Installment Sales Under IRC 453: How to Defer Capital Gains When Selling a Business or Property

By Yarik Yarosh, CPA ·September 5, 2026 ·6 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

An installment sale under IRC 453 is one of the simplest ways to defer capital gains tax when selling a business or investment property. Instead of recognizing the entire gain in the year of sale, the seller reports a proportionate share of the gain as each payment is received. This creates three significant advantages: it defers the tax (keeping more capital working over the installment period), it can keep the seller in a lower tax bracket each year (spreading income over multiple years), and it provides an interest income stream from the buyer. The installment method is automatic for qualifying sales where at least one payment is received after the close of the tax year. However, depreciation recapture under IRC 1245 and IRC 1250 must be recognized in full in the year of sale, even if no cash is received for it, which is a trap that surprises many sellers.

✓Key takeaway

Installment sale mechanics:

Component	Calculation
Selling price	Total contract price (cash + note + assumed liabilities if they exceed basis)
Adjusted basis	Original cost minus depreciation, plus improvements
Gross profit	Selling price minus adjusted basis
Gross profit percentage	Gross profit / selling price
Gain recognized per payment	Principal payment x gross profit percentage
Interest income	Stated interest on the installment note (taxed as ordinary income)

What qualifies vs. does NOT qualify:

Qualifies	Doesn’t Qualify
Real estate (investment or business use)	Dealer property (inventory, property held for sale to customers)
Business assets sold as a going concern	Publicly traded stocks and securities
Equipment and machinery (with limits)	Installment sales of depreciable property to related parties (IRC 453(g))
Goodwill	Sales at a loss (no installment reporting needed)

Special rules:

Rule	Effect
Depreciation recapture (IRC 1245/1250)	Must be recognized in FULL in Year 1, regardless of payments received
Interest requirement	Must charge at least the Applicable Federal Rate (AFR); if not, IRS imputes interest under IRC 483 or 1274
Related party sales (IRC 453(e))	If buyer resells within 2 years, original seller must recognize remaining gain
Pledging the installment note	Treated as a payment received (triggers gain recognition)
Disposition of the note	Gain or loss recognized on the difference between FMV and basis of the note

How does an installment sale save taxes on a business sale?

Hypothetical example

Round numbers. A business owner sells their company (sole proprietorship assets) for $1,000,000. The sale is structured as $200,000 down payment plus a $800,000 promissory note payable over 8 years ($100,000/year principal) at 6% interest.

Asset details:

Asset	Selling Price	Adjusted Basis	Gain
Equipment	$150,000	$50,000 (after depreciation)	$100,000 (all IRC 1245 recapture)
Customer list	$100,000	$0	$100,000
Goodwill	$650,000	$0	$650,000
Inventory	$100,000	$80,000	$20,000 (ordinary)
Total	$1,000,000	$130,000	$870,000

Step 1: Depreciation recapture (Year 1, mandatory)

Item	Amount	Character
IRC 1245 recapture on equipment	$100,000	Ordinary income (taxed at up to 37%)
Inventory gain	$20,000	Ordinary income
Total ordinary income (Year 1)	$120,000	Recognized regardless of installment

Step 2: Compute the installment portion

Calculation	Amount
Total selling price	$1,000,000
Adjusted basis	$130,000
Total gross profit	$870,000
Less: depreciation recapture (recognized Year 1)	($120,000)
Installment gain (capital gains portion)	$750,000
Installment gross profit percentage	$750,000 / $1,000,000 = 75%

Step 3: Annual tax recognition

Year	Principal Received	Gain Recognized (75%)	Interest Income (6%)	Total Taxable
Year 1	$200,000 (down payment)	$150,000 LTCG + $120,000 ordinary (recapture)	$48,000	$318,000
Year 2	$100,000	$75,000 LTCG	$42,000	$117,000
Year 3	$100,000	$75,000 LTCG	$36,000	$111,000
Year 4	$100,000	$75,000 LTCG	$30,000	$105,000
Year 5	$100,000	$75,000 LTCG	$24,000	$99,000
Year 6	$100,000	$75,000 LTCG	$18,000	$93,000
Year 7	$100,000	$75,000 LTCG	$12,000	$87,000
Year 8	$100,000	$75,000 LTCG	$6,000	$81,000
Year 9	$100,000	$75,000 LTCG	$0	$75,000
Total	$1,000,000	$750,000 LTCG + $120,000 ordinary	$216,000	$1,086,000

Comparison: installment vs. lump sum

Metric	Lump Sum Sale	Installment Sale
Year 1 taxable income	$870,000 gain + $48,000 interest	$270,000 gain + $48,000 interest
Year 1 federal tax (approximate)	~$230,000	~$95,000
Bracket impact	Pushes income into 37% ordinary / 20% LTCG + 3.8% NIIT	Spreads income, may stay in 24% ordinary / 15% LTCG
Cash for taxes in Year 1	Must pay ~$230,000 from $200,000 down payment (cash shortfall!)	Pays ~$95,000 from $200,000 down payment (cash positive)
Total federal tax (9 years)	~$230,000 (all in Year 1)	~$215,000 (spread, slightly lower due to bracket management)
Time value benefit	None	~$15,000-$25,000 PV savings from deferral
Interest income received	$0	$216,000 (additional income stream)

The installment sale solves the Year 1 cash problem: on a lump-sum sale, the seller would owe more in Year 1 tax ($230,000) than the cash received ($200,000 down payment). The installment method matches tax payments to cash receipts.

The related-party trap (IRC 453(e)): If the seller sells to a related party (spouse, child, sibling, controlled entity) on an installment basis, and the related party resells the asset within 2 years:

Event	Consequence
Seller sells to child on installment, Year 1	Gain deferred normally
Child resells for cash in Year 2	Seller must recognize ALL remaining deferred gain in Year 2
Effect	Installment deferral is destroyed

The 2-year rule prevents related-party installment sales from being used to convert a lump-sum sale into an installment sale (sell to family member on installments, family member sells for cash immediately).

Electing out of installment reporting (IRC 453(d)):

Reason to Elect Out	Situation
Expect higher tax rates in future years	Recognize all gain now at lower rates
Have NOLs or capital losses to offset the gain	Use the losses now while they’re available
Want to start the capital gains clock on reinvestment	Recognize gain, reinvest proceeds at new basis
Avoid the complexity of installment reporting	Simplicity on one return vs. 9 returns

The election out is made on the tax return for the year of sale and is generally irrevocable.

Illustrative numbers only, not a real client and not advice for your facts.

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Cite this page

Yarik Yarosh, CPA. "Installment Sales Under IRC 453: How to Defer Capital Gains When Selling a Business or Property." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-installment-sale-irc-453-deferred-gain

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.