How to Save Tax with an Installment Sale in 2025

Selling a business, a parcel of real estate, or other highly appreciated assets can trigger a significant tax bill. But if structured properly, an installment sale may offer a practical way to spread out the tax liability—and potentially reduce your total taxes over time.

Here’s how the strategy works, and how it might benefit you in today’s tax environment.

The Basics: What Is an Installment Sale?

An installment sale occurs when you sell an asset and receive at least one payment after the close of the tax year in which the sale takes place. Under the installment method, you report the gain gradually as you receive principal payments, rather than paying all the tax in the year of sale.

This method can be especially appealing when you're looking to:

• Avoid a spike in taxable income in one year
• Spread the income across several years to remain in a lower tax bracket
• Align tax payments with actual cash flow

Example for 2025: Suppose you sell a business in 2025 for $900,000. Your basis in the business is $300,000. Instead of receiving the full amount up front, you structure the deal to receive $300,000 over three years (plus interest). This allows you to report $200,000 of gain per year (not including interest), helping you avoid higher tax rates that might apply if you received the full $600,000 gain all at once.

The Tax Perks—and What to Watch Out For

Using the installment method can offer flexibility, but it's not always the right solution for everyone. Here are some of the main tax-related advantages and limitations:

Benefits:

• Defers taxes over time, freeing up working capital.
• May keep you in a lower tax bracket across multiple years.
• Can be used in combination with other strategies, such as charitable planning or timing deductions.

Cautions:

• Interest income is taxed separately: The IRS requires interest to be charged on the unpaid balance. That portion is taxed as ordinary income.
• Depreciation recapture is not eligible: For sales of real estate or business property, the depreciation recapture portion is fully taxable in the year of sale.
• Potential IRS interest charge: If the installment obligations exceed $5 million, the IRS may assess an interest charge on the deferred tax under IRC Section 453A.

Structuring the Deal

A successful installment sale hinges on thoughtful planning. Before entering into an agreement, it’s important to:

• Establish a clear payment schedule and interest rate.
• Secure the buyer’s payments with collateral, when possible.
• Consider what happens in the event of default or prepayment.
• Work with a tax advisor to properly calculate gross profit ratios and prepare Form 6252, which must be filed annually.

What if Tax Rates Rise?

With ongoing discussions around future tax reform, some sellers may wonder whether deferring gain is still a smart move. If tax rates increase in the coming years, recognizing all the gain now (by electing out of the installment method) might save money in the long run.

On the other hand, deferring gain may still make sense for those looking to manage their income over time or expecting their personal rates to stay the same or decrease.

Example: Let’s say you're selling a commercial property in late 2025 and anticipate retiring in 2026. You might benefit from deferring gain into future years when your taxable income—and therefore your tax rate—may be lower.

Final Thoughts

An installment sale can be a valuable tool for smoothing income, managing taxes, and improving cash flow. But the rules are complex, and each situation is different.

If you’re considering selling an asset and want to explore your options, consult with a qualified tax professional before finalizing the deal. With careful planning, you may be able to reduce your tax liability and keep more of what you’ve earned.

Have questions about whether an installment sale is right for your situation? Contact Porte Brown today to discuss tax-efficient strategies tailored to your goals.

Understanding the Exclusions

The following types of transactions are not eligible for installment sale reporting:

• Sale of inventory of personal property,
• Sales of personal property by a dealer (a person who regularly sells or otherwise disposes of this type of personal property on the installment basis), unless the property is used or produced in farming,
• Sales of timeshares and residential lots by dealers, unless the buyer elects to pay a special interest charge, and
• Sales of stock or securities traded on an established securities market.

For these types of transactions, you must report the entire gain on the sale in the year in which it occurs.

Navigating Other Tax Hurdles

Beware: The tax law contains some hidden "tax traps" for the unwary when property is sold on the installment sale basis. First, any depreciation claimed on the property must be recaptured as ordinary income to the extent it exceeds the amount allowed under the straight-line method. The adjusted basis of the property is increased by the amount of recaptured income, thereby decreasing the gain realized in future years.

In addition, if the sales price of your property (other than farm property or personal property) exceeds $150,000, interest must be paid on the deferred tax to the extent that your outstanding installment obligations exceed $5 million.

Finally, sales of depreciable property to related parties are prohibited unless you can demonstrate that tax avoidance wasn't a principal purpose of the sale. Furthermore, if the related party disposes of the property within two years, either by resale or some other method, the remaining tax is due immediately.

Important note: The definition of a "related party" isn't limited to immediate family members, such as your spouse, children, grandchildren, siblings and parents. It also includes a partnership or corporation in which you have a controlling interest or an estate or trust that you're connected to. To avoid any negative tax results when deals involve related parties, consider adding a clause that stipulates that the property can't be disposed of within two years.