Home / Articles

Installment Sale: How IRC Section 453 Works (Plain-English Guide)

By Hans Goldstein · Updated 2026-09-27

An installment sale is a sale where you receive at least one payment after the tax year of the sale. Under IRC Section 453 you report the gain as the payments arrive, not all at once: each dollar of principal carries the same percentage of taxable gain, and interest on the note is taxed as ordinary income each year. Selling is not the tax event. Receiving the money is.

That one rule can move a large gain out of the top brackets and into lower ones, keep years under the 3.8% net investment income tax line, and line gain up with losses you cannot otherwise use. It also has hard edges: some gain is taxed in year one no matter what, some property does not qualify, and a buyer's early payoff or default can undo the plan.

This guide covers how the installment method works, a 10-year example with the tax by year, what qualifies, the two clean ways to get paid over time, the traps, and how to report it. To run your own numbers, use the free installment sale calculator.

What an installment sale is

The Code's definition is short: an installment sale is "a disposition of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs" (§453(b)(1)). If a sale qualifies, the installment method applies automatically unless you elect out (§453(a), (d)).

The buyer's promise to pay can take many forms: a promissory note secured by a deed of trust, a mortgage, a land contract, or another written obligation (IRS Pub. 537). Section 453 was rewritten by the Installment Sales Revision Act of 1980 and is old, settled law. The IRS summary is in Topic 705, Installment Sales.

How the installment method works

Each payment you receive has up to three parts:

1. Interest. Ordinary income, reported every year.
2. Return of basis. Tax-free.
3. Gain. Taxable in the year received.

The split between basis and gain is set by one number, the gross profit percentage:

Gross profit percentage = gross profit / contract price

• Selling price: everything the buyer pays for the property, including debt the buyer assumes. Not interest.
• Installment basis: your adjusted basis, plus selling expenses, plus any depreciation recapture recognized in year one.
• Gross profit: selling price minus installment basis. This is the total gain you will report over the life of the sale.
• Contract price: selling price minus debt the buyer assumes (plus any assumed debt that exceeds your basis). With no assumed debt, it equals the selling price.

Multiply each year's principal payments by the gross profit percentage, and that is the year's taxable gain. The percentage stays the same for every payment unless the price is later reduced.

A simple example: You sell land for $1,000,000 with a $400,000 basis and no selling costs. Gain is $600,000, which is 60% of the price. Every dollar of principal you receive carries 60 cents of taxable gain.

More detail, including debt and recapture cases: gross profit percentage on an installment sale.

A worked example: a seller-financed rental over 10 years

Simple example, all numbers illustrative. A retired married couple sells a rental building.

• Selling price $1,000,000. No loan on the property.
• Original cost $700,000. Straight-line depreciation taken $300,000. Adjusted basis $400,000.
• Selling expenses $50,000.
• The buyer pays $200,000 down and signs an $800,000 note: $80,000 of principal a year for 10 years, starting the year after the sale, plus 6% interest on the unpaid balance. (6% is a round number for the math. The note must carry at least the applicable federal rate.)
• The couple has $80,000 of other ordinary income a year, files jointly, takes the standard deduction, and 2026 federal brackets hold flat (Rev. Proc. 2025-32).

The percentage. Installment basis = $400,000 + $50,000 = $450,000. Gross profit = $1,000,000 - $450,000 = $550,000. Contract price = $1,000,000. Gross profit percentage = 55%.

The layers. $300,000 of the gain is unrecaptured §1250 gain from the building's depreciation, taxed at a maximum 25% federal rate. On an installment sale it comes out of the earliest payments first (Reg. §1.453-12). The other $250,000 is long-term capital gain at 0%, 15% or 20%.

"Federal tax on the gain" is the extra federal income tax and 3.8% NIIT caused by the gain, stacked on top of the couple's other income and that year's interest. The interest itself is taxed as ordinary income and is not in that column.

The same sale for cash: all $550,000 of gain lands in year one. Federal income tax on the gain is $100,928, plus $14,440 of NIIT, for $115,368. The installment version totals $63,495 (simple example, nominal dollars, not discounted).

