Installment Sales Method Law and Legal Definition
The installment sales method is one of the several accounting practices used to recognize revenue under the US GAAP. This method is used especially when revenue and expenses are recognized at the time of cash collection rather than at the time of sale. This process is very helpful when the payment for the asset is arranged to take place in a series of consecutive payments, rather than on one big amount. An example of such types of transaction is an installment sale. This method makes it easier to only account for the revenue as it is received, a factor that can have an impact on the overall capital gains for a given tax period. This in turn helps to assure that tax liability is not incurred on any portion of the sale prices that has yet to be delivered to the seller.
Generally, the installment sales method is used when the risk of uncollection is reasonably high and when there is no reasonable basis for estimating the proportion of installment accounts.
Some type of sales cannot use the installment sales method for accounting purposes. The installment sales method cannot be used in the following areas:
Stock or Securities: The installment method cannot be used to report gain from the sale of stock or securities traded on an established securities market. The entire gain on the sale must be reported in the year in which the trade date falls.
Installment Obligation: The obligation of the buyer to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you.
Sale of Inventory: The regular sale of inventory of personal property does not qualify as an installment sale, no matter you receive a payment after the year of sale.
Dealer Sales: Sales of personal property by a person who regularly sells or otherwise disposes of the same type of personal property on the installment plan cannot be classified as an installment sales. This rule also covers real property held for sale to customers in the ordinary course of a trade or business. However, installment sale of property used or produced in farming is exempt from the rule.
Special Rule: Dealers of time-shares and residential lots can treat certain sales as installment sales and report them under the installment method if they elect to pay a special interest charge. Section 453(l) of the Internal Revenue Code would be helpful to get more information on this rule.
Taxpayers have the choice to elect out of the installment method and report the entire gain in the year of disposition. Such option may be exercised even though at least one payment will not have been received by the close of that year. However, the election should be made on a timely filed income tax return for the tax year in which the disposition occurs.