9052 / What interest requirements apply when a taxpayer uses the installment method of accounting?
Generally, when a taxpayer uses the installment method of accounting (see Q 9051), if the sale price is over $3,000 and any payment is deferred for more than one year, interest must be charged on payments due more than six months after the sale. Interest must be charged at a rate that is at least 100 percent of the “applicable federal rate,” (AFR) compounded semiannually, or interest will be imputed at that rate.1 However, the following exceptions to this general rule apply:
(1) If less than 100 percent of the AFR, a rate of no greater than 9 percent, compounded semiannually, will be imputed in the case of sales of property (other than new IRC Section 38 property) if the stated principal amount of the debt instrument does not exceed $7,296,700 in 2025 ($7,098,600 in 2024, $6,734,800 in 2023, as indexed annually for inflation);2
(2) If less than 100 percent of the AFR, a rate of no greater than 6 percent, compounded semiannually, is imputed on aggregate sales of land during a calendar year between an individual and a member of the individual’s family (i.e., brothers, sisters, spouses, ancestors, and lineal descendants) to the extent the aggregate sales do not exceed $500,000 (the general rule of 100 percent of the AFR, compounded semiannually, applies to the excess);3 and
(3) A rate of 110 percent of the AFR, compounded semiannually, applies to sales or exchanges of property if, pursuant to a plan, the transferor or any related person leases a portion of the property after the sale or exchange (“sale-leaseback” transactions).4
The applicable federal rate applied will be the lowest of the AFRs in effect for any month in the 3-month period ending with the first calendar month in which there is a binding contract in writing.5
All interest received by the taxpayer is taxed as ordinary income.6 In some cases, depending on the property and amount involved, the interest (or imputed interest) to be paid over the period of the loan must be reported as “original issue discount” that accrues in daily portions; in other cases the interest is allocated among the payments and that much of each payment is treated as interest includable and deductible according to the accounting method of the buyer and seller.