What Is an Installment Sale and How Is It Taxed?
Sam's List Editorial | 2026-08-03
What Is an Installment Sale and How Is It Taxed? An installment sale is a sale where you receive at least one payment after the year of the sale, and it lets you recognize your gain as the payments arrive rather than all at once. You report it on Form 6252 under Section 453, applying a gross profit percentage to each payment to determine how much of it is taxable gain. That is the whole idea in one sentence. What makes installment sales worth understanding is everything the deferral does not cover, because sellers who assume the tax follows the cash are usually wrong in at least two places. How the Gross Profit Percentage Works Every payment you receive gets split into three parts: return of your basis, gain, and interest. The gross profit percentage tells you how much of each payment is gain. Gross profit percentage equals gross profit divided by contract price. Gross profit is the selling price less your adjusted basis and selling expenses. Take an illustrative example. You sell a building for $1,000,000. Your adjusted basis is $400,000 and selling costs are $50,000, so your gross profit is $550,000 and your gross profit percentage is 55 percent. The buyer pays $200,000 down and signs a note for $800,000 payable over four years, with interest stated separately. In year one, you received $200,000 of principal. Fifty-five percent of that, or $110,000, is gain. The remaining $90,000 is return of basis and is not taxed. Each subsequent principal payment gets the same 55 percent treatment. Interest is not part of that calculation at all. The percentage is locked at the time of sale and applies to every principal payment for the life of the note. What You Cannot Defer This is the part that surprises sellers, and it is worth knowing before you sign. Depreciation recapture comes due in year one. Under Section 453(i), ordinary income from depreciation recapture is recognized in the year of sale regardless of when you collect the cash. For a building or equipment you have depreciated for years, that can mean a substantial tax bill in a year when you received only a down payment. Recapture is also taxed as ordinary income rather than at capital gains rates, so it hits harder than the deferred portion. Interest is ordinary income as received. The interest on the note is not part of your gain, it is interest income taxed at ordinary rates in the year you receive it. If the note does not state adequate interest, the imputed interest and original issue discount rules can recharacterize part of what you thought was principal into interest, which generally makes your...
