667 / What is an installment sale? How is the gain taxed?
Editor's Note: Under the 2017 tax reform legislation, the following long-term capital gains tax rates apply:
In 2025, the 0 percent capital gains rate applies to joint filers who earn less than $96,700 (half of that amount for married taxpayers filing separately), heads of households who earn less than $64,750, single filers who earn less than $48,350, and trust and estates with less than $3,250 in income.
In 2025, the 15 percent rate applies to joint filers who earn more than $96,700 but less than $600,050 (half of that amount for married taxpayers filing separately), heads of households who earn more than $64,750 but less than $566,700, single filers who earn more than $48,350, but less than $533,400 and trust and estates with more than $3,250 but less than $15,900 in income.
In 2025, the 20 percent rate applies to joint filers who earn more than $600,050 (half of that amount for married taxpayers filing separately), heads of households who earn more than $566,700, single filers who earn more than $533,400, and trusts and estates with more than $15,900 in income.
In 2026, the 0 percent capital gains rate applied to joint filers who earn less than $98,900, married filing separately who earn less than $49,450, heads of households who earn less than $66,200, single filers who earn less than $49,450, and trusts and estates with less than $3,300 in income.
In 2026, the 15 percent rate applied to joint filers who earn more than $98,900 but less than $613,700, married filing separately who earn more than $49,450 but less than $306,850, heads of households who earn more than $66,200 but less than $579,600, single filers who earn more than $49,450 but less than $545,500, and trusts and estates with more than $3,300 but less than $16,250 in income.
In 2026, the 20 percent rate applied to joint filers who earn more than $613,700, married filing separately who earn more than $306,850, heads of households who earn more than $579,600, single filers who earn more than $545,500, and trusts and estates with more than $16,250 in income. For the tax treatment of installment payments, see Q 702.
Gain resulting from an installment sale is reported using the installment method. Generally, dealers may not report their sales under the installment method (with exceptions for farm property and certain timeshares and residential lots).1 See Q 7517 for the treatment of gain from the sale of publicly-traded stock. An installment sale is a sale or disposition of property (other than marketable securities, certain real property, and "inventory") where at least one payment is to be received by the seller after the close of the taxable year in which the disposition occurs.2 It is not necessary that there be more than one payment.
Example: On December 31, 2024, Asher transfers land to Samuel for $100,000. There is only one payment due on January 2, 2025. In spite of the fact that only one payment is required, the transaction qualifies as an installment sale because that payment is due at the end of the taxable year.
As explained below, installment reporting requires the taxpayer to report gain resulting from the underlying transaction (it does not apply to loss3) ratably over the term of the installment period. The taxpayer must use the installment method unless the taxpayer elects out on or before the due date, including extensions, for filing his federal income tax return for the taxable year in which the disposition occurred.4 For many taxpayers, reporting gain on the installment method is beneficial because without it, the taxpayer would have to report the entire gain in the year of disposition (even though it may take years for the taxpayer to receive the installment payments). Thus, the installment method provides for the ratable reporting of income over the term of years in which payments are due. On the other hand, a taxpayer with a significant capital loss (deductible to the extent of capital gains plus $3,000) may find it beneficial to report all the gain in one year so as to offset such capital loss. For such a taxpayer, electing out of installment reporting (discussed below) is an option.
Example: In 2026, Asher transfers land to Samuel for $100,000. The terms of the sale call for annual payments of $10,000 (plus interest) to Asher over a 10-year period. Asher's total capital gain on the transaction is $90,000. If Asher were to report the sale on the installment method, he would report $9,000 of capital gain in each year of the 10-year term over which the transaction took place. However, Asher has a $90,000 capital loss from another transaction. Thus, if Asher elects out of installment reporting, the entire $90,000 of capital gain would be includible in gross income in a single year to offset the $90,000 of capital loss. This would allow Asher to account for the 2026 gain in a single year (essentially tax-free) by using it to offset capital loss.
If the taxpayer fails to make a timely election out of installment reporting, the IRS may nonetheless approve the election upon a showing that the taxpayer's failure to make a timely election was due to good cause.5 As illustrated by Revenue Ruling 90-46, what constitutes "good cause" is very narrow. A change in the law that would cause electing out to be more tax advantageous or a change of mind by the taxpayer would not constitute good cause. On the other hand, a well-documented mistake (inadvertent failure to make a timely election due to an accountant's error) would constitute good cause.
Similarly, once an election out of installment reporting is made, it cannot be revoked without the permission of the IRS. In granting such permission, a showing of good cause (as illustrated by Revenue Ruling 90-46) is also the standard considered by the IRS. Good cause will not be found if the purpose of a late election out is tax avoidance.6 Generally, what constitutes good cause is determined on a case by case basis. Examples of IRS determinations of good faith can be found in private letter rulings.7
Be mindful, however, that a determination in a private letter ruling applies only to the taxpayer who requested the ruling.
Basic Mechanics of Installment Reporting
As illustrated below, reportable gain for each installment payment is determined by multiplying the gross profit ratio by each payment. The gross profit ratio is "gross profit" divided by the total contract price.8 Gross profit is the selling price minus selling expenses minus the seller's adjusted basis in the transferred property. The total contract price is the selling price minus qualified indebtedness (generally, secured debt on the property assumed by the buyer).9
Example: On December 30, 2026, Asher sells a parcel of land (not subject to a mortgage or lien) to Samuel for $100,000 (there are no selling expenses). Asher's basis in the land is $10,000. Pursuant to a note, for a period of 10 years, beginning January 1, 2027, Samuel is required to make an annual installment payment of $10,000 (plus interest). If Asher were to elect out of installment reporting, he would report a gain of $90,000 ($100,000 selling price minus $10,000 basis). Asher, however, does not elect out of installment reporting.
The computation of Asher's reportable gain is as follows:
Step 1 – Compute the gross profit ratio.
Gross Profit: $90,000 ($100,000 selling price minus $10,000 basis)
Total Contract Price: $100,000
Or
90 percent
Step 2 – Multiply the gross profit ratio by the principal payment amount.
90 percent * $10,000 = $9,000.
Step 3 – Determine the amount of the principal payment that is the tax-free recovery of basis.
$10,000 minus $9,000 = $1,000
Thus, with respect to each $10,000 principal payment, $9,000 is capital gain and $1,000 is the tax-free recovery of basis. As a result, over the 10-year installment payment term, Asher will report $90,000 of capital gain and $10,000 recovery of basis.
1. IRC §§ 453(b)(2)(A), 453(l)(2).
2. IRC § 453(b).
3. IRC § 453.
4. IRC §§ 453(a), 453(d); Bolton v. Commissioner, 92 TC 303 (1989).
5. Treas. Reg. § 15A.453-1(d); Rev. Rul. 90-46, 1990-1 CB 107.
6. Let. Rul. 9230003.
7. Let. Rul. 9218012. See also Let. Rul. 200226039. Let. Ruls. 9419012, 9345027.
8. IRC § 453(c).
9. Treas. Reg. § 15A.453-1(b)(2)(v), (b(3)(ii) and (b)(2)(iii). With respect to qualified indebtedness, Treas. Reg. § 15A.453-1. See, however, Professional Equities, Inc. v. Commissioner, 89 TC 165 (1987).