Why the difference? Three reasons, all bracket math:

• The 25% layer lands in lower brackets. This layer is taxed at ordinary rates when they are below 25% (§1(h)(1)). In the cash sale, the $300,000 climbs through the 22% and 24% brackets. Spread out, it is taxed at 12% and 22%.
• The long-term gain drops from 15% to 0%. In the cash sale, all $250,000 of long-term gain is stacked on top and taxed at 15%. Spread out, much of it stays under $98,900 of taxable income, the top of the 0% bracket for a joint return in 2026.
• The 3.8% tax never applies. No year's modified AGI crosses $250,000, so the NIIT disappears (§1411).

What the example leaves out, and you should not: the buyer can prepay or default, the money arrives over 11 years instead of at once, and the tax rates in future years are not known today.

What qualifies and what does not

Recapture deserves its own warning. Equipment, appliances and cost-segregated 5- and 7-year building parts are §1245 property. Bonus or other faster-than-straight-line depreciation on 15-year land improvements (paving, fencing, landscaping) is §1250 property but is ordinary recapture under §1250(a). All of that recapture is taxed in the year of sale, measured as if every payment had been received that year, even if you received no cash (§453(i)). It is then added to basis so it is not taxed twice. A seller who did a large cost segregation study can face a big year-one bill on a sale that is "deferred" on paper. See installment sale depreciation recapture.

Straight-line depreciation on a building is different. That is unrecaptured §1250 gain, not "recapture income," so it is deferred with the payments (Reg. §1.453-12). It just comes out first.

The two clean ways to get paid over time

Section 453 does not care how the obligation is structured, as long as you are really paid over time and cannot reach the money early. In practice there are two ways.

1. Seller financing (a carry back). You take the buyer's promissory note, usually secured by a deed of trust or mortgage on the property. The buyer pays you. This is the textbook installment sale, with settled legal footing and no commission to anyone. You carry the buyer's risk: late payments, default and foreclosure, bankruptcy, or an early payoff that dumps the remaining gain into one year. Start with the seller financing tax guide.

2. A structured installment sale. The buyer pays the full price at closing with ordinary financing. The obligation to pay you over time is taken on by an assignment company, usually funded by a fixed annuity the assignment company owns (some programs use a funding agreement). The buyer is out of the picture, and the schedule cannot be accelerated. In exchange, you are an unsecured creditor of the assignment company, the payments are locked (no cash-out, no borrowing against them), a commission is built into the pricing, and no statute, regulation or published IRS ruling specifically approves the structure. It relies on the general §453 rules. See how a structured installment sale works.

The comparison in depth: seller financing vs a structured sale. Separate from both is the "monetized installment sale," where a lender hands you most of the cash at closing. The IRS put it on its 2023 "Dirty Dozen" list and has proposed treating it as a listed transaction (Prop. Reg. §1.6011-13, not final as of September 2026). See monetized installment sale.

Interest on the note is ordinary income

Interest is not part of the installment gain. It is taxed as ordinary income in the year you receive it (or accrue it, in some cases), and for a rental seller it is portfolio income that passive losses cannot offset (Temp. Reg. §1.469-2T(c)(3)).

The note must also carry enough interest. If the stated rate is below the applicable federal rate (AFR) for the note's term, part of each principal payment is recharacterized as interest under §483 or §1274. That shrinks your capital gain and raises your ordinary income. AFRs are published monthly on the IRS applicable federal rates page. Details: seller financing interest rate and the AFR.

Rules that trip people up

A loan paid off at closing is a year-one payment. If the buyer's money pays off your mortgage at closing, that cash counts as received by you in the year of sale. Only debt the buyer actually assumes or takes the property subject to is excluded, and only up to your basis (Temp. Reg. §15a.453-1(b)(3)(i)). A cash-out refinance before the sale makes this worse. See installment sales with a mortgage.

Debt over basis. If the buyer assumes debt larger than your installment basis, the excess is treated as a payment in year one and the gross profit percentage becomes 100%.

Big notes and the §453A interest charge. If the face amount of installment obligations from the year's sales (each with a sales price over $150,000) that are still outstanding at year end exceeds $5 million, you pay interest on the deferred tax attributable to the excess (§453A(b), (c)). Farm property and an individual's personal-use property are exempt. Details: the §453A interest charge and pledge rule.

Borrowing against the note is a payment. If you pledge the note as security for a loan, the loan proceeds are treated as a payment on the note, for sales over $150,000 (§453A(d)). This applies even when your notes are well under $5 million.

