Installment sale: defer capital-gain tax and boost buyer interest

Selling a business, rental property or other appreciated asset can trigger a hefty tax bill, but an installment sale spreads the cash and the tax hit over several years.

What is an installment sale?

An installment sale occurs when at least one payment is received after the tax year of the sale. Instead of reporting the entire gain up front, the taxpayer recognizes a portion each year as payments are collected. This reporting method, known as the installment method of accounting, is reported on Form 6252, Installment Sale Income.

Why use an installment method of accounting?

• Defer capital-gain tax
  • The seller spreads recognition of gain (and tax liability) over the payment schedule
• Improve cash flow
  • For the seller, taxes align with cash receipts; potential to avoid a single lump-sum tax bill
• Flexible terms
  • Buyers often prefer a down payment followed by scheduled installment payments; this can expand the pool of potential purchasers

Which sales qualify?

Generally eligible:

• Real property (commercial or residential)
• Tangible personal property (machinery, equipment, etc.)

Not eligible:

• Dealer property
• Inventory
• Revolving‐credit sales
• Publicly traded securities

Key conditions and traps

Ordinary‐income recapture

If the taxpayer claimed depreciation on business property, part of their gain may be subject to recapture rules (under §1245 or §1250). This recaptured gain is taxed in full in the year of sale, regardless of whether they receive payments later.

Interest income

Interest must be reported as ordinary income. Generally, a part of each later payment must be treated as interest, even if it’s not called interest in the sales agreement. There may be unstated interest or an original issue discount (OID) if the agreement doesn’t provide for enough stated interest.

Electing out

Under the general rule, property sellers are required to use the installment method for installment sales [453(a)]; they can elect out of the installment method by reporting the full gain in the year of sale. This may be beneficial if capital gains rates are expected to rise or if the taxpayer has a large loss carryforward that they can utilize.

Example

Arthur sells his business for $500,000 in 2025. He agrees to receive $50,000 at closing and will receive four annual payments of $112,500 (2026-2029). If the sale qualifies for installment reporting, Arthur will report a portion of the gain each year as he receives payment.

However, if $200,000 of his gain is depreciation recapture, he will report the full $200,000 of depreciation recapture in 2025, even if he hasn’t received all the money.

An installment sale can be a powerful tool for smoothing out tax obligations, but the rules are complex. When in doubt, run the numbers both ways, with and without the installment method, so the tradeoffs are understood.

Deeper dive

For a deeper dive into the mechanics of installment sales, including how to handle depreciation recapture, related party rules and special transactions, check out our upcoming webinar, Navigating Installment Sale Mechanics Webinar. You’ll gain practical insights on reporting with Form 6252 and learn when opting out of the installment method might be right.