What Is an Installment Sale? (IRS Definition)

According to the Internal Revenue Service, an installment sale is a sale of property where at least one payment is received after the close of the tax year in which the sale occurs.

Under IRS Topic No. 705 – Installment Sales, eligible taxpayers may report gain using the installment method unless they elect out of it. This method applies primarily to real estate held for investment or business purposes and allows gain to be recognized proportionally as payments are received.

Key IRS reference:

• IRS Topic No. 705 – Installment Sales

• IRS Publication 537 – Installment Sales

How the Installment Method Works

Under the installment method, each payment received from the buyer is broken into three components:

1. Return of basis (non-taxable)

2. Capital gain (taxable portion)

3. Interest income, if the installment note provides for interest

Only the gain portion is subject to capital gains tax in each year, rather than recognizing the full gain upfront.

The taxable portion of each payment is determined using the gross profit percentage, as outlined in IRS Publication 537.

IRS Reporting Requirements

Taxpayers using the installment method must file Form 6252, Installment Sale Income, in:

• The year of sale, and

• Each subsequent year in which a payment is received

Form 6252 calculates the portion of each payment that is taxable and carries the information to the appropriate capital gains schedules.

If a taxpayer chooses not to use the installment method, they must elect out and report the entire gain in the year of sale—even if payments are received in later years.

IRS reference:

• Publication 537

• Form 6252 Instructions

Benefits of Installment Sales in Real Estate

From a tax-planning perspective, installment sales can offer several advantages:

• Deferral of capital gains tax, reducing upfront tax burden

• Smoothing of taxable income, which may help manage marginal tax brackets

• Improved cash-flow alignment, as tax is paid as cash is received

For sellers of highly appreciated real estate, this approach can be particularly effective when liquidity planning is a concern.

Limitations and IRS Restrictions

The IRS places important limits on installment sales:

• Losses cannot be deferred—losses are recognized in the year of sale

• Dealer property and inventory generally do not qualify

• Sales of publicly traded securities are excluded

• Depreciation recapture may be taxed differently and, in some cases, recognized earlier

These limitations are addressed in detail in IRS Publication 537 and should be reviewed carefully before structuring a transaction.

Special Installment Sale Structures

Some real estate sellers use:

• Structured installment sales, which formalize payment timing and interest

• Monetized installment sales, which combine installment reporting with third-party financing

These strategies require careful structuring and carry additional IRS scrutiny. They should only be implemented with professional tax and legal guidance.

IRS Guidance Summary (Quick Reference)

• IRS Topic No. 705 – Installment Sales Defines installment sales and outlines when the installment method is available.

• IRS Publication 537 – Installment Sales Provides detailed rules on eligibility, computation, reporting, elections, and exceptions.

These are the primary IRS authorities governing installment sales in real estate.

Conclusion

Installment sales can be a powerful tax-deferral tool for real estate sellers when structured properly and used in the right circumstances. By aligning tax recognition with payment timing, sellers may reduce upfront tax exposure and improve long-term cash flow.

However, installment sales are governed by strict IRS rules and reporting requirements. Reviewing the transaction under IRS Topic 705 and Publication 537, and coordinating with a CPA, is essential to ensure compliance and optimize results.