Can a structured installment sale plus a seller carryback note close the gap when the buyer is short?

Hans Goldstein structures installment sales for sellers and works alongside their CPAs, attorneys and brokers. Email hans@goldsteinco.net or call 213-414-2808.

Why does the gap close at a lower price?

A cash seller pays the whole tax bill in the year of sale. A structured seller pays tax as payments arrive, so the money that would have gone to tax keeps earning for the seller for years. That is why the same after-tax result can be reached at a lower price.

The trouble is that the buyer who is short at the asking price is usually short of cash, too. A structured installment sale still needs the buyer to pay in full at closing: the part of the price that is structured goes to an assignment company, which takes on the obligation to pay the seller and funds it with a fixed annuity from an insurer. If the sellers need a price above what the buyer can bring to closing, the difference has to come from somewhere. A modest carryback note from the seller is the bridge.

How do the two pieces fit together?

• The structured portion is funded at closing from the buyer's money: their cash and their lender's loan. The buyer is fully paid up on this part the day escrow closes. The seller is not the lender here, which is why a structured sale is not seller financing.
• The carryback note is the buyer's own promise to pay the rest later, secured by a second deed of trust on the property, behind the buyer's lender. This part is seller financing, plainly: the seller is lending to the buyer.

Under IRC §453, both are payments received after the year of sale on a single disposition, so this is one installment sale, not two. Section 453(c) reports gain as the share of each year's payments that "the gross profit ... bears to the total contract price." One sale, one contract price, one ratio. The cash kept at closing, each structured payment's principal and each dollar of note principal all carry gain at the same percentage. Receiving the buyer's note is not itself a payment (Treas. Reg. §15a.453-1(b)(3)); the gain on it is reported as the buyer pays it.

An illustrative example: $7.0 million ask, $5.0 million on the table

Hypothetical, rounded, not a real deal. A California farm held for decades by an LLC taxed as a partnership, owned by four equal members, each married filing jointly with about $100,000 of other income. The LLC asks $7.0 million. The best buyer can bring $5.0 million at closing: a $3.0 million agricultural loan plus $2.0 million of cash. The sellers want $7.0 million.

Assumptions, all illustrative: adjusted basis $1.0 million; $200,000 of past depreciation on vines, irrigation and equipment that is §1245 recapture; selling costs of 5% commission, 0.5% escrow and title, and county transfer tax. Federal tax, California tax and the 3.8% net investment income tax, figured for each member with the advanced calculator's engine and added up. The structured payments run 20 years at an illustrative 5% payout rate. The proposal: a $5.5 million price. The buyer's $5.0 million at closing pays the selling costs, puts $500,000 of cash in the LLC's hands and funds a $4.19 million structured sale. The other $500,000 is a carryback note at 6%, interest only, due in full in year five.

How the last column was built:

• Gross profit ratio. Gross profit is $5,500,000 minus $1,000,000 of basis minus $308,550 of selling costs = $4,191,450. The $200,000 of recapture comes out of the ratio because it is taxed up front (below). Ratio = $3,991,450 / $5,500,000 = 72.6%.
• Year one. $200,000 of recapture, plus 72.6% of the money paid at closing that is not structured (the $500,000 kept and the $308,550 of selling costs paid from it), plus 72.6% of the first structured payment's principal: about $879,000 of gain and about $220,000 of tax across the four members. The $500,000 of cash covers it.
• Years 1 to 20. The structured sale pays about $336,000 a year. Each payment's principal carries 72.6% gain; the interest in it is ordinary income.
• The note. $30,000 of interest a year, then $500,000 of principal in year five, which carries 72.6% gain: about $363,000.
• The comparison. Cash kept plus structured principal plus the note's face, minus the present value of the gain tax at 5%: $500,000 + $4,191,450 + $500,000 minus about $453,000 = about $4,739,000, against about $4,719,000 for $7.0 million in cash. Interest on both sides (the payments' interest here, the reinvested proceeds' interest on the cash side) is taxed as earned and left out of both columns.

Two honest limits on the example. It is sensitive to the members' own tax brackets: with $250,000 of other income each, the same $5.5 million structure lands about $245,000 short of the $7.0 million cash figure, and matching it takes a price of about $5.84 million (a note near $836,000). It applies the 3.8% net investment income tax to every member; members who materially participate in the farming may not owe it. And it counts the note at face value; a second-position note carries the buyer's credit risk, which the structured payments do not. On this example the structured sale alone matches $7.0 million in cash at about $5.4 million, which is more than the buyer can bring to closing. That shortfall is the note's whole job: keep it as small as the math allows.

The California figures in the example above were run on the FTB 2025 California rate schedule. The calculators on this site now use the 2026 schedule (FTB Tax News, October 2026), so a rerun today gives slightly different numbers.

What has to line up for the note to work?

