Jon,
First, I did not mention interest. I was only speaking about the gain on the sale of the real property, §1250 property, which is the condo.
Interest on the note is ordinary income and does not compute in the gain calculation of any asset that is sold nor does it compute in the depreciation recapture rules, if applicable.
Second, you must be confused with §1245 & §1250 property. §1245 property recapture is all depreciation claimed. There will be ordinary recapture, no question, if you allocate any proceeds that are higher than tax basis. §1250 property recapture is the extent of the excess of depreciation over the depreciation that would have been available under the straight-line method. "Residential rental property and nonresidential real property that is placed in service after 1986 and is subject to the MACRS rules must be depreciated under the straight-line MACRS method. Therefore, recapture of depreciation on such property is not required because no depreciation in excess of straight-line could have been taken." 2011 USMTG ¶1780
In your scenerio, Cost $100,000 and depreciated $75,000 so the basis is $25,000. You agree to a sale price of $150,000 and your gain will be $125,000.
Installment sale calculated like so: 125,000/150,000 = 0.8333 profit ratio. You use this to determine your gain on the proceeds you receive over the course of the payments.
Year 1: $50,000 received: 50,000 * 0.8333 = $41,667 Gain recognized (as discussed and proven above - no ordinary recapture)
Years 2 - X: Interest received on the note outstanding is taxed at ordinary rates, but this is not gain on the sale of the property and was never part of my original posting about the gain on the sale of the condo.
Year X: There is $100,000 note left to be repaid and in your scenerio $110,000 is paid. The first $100,000 will be applied to the installment note gain ratio of .8333 so that is $83,333 worth of CAPITAL gain to recognize and then the additional $10,000 amount of extra payment is all gain and would be added to the $83,333 for a total of $93,333. Again, §1250 property does not have Ordinary Recapture so there is no Ordinary Gain to recognize.
In year X, when you receive or change the agreed amount to be paid, you theoretically should go back to amend the original tax filing to adjust the gain ratio and recognize the proper gain in the first year and pay any interest and penalties, if due and recalculate the proper gain in the final year. But there are other factors that would come into play like statute of limitations depending on how long the installment agreement lasted for and then there's substance over form issue that we would just correct in the final year of payment. If you just made a typo, then forget everything I just wrote about in this last paragraph and follow the gain of $83,333.
Again, no Ordinary Recapture on the sale of ANY §1250 property which is buildings and their structural components, and all tangible real property, IE-condo, apartment, home or commercial building. Don't confuse Unrecaptured Gain which is tax at capital gains rates at a maximum of 25%.
I have a ton of experience as well and worked at a BIG 4 firm in the real estate department. I ran a commercial rental real estate engagement that comprisd of 156 consolidated companies (not including the disregarded SMLLCs) and was on the workflow efficiency team to create standardized Excel workbooks for Residential Real Estate Partnerships for all of the offices of the firm to utilize when preparing partnership returns. It helped tremendously when we had to report thousands of GP K-1s to the Upreit partnership that would flow into the REIT tax return.
I am not saying that I am better than anyone or perfect, but I do feel quite confident in saying that I am correct in this little discussion of ours regarding the character of gain recognized in the sale of a condo.
Regards.
