Does an installment sale eliminate capital gains tax?

No. It generally defers when the gain is recognized by spreading it across the years payments are received, but the total gain is still ultimately taxable.

Can I use an installment sale for any type of real estate?

Generally not for dealer property (real estate held primarily for sale to customers in the ordinary course of business). Eligibility depends on the nature of the property and the seller's activity, so this should be reviewed with a tax professional.

Is depreciation recapture deferred along with the rest of the gain?

Generally no. Depreciation recapture is typically recognized as ordinary income in the year of sale, even if the related cash has not yet been collected.

Do I have to charge interest on the installment payments?

Generally yes. Imputed interest rules typically require a minimum interest rate on deferred payments, or the IRS may recharacterize part of the payments as interest.

What happens if the buyer defaults on the payments?

Because the seller is financing the sale, buyer default is a real risk. The seller may need to pursue collection or foreclosure remedies, which can affect the original tax and cash flow planning.

How is an installment sale different from a 1031 exchange?

An installment sale spreads recognition of the gain on the original sale over time as payments are received. A 1031 exchange defers the gain by reinvesting proceeds into replacement real estate under specific identification and closing deadlines.

Can an installment sale be combined with other tax strategies?

It may be considered alongside or compared to other approaches, such as a Delaware Statutory Trust or Qualified Opportunity Zone investment, depending on individual goals. This generally requires a coordinated conversation with your tax and financial professionals.

What forms are required to report an installment sale?

Generally Form 6252 must be filed for the year of sale and each subsequent year until the obligation is paid off or otherwise disposed of, with gain carried to the applicable schedule such as Form 4797 or Schedule D/Form 8949.

Are there limits on installment sales between related parties or large transactions?

Yes. Related-party sales and nondealer installment obligations exceeding $5 million in aggregate outstanding at year-end are subject to additional rules, including a potential interest charge on deferred tax.

Can I choose not to use the installment method even if I qualify?

Yes. A seller can elect out of installment reporting and recognize the full gain in the year of sale, generally by making that election by the return due date, including extensions.

Installment Sales for Real Estate: How Business Owners Can Spread Capital Gains Across Multiple Tax Years

By Toni Sutherland · October 19, 2026

When a business owner sells appreciated real estate, the default assumption is often that the full gain is taxable in the year of sale, or that a 1031 exchange is the only way to defer it. There is a third option worth understanding: the installment sale. Under IRC Section 453, a seller who receives at least one payment after the year of sale can generally spread recognition of the gain across the years in which payments are actually received, rather than paying tax on the entire gain up front.

This is not a replacement for a 1031 exchange, and it is not right for every situation. But for business owners who want to sell to a specific buyer, do not want to immediately redeploy proceeds into another property, or whose timeline or property type does not fit exchange rules, it is a strategy worth putting on the table.

This article is educational information only. It is not individualized tax or legal advice. Every situation is different, and you should consult your own tax and legal professionals before entering into an installment sale arrangement.

Key takeaways

An installment sale generally lets a seller recognize gain as principal payments are received, rather than all at once in the sale year.
The taxable portion of each payment is determined by a gross-profit percentage, calculated once at the time of sale.
Interest on deferred payments is generally taxed separately as ordinary income, and depreciation recapture is generally still taxed in the year of sale.
Unlike a 1031 exchange, an installment sale does not require identifying or closing on replacement property within strict timelines, and proceeds do not need to be reinvested in real estate at all.
Buyer credit risk, imputed interest rules, and limitations on dealer property and large or related-party transactions are important considerations.

What is an installment sale?

An installment sale occurs when a seller finances part or all of a sale by allowing the buyer to make payments over time, with at least one payment received after the tax year in which the sale occurs. According to IRS Publication 537, the installment method generally applies automatically to a qualifying sale unless the seller affirmatively elects out of it by the return due date, including extensions, for the year of sale.

This differs from a typical lump-sum sale, where the seller receives the full purchase price at closing and recognizes the entire gain that year. It also differs from a 1031 exchange, where gain is deferred by reinvesting proceeds into replacement real estate rather than by spreading recognition of the original gain over time. An installment sale does not require buying another property at all. The seller simply collects payments from the buyer according to the terms of the note, and reports gain as those payments come in.

Importantly, the installment method generally cannot be used to report a loss, and it does not apply to dealer property (real estate held primarily for sale to customers in the ordinary course of business), according to IRS Topic No. 705.

How the gross-profit percentage spreads gain over time

The mechanics of an installment sale center on a single calculation made at the time of sale: the gross-profit percentage. The IRS describes this method as allocating each year’s payment between return of basis, taxable gain, and interest.

