What Is an Installment Sale in Real Estate: Rules and Form 6252

An installment sale in real estate follows a specific set of tax rules: under Internal Revenue Code Section 453, if you sell property and receive at least one payment after the close of the tax year, your gain is spread across the years payments arrive rather than taxed all at once. Each principal payment is divided between taxable profit and a nontaxable return of what you originally invested, using a fixed percentage set at the time of sale. Depreciation you claimed on the property gets recaptured up front, the interest rate on the contract has to meet a federal minimum, and larger deals carry additional charges. The mechanics matter, because a small error in how the sale is structured or reported can turn a tax-deferral strategy into an unexpected bill.¹

What Counts as an Installment Sale

The definition is mechanical. If any payment on the sale is due after the end of the tax year in which the sale closes, the installment method applies automatically. The size of the down payment doesn’t matter. A buyer could pay 30% at closing, but as long as the contract calls for future payments, you’re using the installment method by default.¹

What matters to the IRS is when cash actually reaches you, not when the deed is recorded. Ownership can transfer in December while payments continue into January and beyond, and the rules still apply.

One boundary worth flagging. If you hold real estate primarily for resale in the ordinary course of business (a developer flipping subdivisions, for example), you’re a dealer and generally cannot use the installment method at all. Sales of residential lots without seller-made improvements and dispositions of farm property are narrow exceptions.²

How Each Payment Is Split Between Gain and Basis

The core calculation produces a single number, the gross profit ratio, that tells you what percentage of every principal dollar is taxable. That percentage stays fixed for the life of the contract.

Start with the total selling price: the down payment, the face value of the installment note, and any existing mortgage the buyer assumes. Then figure your adjusted basis, which is the original purchase price plus capital improvements, minus depreciation you’ve claimed. Add selling expenses (legal fees, commissions, recording costs) to that basis. The selling price minus this combined figure is your total gain.³

If you claimed depreciation, subtract the depreciation recapture amount from your total gain (that piece is taxed separately in year one, discussed below). What’s left is your gross profit, which is the profit you’ll spread across payments.

The contract price is the selling price minus any mortgage the buyer assumes, but only up to the amount of your basis. Divide gross profit by contract price and you get the gross profit ratio. If your gross profit is $120,000 and your contract price is $300,000, the ratio is 40%. On every $10,000 of principal the buyer sends, $4,000 is taxable gain and $6,000 is a return of basis.

Interest the buyer pays is separate. It’s ordinary income to you, reported on Schedule B, not on the installment form.

When the Assumed Mortgage Exceeds Your Basis

If the buyer takes over a mortgage larger than your adjusted basis, the excess counts as a payment received in the year of sale even though no cash changed hands. A $40,000 basis and a $60,000 assumed mortgage produce a $20,000 deemed payment up front. Because the assumed debt has already covered your basis, the gross profit ratio becomes 100%, and every principal dollar the buyer later pays is fully taxable.⁴

Primary Residence

If you’re selling your main home and qualify for the Section 121 exclusion ($250,000 single, $500,000 married filing jointly), the excluded gain drops out of the gross profit calculation entirely. Fewer of your installment dollars are taxable, and if the exclusion swallows the whole gain, the installment structure loses its tax purpose.³

Depreciation Recapture Is Taxed Up Front

On rental or investment property, the IRS refuses to let you spread depreciation recapture across payments. The recaptured amount is ordinary income in the year of sale, reported on Form 4797, regardless of how much cash you actually collected that year.

There’s also a category unique to real estate called unrecaptured Section 1250 gain, which covers the portion of gain tied to straight-line depreciation. It’s capped at a 25% rate, higher than the standard long-term capital gains rates. Under the installment method, unrecaptured Section 1250 gain is allocated to your earliest payments first. Your opening years may face the 25% rate, and once that layer is used up, later payments drop to the regular capital gains rate.⁵

The Contract Interest Rate Has a Floor

The IRS won’t let you shift value from taxable interest into untaxed principal by setting the contract rate too low. If your installment contract charges less than the Applicable Federal Rate (AFR) and any payment is due more than a year after the sale, part of what you called principal is recharacterized as imputed interest and taxed as ordinary income. The buyer’s basis is reduced by the same amount.⁶

The applicable AFR depends on how long the contract runs:

Short-term (up to 3 years): 3.56% as of early 2026
Mid-term (over 3, up to 9 years): 3.86%
Long-term (over 9 years): 4.70%

These rates change monthly; the rate in effect at the time of sale governs the contract.⁷ Most seller-financed real estate deals run past nine years and fall into the long-term bracket. Setting the contract rate at or above the AFR avoids the problem entirely.

Selling to a Family Member: The Two-Year Rule

Installment sales to related parties are allowed, but there’s a tripwire. If the related buyer resells the property within two years of your original sale, the amount realized on that second sale is treated as if it came to you directly. The gain you were deferring accelerates in full.⁸

The rule targets a common workaround: sell to a family member on a long installment plan, have them sell for cash weeks later, and collect the cash while claiming the deferral. “Related person” is defined broadly and includes family members and certain controlled entities. If you’re structuring a family installment sale, the buyer needs to plan on holding for at least two years.

