DEFINITION of 'Unstated Interest Paid'
The percentage of interest the U.S. Internal Revenue Service (IRS) assumes has been paid on an installment sale, regardless of whether the interest was actually paid, if the interest rate falls below a specified minimum. Unstated interest must be calculated when a contract does not call for enough stated interest (the interest that is provided in the agreement). When property is sold on an installment basis, federal tax code mandates that the applicable federal rate of interest be included in the contract.
BREAKING DOWN 'Unstated Interest Paid'
For instance, an installment sale is a sales method that allows for partial deferral of any capital gain to future tax years, where the buyer makes regular payments (installments) on an annual basis, and where the seller receives at least one payment after the tax year of the sale. When interest isn't charged, or if interest is charged but falls below the minimum required rate, part of the amount that would normally be treated as a principal payment towards, must be treated as interest. This sum is called unstated interest.
IRS Publication 537 "Installment Sales" specifies rules regarding unstated interest as it pertains to installment sales. Because interest income must be reported as ordinary income, the IRS uses unstated interest to prevent abuses of interest-related deductions and various other tax benefits. A taxpayer can elect out of the installment method by reporting the entire gain in the year of sale, even if he or she does not receive all the sale proceeds in that year.