Taxpayer bought Land Contract

[Bonnie]

Taxpayer bought a land contract at a discounted price. He says it cost him $4500 but the person who is paying him back has a loan for $7500 plus interest. I have never heard of anything like this so don't understand how to handle it on the tax return. He has given me an amortization schedule as to how much of the payment is interest. Where do I report this on his tax return? He bought this contract in Jan of 2007 and total payments he received were $1925 of which $515 was interest. Would this be an installment sale the same as if he originally sold property on land contract?

Thank you for any help

Bonnie

[Roland Slugg]

Dear Bonnie

If I'm interpreting your post correctly, your client purchased an installment obligation for $4,500 that will eventually return to him principal of $7,500 plus interest on the unpaid principal until it is paid off. If this is correct ....

The purchase created a built-in deferred gain of $3,000 ($7,500 less $4,500), and the "market discount bond" rules apply. If the proper election is made, a portion of the $3,000 discount may be reported as interest each year in one of two ways: (1) The "ratable accrual method" or (2) the "constant interest rate" method. (See Code §1276(a)(3)(A) and (B), §1276(b)(3), §1278(b)(1) and related Regs.)

The regular interest on the debt instrument itself, of course, is taxable as well.

[Bonnie]

If I'm interpreting your post correctly, your client purchased an installment obligation for $4,500 that will eventually return to him principal of $7,500 plus interest on the unpaid principal until it is paid off. If this is correct ....

The purchase created a built-in deferred gain of $3,000 ($7,500 less $4,500),

Yes, that is correct and thank you very much for your help.

Bonnie