Selling investment or commercial real estate can result in a substantial tax bill if the property has appreciated significantly. One strategy to help ease your tax burden is an installment sale.
What’s an Installment Sale?
In an installment sale, the seller gets at least one payment after the tax year in which the sale occurs. So, if you sell investment or commercial real estate, instead of receiving the full purchase price all at once, you get payments over time.
This allows you to defer recognition of gain and spread the tax liability over several years. Installment sales can also help attract more buyers because they won’t have to pay the entire price upfront and obtaining financing might be easier.
Two types of installment sales
There are a couple of ways to set up an installment sale:
1. Traditional. This generally involves the buyer making payments directly to the seller under the terms of a promissory note.
2. Structured. Here, a third-party assignment company or financial institution assists with the transaction and oversees the payment schedule. The third party typically assumes responsibility for future payments to the seller, which may reduce the seller’s risk.
Tax Considerations
Gains from real estate held for more than one year are typically taxed at favorable long-term capital gains rates — 15% for most taxpayers and 20% for higher-income taxpayers. For 2026, the 20% rate applies when taxable income exceeds $545,500 (singles), $579,600 (heads of household), $613,700 (married couples filing jointly) or $306,850 (married couples filing separately). With the gain spread over multiple years, an installment sale may help keep you below the 20% rate threshold.
Depending on your income level, it might also help prevent you from triggering the 3.8% net investment income tax (NIIT), or at least reduce your NIIT liability. The NIIT applies to net investment income to the extent that modified adjusted gross income exceeds $200,000 (singles and heads of household), $250,000 (joint filers) or $125,000 (separate filers).
However, several tax rules can complicate installment sales. For example, depreciation recapture must be reported as ordinary income in the year of sale, even if payments are received later. Only the remaining gain can be spread out under the installment method. The good news is that if your marginal ordinary rate is 32%, 35% or 37%, depreciation recapture is taxed at only 25%.
Additionally, installment agreements exceeding $5 million may trigger an IRS interest charge on the deferred tax. Special rules apply to related-party sales and may accelerate the remaining tax if the property is resold within two years.
Electing Out
Installment reporting is generally automatic if you sell property and receive at least one payment after the tax year of the sale. However, you can choose to elect out of it and report the entire gain in the year of sale.
This might make sense if you expect higher tax rates in future years, have current-year losses or deductions that could offset the gain, or want to accelerate income for financial planning purposes. When you file your tax return for the year of the sale, you can decide whether to elect out.
Moving Forward
Installment sales can be complex. If you’re thinking about selling investment or commercial real estate, contact the office to determine whether an installment sale makes sense for your situation.
