What Is a Contingent Payment Sale?
A contingent payment sale is a type of sale where the specifics of the sale—such as the entire sales price or the number of fixed payments to complete the sale—depend upon future events.
Because these transactions are contingent on payments that occur in the future, the total selling price may not be able to be determined at the end of the taxable year of the sale. Contingent payment sales can also happen in real estate endeavors.
- A contingent payment sale is a type of sale where the specifics of the sale are tied to future events.
- In these types of business transactions, the total selling price may not be able to be determined in the taxable year of the sale.
- Contingent payment sales may occur when a company is in contract to purchase another company but the financials are not finished.
- Contingent payment sales in real estate are called home sale contingency.
- Section 483 of the Internal Revenue Code (IRC) is useful to learn about handling contingent payments and interest on contingent payments.
Understanding a Contingent Payment Sale
An example of a contingent payment sale may occur when a company is under contract to purchase another company, but the sale will be completed several months out. The final sale price of the target company will be determined by the target company's sales for the remainder of the year.
Contingent payment sales can occur over a period of time longer than a tax year, so they entail a special set of rules that vary according to whether the price or the schedule is the fixed amount. There are two methods for computing taxes due during the tax year for a contingent payment sale: maximum selling price or fixed period.
- With the maximum selling price method, the assumption is made that all contingencies will be met. So, the price is calculated similarly to the installment sales method, and the formula is recalculated if the amount is reduced in subsequent years.
- The fixed period method is used if the maximum selling price cannot be determined. With the fixed period method, the period over which payments may be received is fixed. So the seller's basis is recovered over the period during which payment may be received under the contract.
Another example of a contingent payment sale is that a company may sell an amount of its stock along with a percentage of that company's net profits.
Example of a Contigent Payment Sale in Real Estate
In real estate, unlike business deals, contingent payment sales are enacted a little differently. A contingent payment sale might be issued by the buyer or the seller, and the seller may say the sale is contingent on the potential buyer being approved for a mortgage.
A contingent sale could occur when the buyer has entered into a contract, putting down what is known as "earnest money" that can be used for the downpayment to hold the house essentially. Buyers should beware that the seller can walk away with the earnest money if they cannot meet the agreed contingent.
Some sellers and buyers agree that the sale is contingent on the buyer selling their former house in a certain amount of time. If it doesn't occur, the deal would be off, and the seller could keep the buyer's earnest money.
In some cases, the agreement in a contingent payment sale may not specify either a stated maximum price or limit payments to a fixed period. In this situation, it is fair to question whether or not a sale has realistically occurred. Section 483 of the Internal Revenue Code (IRC) provides descriptions for handling contingent payments and interest on contingent payments.