Real estate and business sales

Installment sales and Form 6252

Carry the buyer’s note, and the tax on the gain comes due as the payments come in, not all at once in the year of sale. It is one of the oldest tools in the Code, it works for land, rentals and businesses, and it turns the seller into a lender — which is the part people forget.

A farm sold to the neighbor on a ten-year note. A rental sold to the tenant with the owner carrying the financing. A business sold to the manager for a down payment and monthly checks. Each is an installment sale, and each is reported on Form 6252, which spreads the gain in proportion to the money received. Here is how the arithmetic works, what gets taxed up front no matter what, the traps, and the warning we give every client who is about to become somebody’s bank.

What it is	Any sale where at least one payment arrives after the year of sale. The installment method applies automatically unless you elect out.
What it does	Each payment of principal carries the same share of gain — the gross profit percentage — and the rest is your basis coming back untaxed.
What it doesn’t do	Depreciation recapture, interest, and inventory are taxed in full in the year of sale regardless of when you are paid. Losses can’t use it. Stock traded on an exchange can’t use it.
The form	Form 6252, filed with the return for the year of sale and every year a payment is received.

Before anything else: you are the lender now

A seller who carries a note has made a loan secured by property they used to own, and the tax deferral is worth nothing if the buyer stops paying. Three rules we hold to. Get a substantial down payment — the buyer needs real money at risk, so walking away costs them something. Have an attorney draw the note and the deed of trust (or the security agreement for a business), with the interest rate, the payment schedule, a due-on-sale clause and the default remedies spelled out; this is not a job for a form off the internet. And treat it as an investment decision first: would you lend this person this much money at this rate if you didn’t own the property? If the answer is no, the tax savings don’t change it.

How the gain is spread

Three numbers do all the work. The selling price is everything you get: cash, the note, and any debt the buyer takes over. The contract price is the selling price minus any mortgage the buyer assumes (up to your basis). The gross profit is the selling price minus your adjusted basis and selling expenses. Divide gross profit by contract price and you have the gross profit percentage — the share of every principal dollar that is taxable gain. The rest of each dollar is return of basis, not taxed.

Say you sell land for $500,000 that cost you $200,000, with $20,000 of selling costs, no mortgage, $100,000 down and a $400,000 note over ten years. Gross profit $280,000; contract price $500,000; percentage 56%. The year of sale, $100,000 came in, so $56,000 is gain. Each later year, $40,000 of principal arrives and $22,400 is gain. The interest on the note is ordinary income on Schedule B, every year, separately. The buyer’s payments of interest are not part of the installment computation at all.

A Castle Rock rental sold on a ten-year note

Purchased in 2012 for $280,000; depreciation taken $85,000; adjusted basis $195,000. Sold in 2026 for $560,000 with $30,000 of selling costs: $110,000 down, the buyer assumes nothing, and a $450,000 note at 6% over ten years.

Gross profit (560,000 − 195,000 − 30,000)	$335,000
Of which depreciation recapture, taxed in 2026 regardless	$85,000
Gain eligible for the installment method	$250,000
Contract price	$560,000
Gross profit percentage (250,000 ÷ 560,000)	44.6%
2026: down payment $110,000 × 44.6%	$49,100 capital gain
2026 total: recapture + installment gain	$134,100
2027–2036: $45,000 of principal a year × 44.6%	about $20,100 a year
Interest on the note, year one (ordinary income)	about $26,000

Without the installment method the whole $335,000 lands in 2026, most of it at 20% plus the 3.8% net investment income tax, and the seller’s Medicare premiums jump two years later. Spread, the yearly gain sits in the 15% bracket and under the NIIT line for a retired couple. The recapture is taxed in 2026 either way, even though the cash to pay it came mostly from the down payment.

What is taxed up front anyway

Depreciation recapture. On a rental or business property, the gain up to the depreciation you took (the unrecaptured §1250 gain on real estate, and the ordinary §1245 recapture on equipment) is taxed in full in the year of sale, whether or not any cash came in. This is the single most common surprise. A seller who takes a small down payment on a heavily depreciated rental can owe more tax in the year of sale than the down payment, and should set the down payment accordingly.

Interest. Every payment of interest is income when received, at ordinary rates.

Inventory, receivables, and property held for sale in a business sale: no deferral. A business sale is allocated among its assets (Form 8594), and only the capital assets, goodwill and real estate get installment treatment.

Publicly traded stock can never use the method. Losses can’t either; a loss is a loss in the year of sale.

The traps

The mortgage over basis. If the buyer assumes a mortgage larger than your basis, the excess is treated as a payment in the year of sale even though no cash changed hands, and the contract price is reduced so the gross profit percentage becomes 100%. Sellers who refinanced the property heavily before selling walk into this.

