J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

5.25 Contingent Payment Sales

Where the final selling price or payment period of an installment sale is not fixed at the end of the taxable year of sale, you are considered to have transacted a “contingent payment sale.” Special rules apply where a maximum selling price may be figured under the terms of the agreement or there is no fixed price but there is a fixed payment period, or there is neither a fixed price nor a fixed payment period.

Stated maximum selling price.

Under IRS regulations, a stated maximum selling price may be determined by assuming that all of the contingencies contemplated under the agreement are met. When the maximum amount is later reduced, the gross profit ratio is recomputed.

EXAMPLE

Smith sells stock in Acme Co. for a down payment of $100,000 plus an amount equal to 5% of the net profits of Acme for the next nine years. The contract provides that the maximum amount payable, including the $100,000 down payment but exclusive of interest, is $2,000,000. Smith’s basis for the stock is $200,000; $2,000,000 is the selling price and contract price. Gross profit is $1,800,000. The gross profit ratio is 90% ($1,800,000÷ $2,000,000). Thus, $90,000 of the first payment is reportable as gain and $10,000 as a recovery of basis.

Fixed period.

When a stated maximum selling price is not determinable but the maximum payment period is fixed, basis—including selling expenses—is allocated equally to the taxable years in which payment may be received under the agreement. ...