02 Jun 2026
Selling property under the installment sale method can be beneficial to both sellers and buyers as it allows a buyer to pay the purchase price over the years and it allows the seller to spread the gain, and therefore the tax on that gain, over the years.
Calculating gain under the installment sale method
When you sell an asset under the installment sale method, you must report the sale to the IRS on Form 6252, unless you elect out of reporting the sale under the installment sale method. The election to use the installment sale method is made by filing certain forms with the IRS.
If you report a sale on the installment sale method, your total gain on the sale is the amount by which the selling price of your property exceeds your adjusted basis in that property. You include in income each year only the part of the gain you receive or are considered to have received. Thus, you don’t include the part of the payment that’s a return of your basis in the property.
The selling price includes:
- the money and the fair market value (FMV) of the property you receive for the sale of your property,
- any of your selling expenses paid by the buyer, and
- existing debt on the property that the buyer pays, assumes, or takes subject to.
FMV is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of all the necessary facts.
Example: Sarah sells a painting for $6,000. Her adjusted basis in the painting is $4,500, and her gross profit is $1,500. Thus, Sarah’s gross profit percentage is 25% ($1,500 ÷ $6,000). After subtracting interest (discussed below), Sarah reports as installment sale income on her tax returns each year 25% of each payment received. The remainder (balance) of each payment is the tax-free return of Sarah’s adjusted basis.
It’s advisable to engage a CPA firm to assist in properly reporting an installment sale transaction on your tax return. Should there be any issues, using an accounting firm will help you avoid any potential penalties relating to an incorrect reporting of the transaction.
Reporting Interest Income on an Installment Sale
An installment sale contract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the principal payment. Interest provided in the contract is called “stated interest.”
A problem can arise if an installment sale contract doesn’t provide for adequate stated interest. In that case, part of the stated principal amount of the contract may be recharacterized as interest income. If your installment sales contract provides for little or no interest, unstated interest or original issue discount will have to be calculated, even if you have a loss. This means that part of the stated principal may be recharacterized as unstated interest or original issue discount for tax purposes, even if you have a loss. Such recharacterization results in additional income to the seller.
Calculating Interest Expense on Your Deferred Tax
A special rule exists if you are not a dealer in the type of property that is being sold in an installment sale. In this case, you must pay interest on the deferred tax relating to any obligation that arises from disposing of property under the installment method if both of the following apply:
- The property has a sales price of over $150,000.
- The total balance of all nondealer installment obligations arising during, and outstanding at the close of, the tax year is more than $5 million.
The nondealer interest charge rule is complicated and, if it applies to you, proper planning with a tax professional can help you minimize or avoid it altogether. Indeed, all rules and regulations in this area are complicated and go beyond this article. They can change with little notice. So again, always work with a professional.
© 2026
Tags: IRSTax