Sales to relatives. Sell to a child, a sibling, a parent, or an entity you control, and if the buyer resells within two years, your deferred gain is pulled forward to the year of their resale. Sell depreciable property to a related party and the installment method is unavailable altogether unless you can show tax avoidance wasn’t a principal purpose.

The minimum interest rate. The note must carry interest at least equal to the IRS’s applicable federal rate for the month of sale (published monthly; a few percent, varying with the term). Charge less and the IRS recharacterizes part of the principal as interest — ordinary income instead of capital gain, and the buyer gets a deduction you didn’t intend. Seller-financed sales under $250,000 of principal to a family member have a lower floor, but there is always a floor.

The pledge rule and the big-note interest charge. Borrow against the note and the loan proceeds are treated as a payment. And a seller whose installment notes from the year exceed $5 million owes the IRS interest on the deferred tax, which removes most of the benefit at that scale.

Dying with the note. The remaining gain does not get a step-up at death. It is income in respect of a decedent, taxed to whoever collects the payments, with a deduction for any estate tax paid on it.

Selling your home on a note

The $250,000 / $500,000 home sale exclusion is applied first, and only the gain above it is spread over the payments. For most homes that means nothing is spread because nothing is taxable. For a long-held home with gain above the exclusion, the combination is powerful: the excess gain arrives at $30,000 a year instead of $300,000 at once. See selling your home and the homeowner therapies.

Electing out

You can report the whole gain in the year of sale by simply reporting it that way on a timely return (including extensions). That is sometimes right: a year with a large loss to absorb the gain, a year in the 0% capital gain bracket, a move coming to a state with no income tax, or a worry that rates will be higher later. The election is nearly impossible to undo, so it is a decision to make with the whole picture in front of you.

If the buyer stops paying

You take the property back, and the Code treats the repossession gently for real estate: gain is recognized only to the extent of payments received that were never taxed, capped by the gain remaining on the original sale, and no loss is allowed. Your basis in the recovered property is your old basis in the note plus the gain recognized plus the costs of repossession. For personal property or a business the rules are less forgiving. The practical point is the one in the box at the top: the down payment and the attorney are what make a default survivable.

Behind the scenes

Form 6252 is filed with the return for the year of sale (Part I, the gross profit computation, once) and every year a payment is received (Part II). Recapture goes to Form 4797 in the year of sale. The interest goes on Schedule B. We keep the amortization schedule with the file, because a buyer who pays extra principal in one year moves gain into that year, and a buyer who pays late moves it out; the form follows the cash, not the schedule. The selling price allocation for a business sale, and the AFR for the month of closing, both have to be nailed down before the closing, not after.

The Colorado side

Colorado follows the federal installment method. The gain on Colorado real estate stays Colorado-source income for every year of the note, so a seller who retires to Arizona in year three still files a Colorado nonresident return each year until the note is paid. The 2% nonresident withholding at closing (DR 1079) applies to the sale price when the seller is already a nonresident at closing, and the withheld amount is credited on that year’s return, so it can exceed the first year’s tax under the installment method; plan the closing accordingly.

What to bring your preparer

The closing statement, the signed note, and the deed of trust or security agreement
The amortization schedule, and the record of what the buyer actually paid each year
The depreciation schedule for a rental or business property
For a business sale, the asset allocation agreed with the buyer (Form 8594)
What you paid for the property and what you spent improving it
Whether the buyer is related to you, and whether any mortgage was assumed

Questions people ask

Can I spread the gain on my rental over the note?

The appreciation, yes. The depreciation you took comes back as tax in the year of sale no matter how little cash you received. Size the down payment to cover it.

My buyer wants to pay zero interest for the first two years.

The IRS won’t see it that way. Interest at the federal rate is imputed into every payment, turning part of your capital gain into ordinary income. Write a market rate into the note from day one.

I want to sell the farm to my son on a note. Any problem?

Two. If he resells within two years, your deferred gain is taxed to you then. And a below-market rate to a relative is still imputed. Otherwise a sale to a child on a properly documented note is common and works.

What if I need the cash and sell the note to a bank?

Selling or pledging the note is a disposition; the remaining deferred gain is taxed at that point. The method defers tax only as long as you hold the paper.

Does this work for selling my business?

For the goodwill, the real estate and the equipment above its depreciation, yes. Inventory, receivables and the recapture on equipment are taxed in the year of sale. Most small business sales end up partly spread and partly not.

Is it better than a 1031 exchange?

Different tool. An exchange defers all the gain but requires buying another property; a note spreads the gain and gives you income. Sellers who are done with real estate and want retirement income usually prefer the note; sellers who want to stay invested prefer the exchange. See 1031 exchanges.

Forms and official pages named in this article

Sources and where to check

IRS Publication 537, Installment Sales
26 U.S.C. §453; §453A (pledges and the interest charge); §1038 (repossession of real property); §483 and §1274 (imputed interest)
Colorado DOR: nonresident real estate withholding

Updated October 26, 2026 · tax year 2026 figures