Figuring taxes on a land sale

Dear Tax Talk,
am contemplating selling some land I own in Washington state. I purchased this land in 1979 for \$25,500 and have an offer for this land of \$65,000 (less a commission of 10 percent to an agent). The terms for purchase are 25 percent down and an 8-percent note, payable in full at the end of one year. How do I calculate my taxes on this sale? From your previous articles that I've read, it would appear I would owe 15-percent long-term capital gains tax on the profit from the sale, less the commission and other expenses associated with the sale. Regards. -- Joe

Dear Joe,
I'm glad somebody is reading my previous articles. There's a lot of good information in them, and they help users draft better questions.

The offer you received is for an installment sale. In an installment sale, the seller reports his gain as payments are received, in proportion to his gross profit on the sale. Assume in your case you'll have \$500 in other closing costs in addition to the \$6,500 commission. Your total cost including the land is \$32,500 so that your gross profit is also \$32,500 or 50 percent (\$65,000 selling price less \$32,500 in costs).

On the sale of the property, you'll receive \$16,250 of which 50 percent represents a return of your investment and the other 50 percent is your gross profit. At the time of sale, your gain is 50 percent of the \$16,250 or \$8,125 on which you'll pay the 15-percent long-term capital gains rate. The economic reality is, of the \$16,250 you receive, \$7,000 will be paid out in commission and closing costs leaving you \$9,250. But since the costs are already taken into account in the gross profit computation, the expenses are recovered ratably over the time in which payments are received, not out of the first payment.

The 8-percent interest on the note balance of \$48,750 or \$3,900 does not qualify for the long-term capital gains rate. Instead, the interest is taxed as ordinary income at the same marginal rate you pay on other noncapital gain income. In one year, when you receive the balloon payment of \$48,750 you'll pay the 15-percent tax on half of the payment, which is your gross profit percentage. Use Form 6252 to report installment-sale gain in the year of sale and every year thereafter until all the proceeds are received.

 -- Posted: June 9, 2004

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