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We sold our home in 2007 and carried back an interest only loan. The remaining principal was to be a lump sum payment in five years or less. The value of the home has dropped and we must agree to a reduced price. We paid tax on the portion of the gross profit that was covered by the down payment. Recalculating the profit with the new sale price results in no profit, so in retrospect, we paid unnecessary tax in 2007.

For example: The 2007 sale price was $910,000.
The basis was $350,000,including the cost of sale, thus our gain was $560,000.
The gross profit after the $500,000 exclusion was $60,000. The gross profit percentage calculates to be 6.6%.

We received a $250,000 down payment. As 6.6% of that was calculated to be profit, we paid tax on 6.6% of $250,000, or on an income of $16,500. This was all reported on form 6252 with the 2007 taxes.

We carry an interest-only loan on the $660,000 unpaid balance. We have received interest and we paid tax on the interest. We have received no further principal and no additional form 6252s have been filed.

Now we have to accept less for the home. Instead of $910,000, we will receive a total of $850,000, a reduction of $60,000.

Had the $850,000 been the original sale price in 2007, there would have been zero gross profit, and we would not have paid tax on $16,500 income with our 2007 taxes.

Q1: How should the final sale be reported?

Q2: Can we get any of the tax back we paid with the 2007 taxes?

Q3: Are there any other issues to be concerned with?
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