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What is an Installment Sale?
As the name suggests, an "installment sale" is an approach where the seller allows the buyer to make payments in installments over a period of time. It is a Revenue Recognition method in which the seller defers the revenues until the payment is received.
In an Installment Sale, the revenues and the expenses are recognized at the time when the actual cash flow occurs, rather than at the time of sale. Installment Sales are quite prevalent in real-estate deals.
Note that, although the buyer gets the goods at the beginning of the installment period, the ownership is not fully transferred at the time of sale. Usually the goods are hypothecated to a lender until all the installments are duly paid.
When the payments are deferred over an extended period of time, there is always a risk of default. Hence, the seller does not recognize all the revenues at the time of sale, because there is a degree of uncertainty involved.
Installment Sales are preferred in bulky deals because it can help the sellers to reduce their tax liability by keeping the revenues within a lower tax bracket. The sellers can defer a part of their total capital gains to the next fiscal year.
Installment sale is not applicable in cases where the goods are sold at a loss or when stocks and similar financial securities are sold.
Why are Installment Sales Common in Real Estate?
Installments Sales are common in real estate due the following reasons
The sellers (builders) normally agree to finance the buyer's purchase because the receivable amount is quite large for an average buyer. Note that it applies to assets and properties with no mortgages.
Installment Sales help the sellers create a steady income over an extended period of time and also reduce their tax liability. If the entire transaction is recorded at the time of sale, then there will be a greater tax liability on the seller.
The buyer also benefits by making small payments at regular intervals, instead of taking a heavy load in a single transaction.
Points to Note
An installment sale is a type of revenue recognition method where the revenues and the expenses are recorded at the time of cash collection and not at the time of sale.
The buyer gets the goods at the time of sale and makes the payments over an extended period of time as installments.
The buyer does not have the full ownership of the goods until all the payments are duly received.
Sellers benefit by spreading their income over a period and thereby reducing their tax liability.
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