Selling Real Estate Without a 1031: Spread the Gain Instead

On a $4,000,000 commercial building held for 20 years, with a $1,000,000 adjusted basis after $800,000 of depreciation, spreading the gain over 10 years cuts the total tax from $1,125,457 to $870,084 in California, and from $763,353 to $592,669 in a state that does not tax the gain. Same price, same buyer: each year's slice of the gain lands in lower brackets, and less of it is pushed into the 20% rate and the 3.8% surtax.

This page covers investment real estate in general. For specific property types see mobile home parks, self-storage, rental portfolios, vineyards and orchards.

A $4M commercial property sale: all at once vs. spread over 10 years

How these were run: married filing jointly, $150,000 of other taxable income every year, an investor (not a real estate professional), so the 3.8% net investment income tax applies; 2026 federal and state tables applied to every year; federal alternative minimum tax included. In the spread version the whole price is paid in 10 equal annual installments and the unrecaptured §1250 gain is recognized first, as Treas. Reg. §1.453-12 requires. Washington's capital gains excise does not apply to real estate. Interest on the unpaid balance is extra ordinary income and is not in these figures. Same engine as our calculator, so you can rerun it with your own numbers.

What can be spread, and what is taxed in year one anyway

• Appreciation on land and buildings: long-term capital gain, taxed federally at 0%, 15% or 20%. Spread across the payment schedule.
• Unrecaptured §1250 gain (the straight-line depreciation you took on buildings and other real property): taxed federally at up to 25%. It is also spread, but it comes out first, in the earliest payments (Treas. Reg. §1.453-12).
• Recapture income (§1245 personal property, and any depreciation on real property above straight line, such as bonus depreciation on land improvements): ordinary income in the year of sale, even if no cash arrives that year (IRC §453(i)). A cost segregation study moves more of the price into this bucket.
• Interest on the deferred payments: ordinary income each year it is paid.

How the price is allocated between land, buildings, land improvements and personal property decides how much lands in each bucket, so settle it in the purchase agreement.

Structured installment sale or 1031 exchange?

A 1031 exchange defers the whole gain, recapture included, but only if you buy more real estate of equal or greater value and keep owning it. A structured installment sale fits when you want out: retiring, simplifying an estate, or done with tenants and debt. The two also combine. If you exchange part of the proceeds, cash you take at closing is taxable boot in the year of sale, while the part paid out under a structured installment sale is reported as it arrives. If an exchange is already under way, the exchange agreement limits when you can touch the money (Treas. Reg. §1.1031(k)-1(g)(6)), so talk to your qualified intermediary and CPA before changing course.

Other points specific to real estate

• Your state may tax the gain differently. Hawaii caps the rate on capital gain at 7.25%; Washington's capital gains excise exempts real estate; California, New York, New Jersey and Oregon tax it as ordinary income. See capital gains tax by state.
• Nonresident withholding. Several states (California among them) require the escrow to withhold part of the price when the seller is not a resident or the property is not a residence. Installment sales have their own election forms, so raise it with escrow early.
• Transfer taxes at closing are a cost of sale. They do not change how the installment method works.
• A former home. If you lived in the property for 2 of the last 5 years, the §121 exclusion ($250,000, or $500,000 married filing jointly) may apply to part of the gain first. Depreciation taken after May 6, 1997 is not excluded.
• Debt. A mortgage paid off at closing out of the proceeds counts as a payment in the year of sale.

The rules that keep the deferral intact

• The $5 million line (§453A). If more than $5,000,000 of installment notes from sales over $150,000 are outstanding at year end, an annual interest charge applies to the deferred tax on the excess. Many structures are sized to stay under it.
• No borrowing against the note (§453A(d)). Pledging the installment obligation as collateral is treated as receiving payment.
• Related buyers (§453(e)). If you sell to a related person and they resell within two years, the deferral can accelerate.
• Electing out is a one-way door (§453(d)). The election is due with the return and can be revoked only with IRS consent.
• Earn-outs. A price that depends on future results is a contingent payment sale: with a stated maximum price, basis is recovered as if the maximum is paid; with only a fixed period, evenly over that period; with neither, over 15 years (Treas. Reg. §15a.453-1(c)).

How the structured version works

The buyer pays the full price at closing. The part you choose to defer goes to an assignment company, which funds your payment schedule with a fixed annuity from a highly rated life insurer. You pick the schedule: level payments, a delayed start, a lump in a later year, or a mix. The buyer gets clean title on day one; you get a contract for future payments instead of one large taxable check. Your CPA reports each year's gain on Form 6252.

The trade-off, stated once: money you defer is not available to spend or invest elsewhere until each payment arrives, and the schedule is fixed once it is funded. Most sellers defer part of the price and keep the rest as cash at closing.

When it fits

• A large gain after a long hold, including years of depreciation.
• You want to exit real estate rather than exchange into more of it.
• The buyer pays cash at closing (all-cash or bank-financed).
• The purchase agreement is not signed yet, or can still be amended, so the assignment step can be written in.

When it does not

• You plan a full 1031 into replacement property.
• Most of the gain is recapture income from a cost segregation study, so it is taxed in year one anyway.
• You need every dollar of the proceeds in year one.

Frequently asked

Q: Can I use a structured installment sale on a rental or commercial property instead of a 1031?
A: Yes. The installment method applies to the sale of investment real estate. Instead of buying replacement property, you receive the price over a schedule you choose and report the gain as it is paid.

Q: Does depreciation recapture get spread too?
A: The straight-line part (unrecaptured §1250 gain, taxed at up to 25%) is spread, and it comes out of the earliest payments first. Recapture income from personal property or accelerated depreciation is taxed in the year of sale (IRC §453(i)).

Q: Can I do a 1031 on part of the sale and spread the rest?
A: Yes. The exchanged part defers under §1031. Cash you take at closing is taxable boot that year; the part structured as installment payments is reported as it arrives.

Q: Is there a minimum size?
A: Insurer minimums start around $100,000 of deferred proceeds. The savings grow with the size of the gain and your state rate.

No retainer and no fee to you. On a funded structure, the insurer pays a one-time commission of about 4% of the amount structured to the brokerage firm that places it (Hans's share is about 2.4%; no trail). It is built into the annuity pricing.

Educational, not tax or legal advice. 2026 figures. Your CPA or attorney should confirm the allocation, character and reporting for your sale.