Have a Tax Question? Ask a Tax Expert
Hi from Just Answer. I'mCustomer and can assist.
The answer is between the two extremes you mention.
Since covenant payments are ordinary income OVER THE LIFE OF THE AGREEMENT, it is neither when paid or over 15 years as 197. It is over the life of the agreement.
If you agreed not to compete for two tax years, then the payment of that portion would be ordinary income over the years of receipt.
We take covenant payments out of the payment stream for the installment gain reporting, and report it separately as other income, 1040, line 21.
Thanks for asking at Just Answer. Positive feedback is appreciated. I'mCustomer
You recognize the covenant income over the life of the agreement.
Let's say you receive $100,000 in year 1 and 2 of your note. A two year covenant that you value at $55,000 would be allocated $55,000 of your note payments. The $45,000 remainder would be considered note payments of your installment sale. Report the income as it is paid to you over the life of the COVENANT.