668 / Does the installment method of reporting apply to depreciation recapture?

The installment method of reporting deferral of gain does not apply to depreciation recapture. Therefore, the portion of gain attributable to depreciation recapture must be reported in the year of sale. Once depreciation has been recaptured, any adjusted net capital gain (the balance of the gain, see Q 702) is computed by adding the amount of depreciation recaptured to the seller’s basis.

Example: On December 30, 2025, Asher sells a tractor used in his trade or business to Samuel for $10,000. Asher’s adjusted basis in the tractor is $2,000. Of Asher’s $8,000 overall gain ($10,000 minus $2,000), $2,000 of it is attributable to depreciation recapture. For that reason, the $2,000 of depreciation recapture must be included in Asher’s gross income in the year of sale (meaning it is not subject to ratable inclusion). Pursuant to a note, for a period of five years, beginning January 1, 2026, Samuel is required to make an annual installment payment of $2,000 (plus interest).

The computation of Asher’s reportable gain is as follows:

Step 1 – Compute the gross profit ratio.

 

Or

60 percent

Step 2 – Multiply the gross profit ratio by the principal payment amount.

60 percent * $2,000 = $1,200.

Step 3 – Determine the amount of the principal payment that is the tax-free recovery of basis.

$2,000 minus $1,200 = $800

Thus, with respect to each $2,000 principal payment, $1,200 is capital gain and $800 is the tax-free recovery of basis. Over the five-year installment payment term, Asher will report $6,000 of capital gain and $4,000 recovery of basis. The $4,000 basis recovery includes $2,000 of adjusted basis plus the $2,000 of depreciation recapture Asher recognized in the year of sale.