The gross-profit percentage is generally calculated as:

Gross profit divided by total contract price

Where gross profit is the selling price minus adjusted basis and selling expenses. Once this percentage is set, it is applied to each principal payment received to determine how much of that payment is taxable gain for that year, with the remainder treated as a nontaxable return of basis.

For example, if a property sale has a $1,000,000 contract price and $400,000 of gross profit, the gross-profit percentage is 40%. If the seller receives $100,000 of principal in a given year, $40,000 of that payment is recognized as taxable gain in that year. The remaining principal received in later years is taxed the same way, using the same 40% ratio, until the full gain has been recognized.

Interest charged on the deferred balance is reported separately as ordinary income in the year received and is not part of the gross-profit calculation.

Key considerations before using an installment sale

Interest must generally be charged on deferred payments. The IRS imputed interest rules generally require that a minimum rate of interest be charged on installment notes. If the stated interest rate is too low or absent, the IRS may recharacterize part of each payment as interest rather than principal, which changes the tax treatment of that portion.
Depreciation recapture is generally not spread out. For real estate that has been depreciated, IRS guidance generally requires that depreciation recapture be recognized as ordinary income in the year of sale, regardless of when the related cash is actually collected. This is a frequently misunderstood point and should be modeled carefully before the sale closes.
The seller is extending credit to the buyer. Because the seller is financing the transaction, there is buyer default and credit risk to consider. If the buyer stops making payments, the seller may need to pursue collection or foreclosure remedies, and the original tax planning around the sale can be disrupted.
Large and related-party transactions have special rules. Sales to related parties, and nondealer installment obligations that exceed $5 million in aggregate outstanding at year-end, are subject to additional limitations and, in some cases, an interest charge on deferred tax, according to IRS Publication 537. These situations generally require more detailed planning.
Reporting requirements continue every year. The seller generally must file Form 6252, Installment Sale Income, for the year of sale and every subsequent year until the final payment is received or the obligation is otherwise disposed of, even in years when no payment is received.

Why consider an installment sale instead of a 1031 exchange

A 1031 exchange can be a powerful deferral tool, but it comes with real constraints: the seller generally must identify replacement property within 45 days and close within 180 days, and proceeds generally need to be reinvested into like-kind real estate. For many business owners, those constraints simply do not fit the transaction they want to do.

An installment sale offers more flexibility in several ways:

Flexible buyer. The buyer does not need to be a party interested in a tax-deferred exchange. The seller can sell to a specific buyer, such as a family member, employee, or strategic acquirer, on terms that make sense for that relationship.
No replacement-property deadlines. There is no requirement to identify or close on replacement property within a fixed window.
No requirement to stay in real estate. Proceeds do not need to be reinvested in real estate at all. The seller can use the collected payments for any purpose, business or personal.
Can be weighed against other strategies. The structure can sometimes be combined with, or compared against, other strategies such as a Delaware Statutory Trust (DST) or a Qualified Opportunity Zone investment, depending on the owner’s broader goals and timeline. Each of these tools addresses the tax-deferral question differently, and the right fit depends on individual circumstances.

Common mistakes to avoid

Assuming the entire gain is deferred. Depreciation recapture is generally still due in the year of sale, which can catch sellers off guard if it was not modeled ahead of time.
Underestimating buyer credit risk. Because the seller is effectively acting as the lender, failing to vet the buyer's ability to pay can turn a planning strategy into a collections problem.
Overlooking imputed interest rules. Setting an interest rate that is too low, or omitting interest altogether, can lead to unexpected recharacterization of payments.
Missing the annual filing requirement. Form 6252 generally needs to be filed every year the obligation is outstanding, not just in the year of sale.
Not comparing alternatives. Some owners default to an installment sale (or a 1031 exchange) without weighing it against other deferral strategies that might better match their goals, timeline, and risk tolerance.

When to talk with us

Installment sales, 1031 exchanges, DSTs, and Qualified Opportunity Zone investments each defer or manage capital gains differently, and the right approach depends on your specific property, timeline, buyer, and broader financial picture. We work with business owners nationally on tax-deferral strategies around real estate sales. If you are considering selling appreciated real estate and want to understand which tax-deferral strategies may be worth exploring, you can schedule a call with us for an introductory consultation, or explore our related resources on 1031 exchanges and Delaware Statutory Trusts.

This article is for general educational purposes only and does not constitute individualized tax, legal, or investment advice. Outcomes depend on your specific facts, circumstances, and applicable law, which can change. Please consult your own tax and legal professionals before entering into an installment sale or any other real estate transaction.

Sources

Specific rules, limits, and requirements under these code sections change over time and depend on individual facts and circumstances. Consult a qualified tax professional for guidance specific to your situation.

Installment Sales for Real Estate: Spreading Capital Gains Across Multiple Tax Years