An installment sale is a type of financial transaction in which a buyer makes regular payments to the seller in order to complete the debt that is owed. This strategy can be used on many different types of property but it is most commonly used in the real estate market. If done correctly, this type of sale can provide some advantages to both the buyer and the seller in the transaction.
With an installment sale, the buyer agrees to make regular payments to the seller for a certain amount of time. The total price of the purchase will be divided over the number of years of the term. In addition to that, interest will be added onto the installment sale payments. According to the IRS, in order to qualify as an installment sale, the sale has to be for something other than a publicly traded security such as a stock. The individual that is selling the property also cannot be a dealer of that particular piece of property. It has to be an individual selling to another individual.
Benefits for the Seller
Even though it might seem advantageous to get a lump sum of money when you are selling a piece of property, using the installment sale method can provide you with some benefits as a seller. Perhaps the biggest benefit that you can receive is that you will be able to defer capital gains taxes and spread them out over the entire sale. For example, if you sell a rental property that has appreciated $100,000 in value and the buyer gives you a lump sum, you would have to pay capital gains taxes on the entire amount of profit at once. This would significantly increase your income for the year and it would put you in a separate tax bracket. It would also negatively affect your ability to take deductions for that year.
If you decided to spread the sale out over 5 years, you could instead count only $20,000 of capital gains in each year. This might keep you in a more reasonable tax bracket and it will allow you to spread the taxes out. Depending on how long you have held the asset, you may be able to pay taxes at the lower capital gains tax rate as well.
Another advantage of this strategy is that you can collect interest on the sale. If you sell it all at once, you will potentially miss out on thousands of dollars in extra interest that you could have been paid.
Benefits for Buyer
With this type of arrangement, the seller can also benefit from this transaction. One of the biggest benefits is that they do not have to come up with all of the cash at once. If they have a long enough term, they may be able to avoid borrowing money from a traditional lender. This could allow them to keep their credit lines open and it may allow them to purchase a property if their credit is poor.