Installment Sales Benefit Buyers and Sellers : Taxes: Advantages are available to both parties when the seller helps to finance the transaction.

Smart real estate buyers and sellers understand the tax benefits of deferred payment sales, also known as installment sales. The major advantages for property sellers include a quick easy sale for top dollar, interest income higher than can be earned with safety elsewhere, and profit tax deferral until the buyer makes principal payments to the seller.

Advantages for realty buyers include easy financing, no red tape obtaining a new mortgage and an affordable, often below-market interest rate.

Effective Jan. 1, 1988, Congress changed the installment sale rules applicable to realty sales up to $5 million. When the seller helps finance the sale, such as by carrying back a first or second mortgage for the buyer, the seller pays tax on the sale profit as principal payments are received over future years from the buyer.

A minimum interest rate, usually at least 9%, must be charged on the unpaid balance. Interest, of course, is fully taxable income in the tax year received.

The installment sale election is automatic. However, a deferred payment seller can “unelect” and report the entire sale profit in the year of sale. If the seller has offsetting losses, reporting all the sale profit in one year can be advantageous. However, such an election cannot be revoked without IRS approval.After the sale, if the property seller pledges or sells the installment sale note, such as borrowing against it at a bank, the loan proceeds become taxable as a payment received on the installment sale obligation. This hypothecation rule applies to installment loans created after Dec. 17, 1987.

When an installment sale of real estate is made to a related party, defined as spouse, child, grandchild, parent, brother or sister, controlled corporation and related partnership or family trust, if the buyer disposes of the property within two years, the sale profit will be taxed back to the original installment sale seller.

This rule prevents shifting profits to taxpayers who may be in more favorable income tax situations. However, installment sales incident to divorce or legal separation are not subject to this provision.

In special situations where the ultimate price of the property is contingent on a future event, such as a land seller sharing in subdivision resale profits, the seller can use an installment sale even though total profit is indefinite. This arrangement allows the buyer to conserve down payment cash while developing the property and enhancing its future value.

Installment sales also are allowed even when the buyer wants to make full payment for the property, but the seller wants to avoid receipt of all the sales price in one tax year. An escrow agreement can authorize installment sale proceeds to be held in an escrow trust beyond the property seller’s control. The advantage for the seller is tax deferral, even though the buyer gets full use of the property without a mortgage encumbrance to the seller. For further installment sale details, please consult your tax adviser.

Reprints of this entire series of “1990 Realty Tax Tips--12 Chapters of Tax Saving Ideas” by Robert J. Bruss are available for $4 from NewspaperBooks, Box 4386, Orlando, Fla. 32802.