Understanding Installment Sale Tax Treatment for Real Estate Owners

When you sell a property with a large gain, the tax bill can be significant. Many real estate owners look for ways to reduce the tax impact of a sale without being forced to reinvest immediately or complete a rushed 1031 exchange. An installment sale—covered under IRS Section 453—is one option that allows you to spread out both the payments and the taxes owed over time.

This article explains how installment sale taxation works, why some property owners choose this strategy, and what to watch out for—especially for larger transactions.

How Installment Sale Taxation Works

An installment sale is simply a sale where the buyer pays over time instead of delivering the full amount at closing. Because the payments come in gradually, the IRS allows sellers to recognize the taxable gain gradually as well. Instead of paying all the taxes in the year of the sale, you only owe tax on the portion you receive each year.

This approach can reduce the spike in income that typically happens when a property is sold in a single lump-sum transaction.

Recognizing Income as Payments Come In

The IRS requires sellers to report installment sales using a specific calculation that divides each payment into three parts:

1. Return of your original investment (non-taxable)
2. Taxable gain
3. Interest income (if interest is part of the agreement)

The amount that becomes taxable each year depends on something called the gross profit percentage.

Understanding the Gross Profit Percentage

The gross profit percentage determines how much of each payment counts as taxable gain. It is calculated by:

1. Subtracting your tax basis from the sale price
2. Dividing the gross profit by the total contract price

If your gross profit percentage is 60%, then 60% of every principal payment is treated as taxable capital gain. This rule spreads the gain across the life of the installment payments.

How Your Basis Adjusts Over Time

Because you receive the sale proceeds gradually, your tax basis in the property must be adjusted each year. Each principal payment reduces your basis, which causes the taxable portion of future payments to increase over time. It’s simply the IRS’s way of tracking how much of your original investment has been returned to you.

Interest Income Is Separate

If an installment sale includes interest—as many do—the interest portion is taxed as ordinary interest income. It does not affect the gross profit percentage and must be reported separately each year.

For many sellers, this interest becomes a steady and predictable income source.

Where IRC Section 453A Comes In

For larger installment sales, there is an additional rule that often catches sellers by surprise.

If you use the installment sale method under Section 453 and the total balance of all installment obligations exceeds $5 million at the end of the year, the IRS imposes an interest charge on the deferred tax liability.

This is known as the IRC 453A interest charge, or more informally, the “sting tax.”

Here’s what it means:

• If your installment obligations stay below $5 million, 453A never comes into play.
• If they exceed $5 million, the IRS charges interest on the deferred tax tied to the excess amount.

For owners selling high-value properties, this rule can affect the overall benefit of an installment sale and should be factored into planning.

Reporting Requirements

Installment sales must be reported on IRS Form 6252 in the year of the sale and again in any year you receive payments. The form breaks down:

• The sale price
• The gross profit percentage
• Payments received
• Taxable gain recognized

Any interest income must also be reported annually.

Deciding Whether an Installment Sale Fits Into Your Exit Strategy

Installment sales can help property owners smooth out taxable income, avoid large one-year gains, and create predictable cash flow. But they aren’t ideal for everyone. Some owners prefer the full tax deferral of a 1031 exchange, the passive benefits of a Delaware Statutory Trust (DST), or the long-term diversification of a 721 UPREIT. Others may find that IRC 453A changes the economics of an installment sale for large transactions.

The right choice depends on your tax bracket, liquidity needs, sale size, and long-term goals. What matters most is understanding how each path affects your income, taxes, and overall financial plan.

At Wealthstone Group, we help property owners compare these strategies side-by-side so they can clearly see the trade-offs and choose the option that best supports their goals. If you're considering an installment sale or want clarity on how it fits into your broader exit strategy, we’re here to help you make an informed and confident decision.

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General Disclosure

Please note that this information is for informational purposes only and does not constitute individual investment advice. It should not be relied upon as tax or legal advice. Consult the appropriate professional regarding your individual circumstances.

Diversification does not guarantee profit or protect against loss in a declining market. It is a method used to help manage investment risk.

Investing in DST properties and real estate securities involves material risks such as liquidity, tenant vacancies, market conditions, competition, interest rate risks, and the risk of losing the entire investment principal. DST 1031 properties are available only to accredited investors and accredited entities. Verify your accredited investor status with your CPA and attorney.

Not an offer to buy, nor a solicitation to sell securities. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing. Any information provided is for informational purposes only. Securities offered through Arkadios Capital, member FINRA/SIPC. Advisory Services offered through Arkadios Wealth. Wealthstone Group and Arkadios are not affiliated through any ownership.