Extra Interest on Large Deals

If the sales price is over $150,000 and the total face amount of your outstanding installment obligations from that year exceeds $5 million at year-end, an interest charge applies to the deferred tax on the portion above $5 million. The rate is the underpayment rate under Section 6621, and the charge is not deductible.⁹

The $5 million threshold is aggregate, not per transaction. Three separate installment sales totaling $6 million in outstanding notes would trigger the charge on $1 million. Sales of personal-use property and farm property are exempt.¹⁰

Don’t Pledge the Note

Using your installment note as collateral for a new loan can accelerate your gain. If the sales price was over $150,000 and you pledge the installment obligation to secure a debt, the net loan proceeds may be treated as a payment on the installment sale. The rule prevents sellers from turning deferred payments into cash through borrowing while still claiming they haven’t received anything.¹¹

When Spreading the Gain Isn’t the Best Move

The installment method is automatic, but you can decline it. The tax bracket math is what usually decides. A $300,000 gain collected in one year could push you into the 20% long-term capital gains bracket; the same gain spread across ten years of payments might stay in the 15% bracket, or even the 0% bracket in years when your other income is low.

For 2026, the long-term capital gains brackets are:

0%: taxable income up to $49,450 single / $98,900 married filing jointly
15%: up to $545,500 single / $613,700 married filing jointly
20%: above those thresholds

Higher-income sellers also face the 3.8% net investment income tax when modified adjusted gross income exceeds $200,000 (single) or $250,000 (joint). Those thresholds are not indexed for inflation. Spreading installment income can keep some sellers below the line.¹²

To elect out and report the full gain in the year of sale, skip Form 6252 and report the sale on Form 8949, Form 4797, or both. The deadline is the due date of your return, including extensions, for the year of sale.¹³ If you already filed on time without electing out, you have a narrow second chance: an amended return within six months of the original due date (not counting extensions), marked “Filed pursuant to section 301.9100-2” at the top. After that, revoking requires IRS permission, which won’t be granted if it looks like tax avoidance.³

Reporting on Form 6252

Installment sale income is reported on Form 6252, filed with your return for the year of sale and every subsequent year until the final payment is received or the obligation is disposed of, including years when no payment arrives.¹⁴ The form walks through the gross profit ratio and applies it to the year’s principal payments.

Interest the buyer pays you goes on Schedule B, not on Form 6252. If the buyer is a related party, Part III of the form has to be completed for the year of sale and the following two years, tracking whether the two-year resale rule has been triggered.

If the Buyer Defaults

Buyer default is a real risk with seller financing, and Section 1038 governs the tax outcome when you reacquire the property. The general rule is protective: repossessing real property you sold on installment doesn’t automatically produce gain or loss on the repossession itself.¹⁵

You may recognize some gain if the total payments received before the repossession (cash and property, excluding the buyer’s remaining note) exceed the gain you’ve already reported. It’s a true-up between what you collected and what you paid tax on, and only the difference is taxable. Recognized gain from the repossession is capped at the original sale gain minus what you’ve already reported, minus any costs of getting the property back.¹⁶

Your basis in the reacquired property equals the adjusted basis of the buyer’s debt at repossession, plus any gain recognized on the repossession, plus any money you paid to get the property back. That figure becomes your starting point if you sell again.

1
Office of the Law Revision Counsel. 26 USC 453 Installment Method
2
Office of the Law Revision Counsel. 26 USC 453 Installment Method – Section: Dealer Dispositions
3
Internal Revenue Service. Publication 537 (2025), Installment Sales
4
eCFR. 26 CFR 15a.453-1 Installment Method Reporting for Sales of Real Property and Casual Sales of Personal Property
5
eCFR. 26 CFR 1.453-12 Allocation of Unrecaptured Section 1250 Gain
6
eCFR. 26 CFR 1.483-1 Interest on Certain Deferred Payments
7
Internal Revenue Service. Applicable Federal Rates for February 2026 (Rev. Rul. 2026-3)
8
Office of the Law Revision Counsel. 26 USC 453 Installment Method – Section: Second Dispositions by Related Persons
9
Office of the Law Revision Counsel. 26 USC 453A Special Rules for Nondealers
10
Office of the Law Revision Counsel. 26 USC 453A Special Rules for Nondealers – Section: Exceptions
11
Internal Revenue Service. Publication 537 (2025), Installment Sales – Section: Pledge Rule
12
Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
13
Office of the Law Revision Counsel. 26 USC 453 Installment Method – Section: Election Out
14
Internal Revenue Service. Form 6252 – Installment Sale Income
15
Office of the Law Revision Counsel. 26 USC 1038 Certain Reacquisitions of Real Property
16
Office of the Law Revision Counsel. 26 USC 1038 Certain Reacquisitions of Real Property – Section: Amount of Gain Resulting