Installment Sales (IRC 453): Deferring Gain 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

When a business or property is sold and the seller receives payments over more than one tax year, IRC 453 allows the gain to be recognized proportionally as payments are received. This is the installment method, and it applies automatically unless the seller elects out. The key concept is the gross profit percentage: the ratio of total gain to the total contract price. Each payment received is split into three components: (1) return of basis (not taxed), (2) gain (taxed at capital gains rates), and (3) interest (taxed as ordinary income). The installment method defers the tax on the gain portion, spreading it across the payment period. It does not apply to inventory sales, publicly traded stock, or depreciation recapture under IRC 1245 (which is recaptured in full in the year of sale).

✓Key takeaway

Installment sale formula:

Gross Profit Percentage = Gain / Contract Price

Each payment received: Payment x Gross Profit Percentage = Taxable Gain

Example:

Sale price: $500,000
Adjusted basis: $200,000
Gain: $300,000
Gross profit percentage: $300,000 / $500,000 = 60%

If the buyer pays $100,000/year for 5 years:

Each year: $100,000 x 60% = $60,000 taxable gain
Plus interest on the unpaid balance (ordinary income)

What qualifies for installment treatment:

Qualifies	Does NOT Qualify
Real property sales	Inventory or stock in trade
Business asset sales (equipment, goodwill)	Publicly traded securities
Ownership interest sales	Depreciation recapture (IRC 1245, taxed Year 1)
Seller-financed transactions	Losses (installment method is for gains only)

Depreciation recapture exception: IRC 1245 ordinary income (depreciation recapture on equipment) is taxed IN FULL in the year of sale, even if no payment is received that year. Only the gain above the recapture is eligible for installment treatment.

Interest requirement: The seller must charge adequate interest on the deferred payments. If the stated interest rate is below the Applicable Federal Rate (AFR), the IRS imputes interest at the AFR, recharacterizing part of each payment from principal to interest (increasing ordinary income, decreasing capital gain).

Related-party sales (IRC 453(e)): If the buyer is a related party (family member, controlled entity) and resells the property within 2 years, the original seller must recognize the remaining deferred gain immediately. This prevents using a related-party installment sale as a step transaction to get cash while deferring tax.

How does a seller-financed business sale work?

Hypothetical example

Round numbers. For current guidance, see IRS installment agreement guidance. A plumbing contractor. Selling the business after 15 years. The buyer can’t get a bank loan for the full amount, so the seller finances.

Sale terms:

Item	Amount
Total sale price	$400,000
Down payment	$80,000 (20%)
Seller note	$320,000 (80%)
Note term	5 years
Interest rate	7% (above AFR)
Annual principal payments	$64,000/year

Asset allocation (purchase price allocation, Form 8594):

Asset	FMV	Basis	Gain	Character
Equipment (trucks, tools)	$60,000	$0 (fully depreciated)	$60,000	Ordinary (IRC 1245 recapture)
Customer list	$40,000	$0	$40,000	Capital gain (15 years amortizable)
Goodwill	$250,000	$0	$250,000	Capital gain
Non-compete agreement	$50,000	$0	$50,000	Ordinary income
Total	$400,000	$0	$400,000

Year 1 tax (without installment method): If the full gain were recognized in Year 1:

Income	Amount	Rate	Tax
Ordinary income (recapture + non-compete)	$110,000	24-32%	$27,000
Capital gain (goodwill + customer list)	$290,000	15-20%	$50,000
Total tax			$77,000

But the seller only received $80,000 in cash (the down payment). Paying $77,000 in tax on $80,000 of cash leaves $3,000.

Year 1 tax (with installment method): First, the depreciation recapture ($60,000) and non-compete ($50,000) are recognized in FULL in Year 1 regardless of payments received:

Item	Amount	Tax
IRC 1245 recapture	$60,000	$15,000 (ordinary rates)
Non-compete	$50,000	$12,000 (ordinary rates)

Remaining gain eligible for installment treatment: $290,000 (capital gain on goodwill + customer list) Contract price for installment calculation: $400,000 - $110,000 (already recognized) = $290,000 eligible gain on $400,000 contract Gross profit percentage on remaining: $290,000 / $400,000 = 72.5%

Down payment ($80,000): $80,000 x 72.5% = $58,000 capital gain recognized Plus interest on the note: $320,000 x 7% = $22,400 ordinary income

Year 1 total:

Component	Amount	Tax
Recapture (mandatory)	$60,000	$15,000
Non-compete (mandatory)	$50,000	$12,000
Installment gain	$58,000	$8,700 (15% LTCG)
Interest income	$22,400	$5,400
Total	$190,400	$41,100

Cash received: $80,000 down + $0 principal (first principal payment in Year 2) = $80,000 Cash after tax: $80,000 - $41,100 = $38,900

Compared to the lump-sum scenario ($3,000 remaining), the installment method leaves $38,900 in the seller’s pocket in Year 1.

Years 2-6 (principal + interest payments):

Year	Principal	Interest	Installment Gain (72.5%)	Tax
2	$64,000	$22,400	$46,400	$12,200
3	$64,000	$17,920	$46,400	$11,100
4	$64,000	$13,440	$46,400	$10,000
5	$64,000	$8,960	$46,400	$8,900
6	$64,000	$4,480	$46,400	$7,800

Total tax over 6 years: approximately $91,100 Total tax if all recognized in Year 1: approximately $77,000

The installment method costs $14,100 MORE in total tax (because the capital gains rate doesn’t change, but the interest income is additional ordinary income). But the cash flow advantage is substantial: the seller never faces a tax bill that exceeds cash received, and the time value of money on the deferred tax partially offsets the additional interest income tax.

When installment sales make sense:

Buyer can’t pay the full price at closing
Seller wants to stay in lower tax brackets
Seller wants to defer gain to a year with offsetting losses
Sale of a high-value asset where capital gains would push into the 20% bracket + 3.8% NIIT

When to elect OUT of installment treatment:

Seller has large NOL carryforwards that would absorb the gain (use the NOL now, not later)
Tax rates are expected to increase significantly (recognize gain at today’s lower rates)
Seller needs the full tax basis in the note for other purposes

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

What is the difference between short-term and long-term capital gains rates?

Assets held for one year or less generate short-term capital gains, taxed at your ordinary income tax rate (up to 37% federal). Assets held for more than one year qualify for long-term capital gains rates of 0%, 15%, or 20%, depending on your taxable income. High-income taxpayers may also owe the 3.8% net investment income tax (NIIT) under IRC 1411 on top of the capital gains rate. The holding period starts the day after you acquire the asset and includes the day you sell it. For business owners planning a sale, timing the disposition to cross the one-year threshold can save 15-20 percentage points in federal tax on the gain.

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Cite this page

Yarik Yarosh, CPA. "Installment Sales (IRC 453): Deferring Gain When Selling a Business or Property." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-installment-sale-irc-453-tax-deferral

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

Installment Sales (IRC 453): Deferring Gain When Selling a Business or Property

How does a seller-financed business sale work?

What is the difference between short-term and long-term capital gains rates?

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