GROSS PROFIT RATIO


In an installment sale, the gross profit ratio is the relationship between the gross profit (gain) and the contract price.

The resulting fraction is applied to periodic receipts from the buyer to determine the taxable gain from each receipt.

The gross profit percentage is calculated by dividing the gross profit by the contract price. The gross profit is the difference between the contract price and the adjusted basis of the property sold. The adjusted basis is the original cost of the property plus any capital improvements, less any depreciation taken.

The gross profit percentage is then multiplied by the payments received during the year to determine the taxable gain for that year. The taxable gain is the portion of the payment that represents profit rather than a return of capital.

Here’s an example to illustrate how the gross profit ratio works in an installment sale:

Suppose you sell a property for $108,500 on an installment basis. The property has an adjusted basis of $56,425, resulting in a gross profit of $52,075 ($108,500 - $56,425). The gross profit percentage is 48% ($52,075 ÷ $108,500).

If the buyer makes a payment of $10,000 in the first year, the taxable gain for that year would be $4,800 ($10,000 x 48%). The remaining portion of the payment would be considered a return of capital and would not be taxable.


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