Oregon Tax Consultants Practice Exam

When do you pay taxes on interest from an installment sale?

1. In the year it was received

2. At the end of the installment period

3. When the sale is finalized

4. Only when filing a tax return

The correct answer is: In the year it was received

Taxes on interest from an installment sale are paid in the year the interest is received. This is because interest income is considered taxable in the year it is actually received, regardless of whether or not the underlying sale transaction has been fully completed. The Internal Revenue Service (IRS) requires taxpayers to recognize income in the year it is received in cash or property, which includes interest payments from an installment sale. This treatment is consistent with the accrued recognition of income, where the taxpayer reports the income as it flows into their hands. Therefore, it aligns with general tax principles that dictate income should be reported in the tax year it is realized and received. The other options do not accurately represent the timing for recognizing tax liability on interest income. The end of the installment period, the finalization of the sale, or just during the filing of a tax return do not align with the tax rules regarding when interest income must be reported.