Installment Sale Real Estate Example: Gross Profit, Reporting, Opt-Out

An installment sale of real estate lets you spread the capital gain over the years you actually collect payments instead of paying tax on the whole profit in the year you close. The mechanism is a single ratio called the gross profit percentage, fixed at closing and applied to every principal dollar the buyer sends you. Here is a full installment sale of real estate example, with the numbers worked out year by year, plus the variations that most often change the math.

You don’t have to elect the installment method. It applies automatically to any qualifying sale where at least one payment arrives after the tax year of the sale.¹

The Gross Profit Percentage

Everything runs through this ratio. Once set, it stays locked for the life of the note, and you multiply every principal payment by it to find that year’s taxable gain. The rest of each payment is a tax-free return of your basis.

Four figures feed the calculation:

Selling price: total consideration, including cash, the fair market value of any other property the buyer gives you, and any debt the buyer assumes.
Adjusted basis: your original cost plus capital improvements, minus any depreciation you claimed or could have claimed.
Gross profit: selling price minus adjusted basis. This is the total gain you’ll eventually recognize.
Contract price: generally the selling price minus any mortgage the buyer assumes, to the extent that mortgage doesn’t exceed your basis. If the assumed mortgage is larger than basis, the excess gets added back into the contract price.

Gross profit percentage equals gross profit divided by contract price.²

A Full Numerical Example

You sell a vacant investment lot on November 15, 2025, for $500,000. Your adjusted basis is $200,000. No mortgage encumbers the land. The buyer pays $100,000 down at closing, then makes four annual principal payments of $100,000 starting in 2026, plus 5% interest on the declining balance.

With no mortgage in the picture, the contract price equals the full $500,000 selling price. Gross profit is $500,000 minus $200,000, or $300,000. Divide $300,000 by $500,000 and the gross profit percentage is 60%.

So sixty cents of every principal dollar is capital gain, and forty cents is a return of your basis. Year by year, it looks like this:

2025 (year of sale): the $100,000 down payment produces $60,000 of capital gain and $40,000 of return of basis. No interest is due yet.
2026: another $100,000 principal payment produces $60,000 of capital gain. The buyer also owes $20,000 of interest (5% of the $400,000 remaining balance), reported separately as ordinary income.
2027: $60,000 capital gain on principal, plus $15,000 of interest (5% of $300,000).
2028: $60,000 capital gain, plus $10,000 interest (5% of $200,000).
2029: final $60,000 capital gain, plus $5,000 interest (5% of $100,000).

Across the five years you recognize all $300,000 of gross profit and $50,000 of interest income. The interest is taxed at ordinary rates. The capital gain qualifies for long-term rates because you held the lot more than a year. For 2026, long-term capital gains rates are 0%, 15%, or 20% depending on your taxable income.

When the Buyer Assumes a Mortgage

Real estate deals often involve the buyer taking over existing financing, and that shifts the contract price.³

Take the same $500,000 sale price and $200,000 basis, but say the buyer assumes a $150,000 mortgage. Contract price becomes $500,000 minus $150,000, or $350,000. Gross profit is still $300,000. Gross profit percentage jumps to roughly 85.7% ($300,000 divided by $350,000). A bigger share of each principal dollar you actually receive is taxable, because fewer dollars flow through your hands in total.

If the assumed mortgage were larger than basis, say $250,000 against the $200,000 basis, the $50,000 excess is treated as a payment received in the year of sale even though no cash changes hands for that piece.² That $50,000 also gets added back to the contract price. The result is accelerated gain in year one and a bigger tax bill before you’ve collected the corresponding cash.

If the Property Was a Rental

Depreciation changes the picture. Any gain that would be ordinary-income depreciation recapture has to be recognized in full in the year of sale, no matter how little cash you receive that year.¹ Only the gain above the recapture amount gets spread across the payments.²

For real property placed in service after 1986, you almost certainly used straight-line depreciation, so the ordinary-income recapture amount is typically zero. The depreciation you did claim falls into “unrecaptured Section 1250 gain,” taxed at a maximum 25% rate rather than at ordinary rates. That 25%-rate gain can be deferred under the installment method, but the IRS requires you to recognize all of the unrecaptured Section 1250 gain before any of the lower-taxed capital gain.⁴ Your earliest installment payments therefore carry the highest tax rate.

