An installment sale is any sale where the seller receives at least one payment after the year of sale. IRC §453 spreads gain recognition proportionally as payments arrive, using the gross profit ratio. This is usually favorable - it defers tax to match cash flow. But depreciation recapture cannot defer, the §453A interest charge bites on large deals, and related party rules can accelerate everything. Model all three before agreeing to seller financing.
Gross Profit Ratio (GPR) = Gross Profit ÷ Contract Price
Gain recognized each year = Payments received × GPR
Recapture (§1245/§1250) = Recognized 100% in year of sale - does NOT defer
Interest income = Always recognized separately; never runs through GPR
Gross profit is the total gain - selling price minus adjusted basis and selling expenses. Contract price is generally the selling price minus liabilities the buyer assumes that do not exceed the seller's basis. Where assumed liabilities exceed basis, the excess is treated as a payment in year one and added to contract price. Payments are cash and FMV of property received plus assumed liabilities above basis - but not the buyer's assumption of liabilities up to basis.
IRC §453(i) requires §1245 recapture (personal property) and §1250 unrecaptured section gain to be recognized in full in the year of sale - regardless of payments received. This cannot be deferred. If you sell a business with $400,000 of §1245 equipment recapture and receive only a $100,000 down payment, you still owe tax on all $400,000 of recapture in year one.
If at year-end the total face amount of your outstanding installment obligations from sales of property (other than timeshares and residential lots) exceeds $5,000,000, IRC §453A imposes an interest charge. The charge equals the applicable federal rate (AFR) multiplied by the deferred tax attributable to obligations above $5 million. This is a non-deductible charge - it is added to your tax liability with no offsetting deduction.
For transactions in the $10M-$100M range, the §453A charge is a real cost that must be modeled against the benefit of deferral. At high enough deal values and multi-year payment terms, electing out and paying all tax in year one can produce a better net present value outcome than the deferral plus §453A charges.
If a related party (sibling, spouse, ancestor, lineal descendant, or controlled entity) buys property from you on installment and then disposes of it within two years, the original seller must accelerate gain recognition. The amount realized by the related buyer on its disposition is treated as received by the original seller as of the date of the second sale. This prevents the classic abuse: sell to a related party on installment, related party immediately sells for cash, deferral is effectively permanent while cash is in the family.
Under §453(d), the seller can elect out of installment reporting and recognize the entire gain in the year of sale. The election is made on a timely filed return (including extensions) and is irrevocable. Consider electing out when: capital loss carryforwards can absorb the gain; current rates are lower than anticipated future rates; the §453A charge would be substantial; or the administrative burden of tracking installment obligations for years outweighs the deferral benefit.