exchange and all contracts arising from the same transaction (or a series of related transactions) are treated as a single contract. Also, the total consideration due under an installment sale contract is determined at the time of the sale or exchange. Any payment (other than a debt instrument) is taken into account at its FMV.

Taxmap/pubs/p537-002.htm#TXMP5d9e23bf Section 1274

Section 1274 applies to a debt instrument issued for the sale or exchange of property if any payment under the instrument is due more than 6 months after the date of the sale or exchange and the instrument does not provide for adequate stated interest. Section 1274, however, does not apply to an installment sale contract that is a cash method debt instrument (defined next) or that arises from the following transactions.

• A sale or exchange for which the total payments are $250,000 or less.
• The sale or exchange of an individual's main home.
• The sale or exchange of a farm for $1,000,000 or less by an individual, an estate, a testamentary trust, small business corporation (defined in section 1244(c)(3)), or a domestic partnership that meets requirements similar to those of section 1244(c)(3).
• Certain land transfers between related persons (described later).

Taxmap/pubs/p537-002.htm#TXMP735e5158 Cash method debt instrument.

This is any debt instrument given as payment for the sale or exchange of property (other than new section 38 property) with a stated principal of $3,129,500 or less if the following items apply.

1. The lender (holder) does not use an accrual method of accounting and is not a dealer in the type of property sold or exchanged.
2. Both the borrower (issuer) and the lender jointly elect to account for interest under the cash method of accounting.
3. Section 1274 would apply except for the election in (2) above.

Taxmap/pubs/p537-002.htm#TXMP2815461d Land transfers between related persons.

The section 483 rules (discussed next) apply to debt instruments issued in a land sale between related persons to the extent the sum of the following amounts does not exceed $500,000.

• The stated principal of the debt instrument issued in the sale or exchange.
• The total stated principal of any other debt instruments for prior land sales between these individuals during the calendar year.

The section 1274 rules, if otherwise applicable, apply to debt instruments issued in a sale of land to the extent the stated principal amount exceeds $500,000, or if any party to the sale is a nonresident alien.

Related persons include an individual and the members of the individual's family and their spouses. Members of an individual's family include the individual's spouse, brothers and sisters (whole or half), ancestors, and lineal descendants. Membership in the individual's family can be the result of a legal adoption.

Taxmap/pubs/p537-002.htm#TXMP021b2390 Section 483

Section 483 generally applies to an installment sale contract that does not provide for adequate stated interest and is not covered by section 1274. Section 483, however, generally does not apply to an installment sale contract that arises from the following transactions.

• A sale or exchange for which no payments are due more than one year after the date of the sale or exchange.
• A sale or exchange for $3,000 or less.

Taxmap/pubs/p537-002.htm#TXMP23e92fb3 Exceptions to Sections 1274   and 483

Exceptions to Sections 1274 and 483

Sections 1274 and 483 do not apply under the following circumstances.

• An assumption of a debt instrument in connection with a sale or exchange or the acquisition of property subject to a debt instrument, unless the terms or conditions of the debt instrument are modified in a manner that would constitute a deemed exchange under Regulations section 1.1001-3.
• A debt instrument issued in connection with a sale or exchange of property if either the debt instrument or the property is publicly traded.
• A sale or exchange of all substantial rights to a patent, or an undivided interest in property that includes part or all substantial rights to a patent, if any amount is contingent on the productivity, use, or disposition of the property transferred. See Publication 544 for more information.
• An annuity contract issued in connection with a sale or exchange of property if the contract is described in Internal Revenue Code section 1275(a)(1)(B) and Regulations section 1.1275-1(j).
• A transfer of property subject to Internal Revenue Code section 1041 (relating to transfers of property between spouses or incident to divorce).
• A demand loan that is a below-market loan described in Internal Revenue Code section 7872(c)(1) (for example, gift loans and corporation-shareholder loans).
• A below-market loan described in Internal Revenue Code section 7872(c)(1) issued in connection with the sale or exchange of personal-use property. This rule applies only to the holder.