Older commercial buildings that used accelerated depreciation, and personal-property components like appliances and fixtures that fall under Section 1245, can produce true ordinary-income recapture that lands entirely in the year of sale.

The Minimum Interest Rate

You can’t set the note’s interest rate anywhere you like. If your stated rate falls below the Applicable Federal Rate the IRS publishes monthly, the tax code recharacterizes part of what you called principal as imputed interest.⁵ That reclassification turns some of your capital gain into ordinary interest income, taxed at higher rates.

Which AFR applies depends on the term of the note: the short-term rate for three years or less, mid-term for over three but not more than nine years, and long-term for anything beyond nine years. Set the note’s rate at or above the applicable AFR and imputed interest is not a problem.

How to Report It

Form 6252 is the reporting workhorse. You file it in the year of sale to fix the gross profit percentage, and then again every year until the note is paid off or disposed of, including years when no payment arrives.⁶ The form walks through selling price, adjusted basis, gross profit, contract price, the percentage itself, and each year’s recognized gain.

The gain from Form 6252 then flows to Schedule D for capital gains or Form 4797 for property used in a business.⁷ If depreciation recapture applies, the recapture portion goes on Form 4797 in the year of sale as ordinary income, and the remaining gain continues through Form 6252 in later years.

Interest income from the buyer is reported separately. If you financed the sale and the buyer uses the property as a personal residence, Schedule B requires the buyer’s name, address, and Social Security number alongside the interest amount.⁸

Opting Out

The installment method is automatic, but you can opt out and report the full gain up front. You might want to if you have capital losses to soak up the gain, expect higher rates in future years, or just don’t want to track the note for years.

To elect out, report the full gain on a timely filed return, including extensions, using Schedule D or Form 4797, and don’t file Form 6252.⁶ If you miss that deadline, you can still elect out on an amended return filed within six months of the original due date (extensions not counted) by writing “Filed pursuant to section 301.9100-2” at the top. Once made, the election is effectively permanent. Revocation requires IRS consent, which is rarely granted.¹

A Few Things That Change the Answer

The example above assumes an arm’s-length sale of investment real estate at a moderate price. Three situations can change the tax picture and are worth flagging before you rely on the numbers.

Sales to related parties (spouse, children, grandchildren, parents, siblings, controlled entities) trigger a two-year resale rule that can accelerate your gain if the related buyer flips the property within two years.¹ For depreciable property sold to a related person, installment reporting is generally denied outright: all payments are treated as received in the year of sale.

High-value deals carry an interest charge. If the sale price exceeds $150,000 and your total outstanding installment obligations from that year exceed $5 million at year end, the IRS charges you interest on the deferred tax liability.⁹

Installment gain can also pull you into the 3.8% net investment income tax if your modified AGI exceeds $200,000 (single) or $250,000 (married filing jointly).¹⁰ Spreading the gain across years can keep you under the threshold in some years where a lump-sum sale would have pushed you over, which is a quiet advantage for higher-income sellers.

1
Office of the Law Revision Counsel. 26 USC 453 – Installment Method
2
Internal Revenue Service. Publication 537 – Installment Sales
3
eCFR. 26 CFR 15a.453-1 – Installment Method Reporting for Sales of Real Property
4
eCFR. 26 CFR 1.453-12 – Allocation of Unrecaptured Section 1250 Gain Reported on the Installment Method
5
Office of the Law Revision Counsel. 26 USC 1274 – Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property
6
Internal Revenue Service. Form 6252 – Installment Sale Income
7
Internal Revenue Service. Topic No. 705 – Installment Sales
8
Internal Revenue Service. About Schedule B (Form 1040)
9
Office of the Law Revision Counsel. 26 USC 453A – Special Rules for Nondealers
10
Internal Revenue Service. Questions and Answers on the Net Investment Income Tax