How does an installment sale work under IRC §453?

What it is

An installment sale is a sale in which you receive at least one payment after the close of the tax year of the sale. Instead of reporting the whole gain when you close, you report it as you collect principal. This is a timing rule: it does not reduce the total gain, but it can change the rate and when you pay it.

It is common in sales of closely held businesses, real estate, and other capital assets in which the seller carries a note from the buyer.

What the law says

IRC §453(b)(1) defines an installment sale, and §453(c) defines the installment method: income recognized each year is the part of that year's payments that the gross profit bears to the total contract price. The method applies automatically unless you elect out on a timely filed return (§453(d)).

Several provisions limit it. Section 453(b)(2) excludes dealer dispositions and personal property of a kind that belongs in inventory. Section 453(i) requires recapture income, such as §1245 depreciation recapture, to be reported in the year of sale. Section 453(k) bars the method for publicly traded stock or securities. Section 453(e) accelerates gain if a related buyer resells within two years. Section 453A charges interest on deferred tax for certain obligations when the face amount of such obligations arising in the year and outstanding at year-end exceeds $5,000,000, and treats a pledged note as payment.

Requirements and tests

• At least one payment is received after the year of sale.
• The property is not dealer property, inventory, or publicly traded stock or securities.
• Gross profit percentage = gross profit ÷ contract price, applied to principal received each year.
• Recapture income is reported in the year of sale and added to basis for the gross profit computation.
• The note carries adequate stated interest under §483 or §1274. Otherwise part of the principal is recharacterized as interest.
• Related-party resales within two years, dispositions of the note, and pledges of the note can trigger gain.
• Report the sale on Form 6252 each year you receive payments.

How it works

You sell property with a $1,000,000 contract price and a $600,000 adjusted basis, so gross profit is $400,000 and the gross profit percentage is 40%. Each dollar of principal you collect carries 40 cents of gain. Interest on the note is ordinary income, reported separately.

Whether spreading the gain helps depends on the rest of your income. For 2026, the 15% long-term capital gain rate for married couples filing jointly applies until taxable income reaches $613,700 (Rev. Proc. 2025-32). Many sellers stay in the 15% band even with a lump sum, so the larger savings often come from the 3.8% net investment income tax, which applies above a fixed $250,000 modified AGI threshold for joint filers.

Year by year, you report the sale on Form 6252: the contract price, the gross profit percentage, the payments received, and the resulting gain. Any recapture reported in the year of sale is added to your basis before the gross profit percentage is computed, so the same gain is not taxed twice. If the buyer assumes a mortgage that exceeds your basis, the excess is treated as a payment in the year of sale.

Risks and IRS scrutiny

The biggest practical risk is credit risk: if the buyer stops paying, you may have to repossess the property or sue on the note, with separate tax rules for repossessions. Tax risks include missing the recapture rule, charging inadequate interest, related-party resales, and pledging the note for a loan, which is treated as a payment under §453A(d). Future rate changes also apply to gain you collect in later years.

Who it is not for

This is not for dealers or sellers of inventory, for sellers of publicly traded securities, for sellers who need the full price at closing, or for sellers whose gain is mostly depreciation recapture. It is also not for anyone who cannot evaluate and secure the buyer's credit.

It is also a poor fit when you expect your own tax rate to rise in later years, because gain collected later is taxed at the rates in effect when you collect it. And if the buyer is related to you, plan for the two-year resale rule before closing, not after.

How ebotCPA helps

We compare a lump-sum sale with an installment structure on your actual numbers, including recapture, NIIT, interest on the note, and any §453A charge, and we prepare Form 6252 each year. We coordinate with your attorney, who drafts the legal documents. Those include the note, the security agreement, and the purchase agreement.

Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.

Primary sources

1. 26 U.S.C. §453(b)(1) and (c). Installment sale and installment method.

   “The term “installment sale” means 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.”

   Defines an installment sale and requires gain to be reported in proportion to payments received.

2. 26 U.S.C. §453A. Special rules for nondealers: interest on deferred tax and pledges.

   Imposes an interest charge on deferred tax for large installment obligations and treats pledged notes as payment.

3. Treas. Reg. §15a.453-1. Installment method reporting.

   Provides the regulatory rules for computing gross profit, contract price, and payments.

4. Rev. Proc. 2025-32, §4.03. 2026 capital gain rate thresholds.

   Sets the 2026 maximum 15% rate amount at $613,700 for joint filers and $545,500 for single filers.

5. IRS Publication 537, Installment Sales. IRS guidance on installment sales.

   “you must report any depreciation recapture income in the year of sale”

   Explains recapture, related-party sales, and interest on deferred tax.

Frequently asked questions