Selling, giving away or canceling the note. Any disposition of the obligation triggers the remaining gain (§453B(a)). A transfer to a spouse or incident to divorce is not a disposition, and a transfer at death is handled under §691 instead.

Early payoff. If the buyer refinances or sells, you receive the rest of the principal, and the rest of the gain is taxed that year. A due-on-sale clause in your own note usually forces this when the buyer resells.

Default and repossession. If you take real property back, §1038 limits the gain on the repossession but still taxes part of what you already received. See buyer defaulted or paid early.

Related parties. Sell depreciable property to a related person as defined in §453(g) and the installment method is generally unavailable. Sell other property to a related party who resells within two years and your deferred gain can be accelerated (§453(e)). See related-party installment sales.

Death. A note you still hold at death passes to your heirs as income in respect of a decedent: no step-up in basis, and the heirs pay income tax on the gain as payments arrive (§§691(a)(4), 1014(c)).

Character is fixed at the sale. Long-term gain stays long-term in later years (Pub. 537). For rental owners, whether the gain is passive is also fixed in the year of sale (Temp. Reg. §1.469-2T(c)(2)(i)(A)).

Reporting: Form 6252 every year

You report an installment sale on Form 6252 for the year of sale and every year after, until the final payment, even in a year with no payment. Recapture is figured on Form 4797, Part III and taken in year one. Each year's installment gain flows to Form 4797 or Schedule D. Interest goes on Schedule B, not Form 6252.

Line-by-line walkthrough with a filled-in example: Form 6252 instructions.

Electing out. To report all the gain in the year of sale, skip Form 6252 and report the whole sale on Form 4797, Form 8949 or Schedule D on a return filed by its due date, including extensions (§453(d)). When that can be the better choice: installment sale vs lump sum.

Is an installment sale right for you?

It tends to help when:

• The gain is large relative to your other income, so a lump sum would push it into the 20% bracket and the 3.8% NIIT.
• You can live on the payments, your savings and the tax-free basis inside each payment, and do not need the full price now.
• You have losses that arrive over several years. For rental owners with suspended passive losses, installment gain from a passive rental is passive income that can meet them year by year (Temp. Reg. §1.469-2T(c)(2)), and the sold activity's own suspended losses are released in proportion to the gain recognized (§469(g)(3)). The book below covers this in depth.
• You live in a high-tax state that taxes gain as ordinary income, where spreading can keep each year in lower state brackets.

It tends not to help when:

• You need the cash now.
• The gain is small, or you already have a low-income year that would absorb it.
• Most of the gain is §1245 recapture, which is taxed in year one anyway.
• You are older and likely to hold the property until death, when heirs would receive a stepped-up basis on the property (but not on a note).
• The note would exceed $5 million and the §453A charge would eat the benefit, unless it is farm or personal-use property.
• You do not trust the buyer's credit and do not want a structured sale.

Bottom line

The installment method taxes gain when you are paid, at a fixed gross profit percentage. Spread well, it can lower the total tax on a sale by keeping each year's slice in lower brackets. It does not defer §1245 recapture, a loan paid off at closing, or gain when the buyer pays early. Pick the way you get paid (buyer's note or structured sale) by the risk you would rather hold, not by the rate alone. Then run your numbers in the calculator.

If you own rentals with suspended passive losses, the free book The Waterfall Strategy shows how installment gain can be timed to meet them.

Questions to ask your CPA

• What is my installment basis and gross profit percentage, including selling expenses and recapture?
• How much §1245 recapture will be taxed in the year of sale, and what will that cost?
• How much of the gain is unrecaptured §1250 gain, and in which years will it come out?
• Will any loan be paid off at closing, or will the buyer assume it?
• Given my other income, what payment size keeps each year in the 0% or 15% bracket and under the NIIT line?
• Does the note's rate meet the AFR test for its term?
• If I die holding the note, what will my heirs owe?
• Should I consider electing out, and what is my deadline?

Educational only, not tax, legal or investment advice. Examples are illustrative. Have your CPA or tax attorney review your facts before you act. Hans Goldstein is a licensed insurance agent (CA Insurance License #4273294) and is not a CPA or attorney. He is paid a commission only if a structured installment sale is funded; seller financing pays him nothing. Disclosures.