Taxmap/pubs/p537-002.htm#TXMP658264e4 More information.

For information on figuring unstated interest and OID and other special rules, see Internal Revenue Code sections 1274 and 483 and the related regulations. In the case of an installment sale contract that provides for contingent payments, see Regulations sections 1.1275-4(c) and 1.483-4.

Taxmap/pubs/p537-002.htm#TXMP797d238c Disposition of an   Installment Obligation

Disposition of an Installment Obligation

A disposition generally includes a sale, exchange, cancellation, bequest, distribution, or transmission of an installment obligation. An installment obligation is the buyer's note, deed of trust, or other evidence that the buyer will make future payments to you.

If you are using the installment method and you dispose of the installment obligation, generally you will have a gain or loss to report. It is considered gain or loss on the sale of the property for which you received the installment obligation. If the original installment sale produced ordinary income, the disposition of the obligation will result in ordinary income or loss. If the original sale resulted in a capital gain, the disposition of the obligation will result in a capital gain or loss.

Taxmap/pubs/p537-002.htm#TXMP1035dab9 Rules To Figure Gain or Loss

Rules To Figure Gain or Loss

Use the following rules to figure your gain or loss from the disposition of an installment obligation.

1. If you sell or exchange the obligation, or you accept less than face value in satisfaction of the obligation, your gain or loss is the difference between your basis in the obligation and the amount you realize.
2. If you dispose of the obligation in any other way, your gain or loss is the difference between your basis in the obligation and its FMV at the time of the disposition. This rule applies, for example, when you give the installment obligation to someone else or cancel the buyer's debt to you.

Taxmap/pubs/p537-002.htm#TXMP5e31a639 Basis.

Figure your basis in an installment obligation by multiplying the unpaid balance on the obligation by your gross profit percentage. Subtract that amount from the unpaid balance. The result is your basis in the installment obligation.

Taxmap/pubs/p537-002.htm#TXMP3740fc4b
Example.

Several years ago, you sold property on the installment method. The buyer still owes you $10,000 of the sale price. This is the unpaid balance on the buyer's installment obligation to you. Your gross profit percentage is 60%, so $6,000 (60% × $10,000) is the profit owed you on the obligation. The rest of the unpaid balance, $4,000, is your basis in the obligation.

Taxmap/pubs/p537-002.htm#TXMP4e65fd2c Transfer between spouses or former spouses.

No gain or loss is recognized on the transfer of an installment obligation between a husband and wife or a former husband and wife if the transfer is incident to a divorce. A transfer is incident to a divorce if it occurs within one year after the date on which the marriage ends or is related to the end of the marriage. The same tax treatment of the transferred obligation applies to the transferee spouse or former spouse as would have applied to the transferor spouse or former spouse. The basis of the obligation to the transferee spouse (or former spouse) is the adjusted basis of the transferor spouse.

The nonrecognition rule does not apply if the spouse or former spouse receiving the obligation is a nonresident alien.

Taxmap/pubs/p537-002.htm#TXMP27175c02 Gift.

A gift of an installment obligation is a disposition. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you make the gift.

For gifts between spouses or former spouses, see Transfer between spouses or former spouses, earlier.

Taxmap/pubs/p537-002.htm#TXMP79743114 Cancellation.

If an installment obligation is canceled or otherwise becomes unenforceable, it is treated as a disposition other than a sale or exchange. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you cancel it. If the parties are related, the FMV of the obligation is considered to be no less than its full face value.

Taxmap/pubs/p537-002.htm#TXMP2fae3d39 Forgiving part of the buyer's debt.

If you accept part payment on the balance of the buyer's installment debt to you and forgive the rest of the debt, you treat the settlement as a disposition of the installment obligation. Your gain or loss is the difference between your basis in the obligation and the amount you realize on the settlement.