A Tax Strategy Guide for Real Estate Investors

Installment sales can be a highly effective strategy for deferring capital gains taxes but investors considering selling high-value real estate assets and privately-held businesses need to be aware of the potential interest charge under IRC Section 453A. Here’s what you should know if you're thinking about selling property and collecting payments over time.

What Is an Installment Sale?

An installment sale, as defined under IRC Section 453, allows a seller to receive at least one payment after the tax year in which the sale occurs. Rather than collecting the full purchase price upfront, payments are made over time often through a promissory note.

For real estate investors, this structure can help soften the tax impact by spreading capital gains across multiple years, improving liquidity and smoothing income tax obligations. You report the gain only as payments are received, using the installment method on IRS Form 6252.

Where IRC Section 453A Comes In

For large transactions, the IRS imposes an interest charge on the deferred tax liability. That’s where IRC 453A comes in, often nicknamed the “sting tax”.

The provision is triggered when:

• You use the installment method under IRC 453 to report a sale of eligible property, and
• The total balance of installment obligations arising in a given year exceeds $5 million at year-end.

Therefore, if you’re deferring taxes on more than $5 million of installment obligations, the IRS wants to charge interest on the portion above that threshold. This is known as the interest on deferred tax liability, and it’s what gives 453A its reputation for stinging unsuspecting sellers.

What Types of Property Are Affected?

IRC 453A applies broadly to real or depreciable personal property used in a trade or business—but excludes:

• Personal-use property (like your primary residence)
• Farmland used in active agriculture (as defined in IRC 2032A)
• Certain dealer dispositions (like timeshares and residential lots, which fall under IRC 453(I))

This means 453A is most relevant to the sale of investment real estate, commercial property, rental portfolios, or closely held businesses where ownership transfers via installment notes.

How the Interest is Calculated

The interest charge under 453A is based on the following formula:
Interest = Deferred Tax Liability × Applicable Percentage × IRS Underpayment Rate

Here's a breakdown:

• Deferred Tax Liability: The portion of unrecognized capital gain multiplied by your capital gains tax rate
• Applicable Percentage: The portion of installment obligations over $5 million, divided by the total outstanding balance
• IRS Underpayment Rate: A variable interest rate published quarterly by the IRS (e.g., 6% in some recent quarters)

This interest must be recalculated each year the installment obligation is outstanding. While the applicable percentage is locked in the first year, the deferred tax liability declines over time as payments are made and gains are recognized.

Though the formula is mechanical, the resulting interest cost can quietly erode your after-tax proceeds if not accounted for up front.

Planning Strategies for Investors

If you’re considering an installment sale on a high-value property or business, you don’t want the “sting tax” to catch you by surprise. Here are some planning strategies to consider:

• Keep installment obligations under the $5M threshold when possible
• Structure sales across multiple tax years to spread out obligations
• Explore alternative vehicles, such as Deferred Sales Trusts (DSTs), to retain flexibility
• Run projections with your CPA or tax advisor to model how 453A could impact your long-term outcomes

Each deal is different, so thoughtful structuring is key.

Final Thoughts

Installment sales remain a powerful and flexible tool for deferring capital gains but once the total obligation is over $5 million, IRC 453A introduces an additional layer of necessary planning.

Whether you’re selling real estate or a business, understanding how this “sting tax” works can help you avoid unexpected costs and preserve more of your gains.

As always, consult with a qualified tax advisor or planning professional to determine whether an installment strategy aligns with your goals. With the right guidance and structure, you can defer taxes without unexpected surprises.

General Disclosure