An IRC Section 453 installment sale lets you spread the taxable gain from selling property across the years you actually collect payments, instead of paying tax on the entire profit in the year of sale. Any sale where you receive at least one payment after the close of the tax year of sale qualifies, and the method applies automatically unless you elect out. That default treatment is generous, but Section 453 comes bundled with exclusions, a minimum interest requirement, a related-party trap, and an interest charge on very large deferrals that can quietly reshape the tax result.
What Section 453 Covers
The statutory definition is broader than most people expect. If a buyer’s note calls for even one payment in a tax year after the year of sale, the transaction is an installment sale by default. Sell a rental property in October with monthly payments running into January, and Section 453 already applies.
Real estate is the most common setting, but the method reaches sales of a business, equipment, and other property that isn’t specifically excluded. The trigger is timing: if every dollar of the purchase price lands before December 31 of the sale year, there’s nothing to defer. And the method only applies to sales at a gain. A loss is reported in full in the year of sale regardless of when payments arrive.
You don’t file any election to use installment reporting. It kicks in automatically for every qualifying disposition unless you affirmatively choose to report the full gain upfront.
Sales That Don’t Qualify
Several categories are carved out even when payments stretch across years.
- Inventory sales. Property held for sale to customers in the ordinary course of business is excluded, which covers retailers, wholesalers, and anyone selling stock-in-trade.
- Dealer dispositions. If you regularly sell personal property on an installment plan, or hold real property for sale to customers, those sales must be reported in full in the year of sale. Limited exceptions exist for farm property and certain timeshare or residential lot sales.
- Publicly traded securities. Any sale of stocks or securities traded on an established market is treated as if you received the full payment on the trade date.
- Revolving credit plans. Sales of personal property under revolving credit arrangements are excluded.
Depreciation Recapture Is Taxed Up Front
Sellers of depreciable property face a partial acceleration that often goes unnoticed until the return is prepared. Any gain attributable to depreciation recapture under Section 1245 or Section 1250 must be recognized entirely in the year of sale, even before you’ve collected a single payment. The statute is explicit that recapture gain is recognized notwithstanding any other provision of the code.
For Section 1245 property (equipment, machinery, and certain other depreciable assets), the recapture amount is the lesser of the gain or the total depreciation previously deducted, all taxed as ordinary income in year one. For Section 1250 property (depreciable real estate), the recapture rules are narrower and generally apply only to depreciation taken in excess of straight-line, but unrecaptured Section 1250 gain is taxed at a maximum rate of 25% rather than the usual long-term capital gains rates.
Only the gain remaining after recapture qualifies for installment treatment. The first-year tax bill on an installment sale of a depreciated asset can therefore be larger than the cash you’ve actually collected suggests.
How Each Payment Is Split
The gross profit percentage drives everything. It’s the fraction of each principal payment you report as taxable gain, and you apply the same percentage for the life of the note.
Start with three figures: the selling price, your adjusted basis, and selling expenses. The selling price includes cash, the fair market value of any other property received, and any debt the buyer assumes. Adjusted basis is the original cost plus capital improvements, minus depreciation claimed. Selling expenses, like broker commissions, legal fees, and transfer taxes, reduce the gain.
Gross profit is the selling price minus adjusted basis and selling expenses. Divide gross profit by the contract price and you have the gross profit percentage. Each year, multiply that percentage by the principal payments received (interest is handled separately) to get the taxable gain for the year.
Contract price usually equals selling price, but the two diverge when the buyer assumes a mortgage. In that case the contract price is reduced by the mortgage amount, to the extent it doesn’t exceed your adjusted basis, because an assumed mortgage isn’t cash you’re collecting over time. Publication 537 provides the full worksheet.
Interest on the Note and the AFR
Each installment payment has up to three components: interest income, tax-free return of basis, and gain on the sale. Interest is ordinary income, reported separately from the installment sale gain.
Finance the sale of your home to an individual buyer and you report the interest you receive on Schedule B. You’ll also need to give the buyer your Social Security number so they can deduct the mortgage interest, and penalties apply if either party fails to report the other’s identifying information.
The IRS requires the note to charge at least a minimum rate. If the contract states no interest, or a rate below the applicable federal rate, Section 483 recharacterizes part of each principal payment as imputed interest. The consequence is less capital gain and more ordinary income than you expected.
