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

By Yarik Yarosh, CPA ·September 5, 2026 ·7 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 for a lump sum, the entire capital gain is taxed in the year of sale, often pushing the seller into the highest tax bracket and triggering the 3.8% Net Investment Income Tax. Under IRC 453, the installment method allows the seller to recognize gain proportionally as payments are received, spreading the tax burden over the term of the note. The installment method is automatic; no election is required. If the seller wants to recognize all gain in the year of sale (for example, to use expiring capital losses), they must affirmatively elect out of the installment method on a timely filed return. The installment method doesn’t apply to depreciation recapture under IRC 1245 or IRC 1250, which is recognized in full in the year of sale regardless of when payments are received. It also does not apply to ordinary income from inventory sales or to losses (which are recognized in full in the year of sale). For sellers of appreciated businesses or real estate who are willing to finance part of the purchase price, the installment sale is one of the most effective tools for managing the timing and amount of capital gains tax.

✓Key takeaway

Installment sale basics:

Element	Details
Default method	Automatic for any sale with at least one payment after the tax year of sale
Elect out	Must affirmatively elect out on a timely filed return (Form 6252, checking the box)
Gain recognition formula	(Gross Profit / Contract Price) x Payment Received = Gain Recognized
Interest requirement	Must charge at least the AFR (Applicable Federal Rate); imputed interest if rate is too low
Depreciation recapture	Recognized in full in Year 1 (not deferred under installment method)
Inventory	Not eligible for installment method
Losses	Not eligible (loss recognized in full in Year 1)
Publicly traded securities	Not eligible
Form	Form 6252 (Installment Sale Income)

Key terms:

Term	Definition
Selling price	Total amount to be received (including notes, cash, and FMV of other property)
Gross profit	Selling price minus adjusted basis minus selling expenses
Contract price	Selling price minus any mortgage assumed by the buyer (if the mortgage does not exceed the seller’s basis)
Gross profit ratio	Gross profit / Contract Price (the percentage of each payment that’s taxable gain)
Payment	Cash, FMV of property received, and the amount of any mortgage assumed by the buyer in excess of the seller’s basis

How does an installment sale save taxes?

Hypothetical example

Round numbers. For current guidance, see IRS installment agreement guidance. A business owner sells a commercial property for $2,000,000. The property has an adjusted basis of $600,000 (original cost minus depreciation) and a $400,000 mortgage that the buyer assumes. The seller receives $200,000 at closing and a $1,400,000 note payable over 7 years at 6% interest.

Installment sale calculation:

Item	Amount
Selling price	$2,000,000
Adjusted basis	$600,000
Selling expenses (broker, legal)	$100,000
Gross profit	$1,300,000
Mortgage assumed by buyer	$400,000
Contract price (selling price - mortgage assumed, since mortgage ≤ basis + selling expenses)	$1,600,000
Gross profit ratio	81.25% ($1,300,000 / $1,600,000)

Depreciation recapture (Year 1, regardless of payments): Assume $300,000 of the $600,000 basis reduction was depreciation (straight-line on real property). Under IRC 1250, the unrecaptured Section 1250 gain is taxed at 25% in Year 1.

Item	Amount
Depreciation recapture (unrecaptured 1250 gain)	$300,000
Tax on recapture (25%)	$75,000
Remaining capital gain to be deferred	$1,000,000

Payment schedule and tax (installment method):

Year	Payment Received	Gain Recognized (81.25% x payment)	Interest Income (6% on outstanding balance)	Capital Gains Tax (20% + 3.8% NIIT)	Interest Tax (37%)
1 (closing)	$200,000	$162,500	$0	$38,675	$0
2	$200,000	$162,500	$84,000	$38,675	$31,080
3	$200,000	$162,500	$72,000	$38,675	$26,640
4	$200,000	$162,500	$60,000	$38,675	$22,200
5	$200,000	$162,500	$48,000	$38,675	$17,760
6	$200,000	$162,500	$36,000	$38,675	$13,320
7	$200,000	$162,500	$24,000	$38,675	$8,880
8	$200,000	$162,500	$12,000	$38,675	$4,440
Total	$1,600,000	$1,300,000	$336,000	$309,400	$124,320

Comparison: installment sale vs. lump sum sale

Lump sum (all cash in Year 1):

Item	Amount
Total capital gain	$1,000,000
Depreciation recapture	$300,000
Capital gains tax (20% + 3.8% NIIT on $1,000,000)	$238,000
Recapture tax (25% on $300,000)	$75,000
Total Year 1 tax	$313,000

Installment sale (over 8 years):

Item	Amount
Depreciation recapture tax (Year 1)	$75,000
Capital gains tax (spread over 8 years)	$309,400
Total tax on gain	$384,400

The installment sale produces slightly higher total tax because the interest income ($336,000) is taxed as ordinary income. However, the benefits include:

Benefit	Value
Year 1 tax reduction	$313,000 (lump sum) vs. $113,675 (installment) = $199,325 deferred
Time value of money (6% discount rate, 8 years)	Deferral savings of ~$40,000-$60,000 in present value
Bracket management	Installment payments may keep seller below NIIT threshold ($250,000 MFJ)
Cash flow matching	Tax payments match cash receipts

When installment sales produce the biggest tax savings:

Scenario	Why Installment Works
Seller’s only income is the sale	Installment payments can keep income in the 15% capital gains bracket ($0 rate for low-income years)
Seller has expiring NOLs or capital losses	Can elect OUT to use them against the full gain in Year 1
Seller is near retirement (lower future income)	Future installment payments taxed at lower rates
Sale price exceeds $5 million	IRC 453A interest charge applies; installment may still be beneficial but must model the interest cost

Related-party rules (IRC 453(e) and (f)):

Rule	Details
Resale within 2 years	If the related-party buyer resells the property within 2 years, the deferred gain is accelerated to the original seller
Purpose	Prevents using installment sales to related parties to step up basis while deferring gain
Related parties	Spouse, children, grandchildren, siblings, controlled entities (>50% ownership)
Exceptions	Death of buyer or seller, involuntary conversion, resale for a price less than the installment sale price

IRC 453A (interest on deferred tax for large sales): For installment obligations where the face amount exceeds $5 million:

Rule	Details
Interest charge	Seller must pay interest on the deferred tax liability at the underpayment rate
Calculation	(Deferred gain x applicable tax rate) x underpayment rate
Pledging the note	If the seller pledges the installment note as collateral for a loan, the net proceeds are treated as a payment, triggering gain
Exception	Sales of personal-use property and farm property (under $150,000 sale price)

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 Under Section 453: How to Defer Capital Gains Tax When Selling a Business or Property." Blue Cloud CPA, September 5, 2026. https://bluecloudcpa.com/guides/small-business-installment-sale-section-453-deferring-gain

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

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

How does an installment sale save taxes?

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

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