What is taxed in the year of sale in a structured installment sale?

Hans Goldstein structures installment sales for sellers and works alongside their CPAs. Email hans@goldsteinco.net or call 213-340-2018.

What lands on the year-one return?

The mortgage line is the one sellers miss. If your lender is paid at closing, that money was yours: it counts as cash received, and the gross profit ratio applies to it. A buyer assuming your loan is different, and rare in practice, because only the excess over basis is treated as a payment.

What is not taxed in year one?

• The gain inside the structured portion. It is reported as each payment arrives, at the same gross profit ratio.
• Unrecaptured §1250 gain on the structured portion. It spreads, but it comes out first from each payment's gain, ahead of 15% or 20% capital gain (Treas. Reg. §1.453-12). It is taxed at a maximum of 25%.
• Basis recovery. The non-gain part of every payment is a return of your own basis, and basis recovery is tax-free.

You cannot elect "basis first." Every dollar received carries the same ratio of gain.

How does §453(i) change the gross profit ratio?

Recapture income recognized in the year of sale is added to your adjusted basis before the installment method is applied (IRC §453(i)(1)(B)). That matters. If you skip the adjustment, you tax the recapture twice: once in year one under §453(i), and again as part of the gross profit on every payment.

The correct sequence:

1. Total gain = selling price minus adjusted basis (selling expenses reduce the gain).
2. Recapture income = §1245 recapture plus any §1250 additional depreciation. Taxed in full in year one.
3. Gross profit for the installment method = total gain minus recapture income.
4. Gross profit ratio = that gross profit divided by the contract price.

What does this look like with real numbers?

Illustrative facts. A married couple filing jointly sells a commercial building for $3,000,000. Adjusted basis is $1,000,000 after $600,000 of straight-line depreciation on the building and $150,000 of depreciation on cost-segregated personal property. No mortgage, no selling expenses (to keep the arithmetic clean). They take $500,000 in cash at closing and structure $2,500,000 over 10 years, $250,000 of principal a year starting the following year. Other taxable income: $150,000, none of it investment income. A real sale allocates the price between the building and the personal property; your CPA does that allocation.

Year-one taxable sale income: $150,000 of ordinary §1245 recapture plus $308,333 of unrecaptured §1250 gain. No interest has been paid yet.

Year-one tax (federal, 2026 married-filing-jointly brackets, Rev. Proc. 2025-32; state tax extra):

• Federal income tax on the added income: about $110,800. The recapture fills the 22% and 24% brackets; the §1250 gain fills the 24% bracket and then stops at its 25% ceiling.
• NIIT: MAGI of about $608,300 is $358,300 over the threshold, so about $13,600.
• Total: about $124,400, against $500,000 of cash received.

For comparison, the same sale taken all in cash puts the full $2,000,000 gain on one return: about $527,400 federal including NIIT and AMT. In the structured version, the next payment ($250,000 of principal) carries $154,167 of gain, all of it unrecaptured §1250, plus whatever interest is paid that year.

The point of the example: the cost segregation recapture and the first slice of §1250 gain are the year-one bill. Size them before you sign, and keep enough cash at closing to pay them.

Frequently asked

Q: Do I owe tax in year one if I take no cash at closing? A: Possibly. §453(i) recapture is taxed in the year of sale even with zero cash, and a mortgage paid off at closing counts as cash you received. Have your CPA confirm the amount before closing.

Q: Is the mortgage payoff at closing taxed? A: The payoff is treated as cash you received at closing, so the gross profit ratio applies to it. Only a mortgage the buyer assumes is treated differently, and then only the excess over your basis is a year-one payment.

Q: Is unrecaptured §1250 gain taxed in the year of sale? A: Only the part carried by the cash you actually receive that year. The rest spreads with the payments, and it comes out first from each payment's gain under Treas. Reg. §1.453-12.

Q: Does the 3.8% NIIT apply in year one? A: Yes, to the extent your MAGI is over $250,000 MFJ ($200,000 single). Spreading can keep a moderate-income seller under the threshold in later years, but a high-income seller pays it on the gain regardless.

What should you read or run next?

• How are the payments taxed?
• Should I just pay the capital gains tax instead?
• Can I structure only part of my sale?
• Can I use a structured installment sale on a rental property?
• Depreciation recapture and cost segregation and recapture
• Unrecaptured Section 1250 gain
• Gross profit percentage calculator
• All structured installment sale questions

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