The AFR is published monthly and varies by the term of the note. As of April 2026, the short-term AFR (obligations of three years or less) is 3.59%, the mid-term AFR (over three years but not over nine) is 3.82%, and the long-term AFR (over nine years) is 4.62% compounded annually. The rate that matters is generally the one in effect at closing. Setting the note’s interest at or above the applicable AFR sidesteps the imputed interest problem.
Selling to a Related Party
Section 453(e) targets an obvious workaround: selling to a relative on deferred terms and having the relative immediately resell for cash. If a related party buyer resells the property within two years of the original installment sale, the amount realized on that second sale is treated as if you received it directly, and the deferred gain accelerates. The two-year clock is suspended during any period the related buyer hedges away the risk of loss through a put, a short sale, or a similar arrangement.
“Related person” here includes family members whose stock ownership would be attributed to you under the constructive ownership rules, as well as entities in which you hold a controlling interest. Spouses, children, grandchildren, parents, and controlled corporations or partnerships are all swept in.
There are exceptions. The resale rule doesn’t apply if the second sale results from an involuntary conversion (a condemnation, for instance) that wasn’t foreseeable at the time of the first sale, if the resale follows the death of either the original seller or the related buyer, or if both parties can show the IRS that neither disposition had tax avoidance as a principal purpose. For marketable securities sold to a related party, the two-year safe harbor doesn’t apply at all; the resale trigger is permanent.
Large Sales: The Section 453A Interest Charge
Sellers with substantial installment obligations pay an additional cost. Under Section 453A, an interest charge applies to the deferred tax when two conditions are both met: the property’s sales price exceeds $150,000, and the total face amount of all installment obligations arising during the tax year and still outstanding at year-end exceeds $5,000,000.
The charge is calculated by multiplying the deferred tax liability (unreported gain times the applicable tax rate) by an applicable percentage, then by the IRS underpayment interest rate. The applicable percentage reflects only the portion of outstanding obligations that exceeds the $5,000,000 floor. Both thresholds are fixed by statute and are not indexed for inflation.
Pledging the Note as Collateral
A separate rule in Section 453A catches sellers who borrow against their installment notes. Use an installment obligation as collateral for a loan and the net loan proceeds are treated as a payment received on the note. Gain is recognized immediately, up to the remaining unrecognized gain on the contract, even though the buyer hasn’t paid you anything additional. The deemed payment is triggered at the later of when the loan becomes secured by the note or when you receive the loan proceeds.
Reporting on Form 6252
Installment sale income is reported on Form 6252, attached to your federal return in the year of sale and in every subsequent year of the agreement, including the year of final payment, even if no payment was received in a given year. Selling price goes on line 5, adjusted basis on line 10, and the gross profit percentage on line 19. That percentage is then applied to the payments received during the year to compute the taxable portion.
Gain from Form 6252 flows to Schedule D if the property was a capital asset, or to Form 4797 if it was business or rental property. Some sales involve both forms because part of the gain is recapture and part is capital gain.
Sellers with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly) should also account for the 3.8% net investment income tax, which applies to capital gains including installment sale gain. The surtax can bite in years when your other income pushes you above the threshold even if the installment payment alone wouldn’t.
When Electing Out Makes Sense
Sometimes reporting all the gain upfront saves money overall. If you’re in a low tax bracket in the year of sale but expect higher income later, or if you want to start the capital gains clock on a reinvestment, electing out can be the better move.
To elect out, report the full sale on Schedule D or Form 4797 in the year of disposition and skip Form 6252. The election must be made by the due date of the return, including extensions, for the year of sale. Reversing the election later requires IRS consent, and that consent is not freely given; in practice you’d need a formal ruling and a showing that the original election wasn’t for tax avoidance.
If the Buyer Defaults
When a buyer stops paying and you take back real property, Section 1038 governs the tax result, not the normal gain or loss rules. The general rule is more favorable than sellers usually expect: repossessing real property that secured the buyer’s obligation does not automatically produce a large gain or loss.
Gain on repossession is limited to the amount by which cash and other property (not counting the buyer’s remaining obligation) received before repossession exceeds the gain already reported in prior years. There’s a further ceiling: total gain recognized on repossession can’t exceed the original profit on the sale, reduced by gain already reported and by any costs to reacquire the property.
Your basis in the reacquired property equals the adjusted basis of the buyer’s debt to you at the time of repossession, increased by the gain recognized on repossession and any costs paid to get the property back. If any part of the buyer’s debt remains outstanding after reacquisition, the basis of that remaining debt drops to zero. The mechanics get complicated quickly, and default on a large installment note is generally the point at which professional tax advice earns its cost.