The buyer's lender has to consent. A second deed of trust behind an agricultural or commercial first loan is subordinate financing, and the first lender's documents almost always require written approval. Farm Credit lenders, for example, must hold a first lien on their own long-term real estate loans and cap them at 85% of appraised value (12 CFR §614.4200), so a seller's note can only sit second, behind them. Expect a subordination or intercreditor agreement: the seller agrees not to foreclose or collect while the first loan is in default, and the lender looks at combined loan-to-value and whether the buyer borrowed the down payment. FSA's Down Payment program is built for seller and lender partnerships but caps its own loan at 45% of the price, up to $667,000 (7 CFR §764.203), so at this size it is a small piece. Get the consent into the loan commitment before the purchase agreement is final.

The note needs adequate stated interest. If the note's rate is below the applicable federal rate, part of what the contract calls principal is recharacterized as interest, which is ordinary income instead of capital gain (IRC §1274; IRC §483). A five-year note is tested against the mid-term rate, and for a sale the seller may use the lowest rate in the three months ending with the month of the binding written contract (§1274(d)(2)). As of October 2026 the mid-term AFR was 4.61% with annual compounding (IRS Rev. Rul. 2026-19), so the example's 6% clears it. The special farm exception in §1274(c)(3)(A) only covers farm sales of $1,000,000 or less, so it does not help at this price.

The structured sale's insurer has to approve the note. The insurer behind the assignment company reviews the purchase agreement before it funds, so disclose the seller note up front and let that review shape its terms. Raise it at the first call, not in escrow. The sellers should also hold no claim on the funding itself: a buyer note secured by cash or a cash equivalent counts as a payment received (Treas. Reg. §15a.453-1(b)(3)).

The recapture is due in year one. §453(i) makes §1245 and §1250 recapture taxable in the year of sale no matter how the price is paid. On a vineyard that usually means the vines (10-year property under §168(e)(3)(D)(ii)), trellis, drip irrigation, pumps and equipment; the land itself carries no recapture. Any unrecaptured §1250 gain on farm buildings is not forced into year one, but it comes out of the payments first (Treas. Reg. §1.453-12). Your CPA allocates the price across those assets. Size the cash at closing so it covers that year's tax with room to spare. See depreciation recapture in an installment sale.

Where does §453A come in?

IRC §453A has two parts, with different triggers.

• The interest charge applies only for a year in which the face amount of installment obligations that arose that year and are still outstanding at year end exceeds $5,000,000 (§453A(b)(2)). Then interest is owed on the deferred tax on the share above $5 million. In the example, the structured sale plus the note come to about $4.69 million, under the line. For an LLC taxed as a partnership, the IRS has each member figure the charge from their own share: the LLC reports the §453A information on each member's K-1 (Schedule K-1 instructions, code P). Four members at about $1.17 million each are far below $5 million. More on the §453A interest charge.
• The pledge rule has no $5 million threshold. It reaches any obligation from a sale over $150,000: if the seller borrows against the structured payments or the note, the loan proceeds are treated as a payment received, and the gain comes due (§453A(d)).
• Farm property is outside §453A entirely. §453A(b)(3)(B) excludes an obligation from the disposition "of any property used or produced in the trade or business of farming," as defined in §2032A(e)(4) and (5), which counts orchards and the raising of horticultural commodities. A working farm sale escapes both the interest charge and the pledge rule. Whether a farm the owners lease to an operator qualifies is a question for your CPA.

How should a multi-owner LLC think about it?

The LLC is the seller. It holds title, signs the purchase agreement, and reports the installment sale on its own return. Each member then reports their share of each year's gain from the LLC's Schedule K-1. Elections that affect the LLC's taxable income are the LLC's to make, not each member's (IRC §703(b)), so the installment method, or electing out of it under §453(d), is one decision for everyone. Inside one LLC, every member rides the same schedule in proportion to their share, unless the operating agreement and a tax attorney build something more custom.

The alternative: distribute first. If the members want different outcomes (one wants cash, one wants a structured sale, one wants a 1031 exchange), the LLC can distribute the property to them as tenants in common, so each owner sells their own undivided interest. A distribution of property by a partnership is generally not taxable (IRC §731(a)), with exceptions if a member contributed the property, or other appreciated property, within the last seven years (§704(c)(1)(B) and §737), or if the steps look like a disguised sale (§707(a)(2)(B)). The bigger catch is timing. In Commissioner v. Court Holding Co., 324 U.S. 331 (1945), a corporation negotiated a sale, then distributed the building to its shareholders, who closed on the same terms, and the Court taxed the sale to the corporation: "A sale by one person cannot be transformed for tax purposes into a sale by another by using the latter as a conduit through which to pass title." In United States v. Cumberland Public Service Co., 338 U.S. 451 (1950), a genuine distribution before the entity negotiated anything was respected. Courts apply the same step-transaction thinking to partnerships, and it is the same concern brokers know from the "drop and swap" before a 1031. No rule says how long is long enough, and California's Franchise Tax Board has challenged late distributions before a sale. Once the LLC has listed the property and is negotiating with a buyer, the facts already look like Court Holding. If the members want to go this way, it belongs with a tax attorney well before a letter of intent, and it brings its own questions: lender consent, title, and California withholding. An LLC taxed as a partnership is generally exempt from California's real estate withholding when it sells in its own name (FTB Form 593 instructions, line 7); members selling as individuals generally are not, and on an installment sale the buyer withholds 3 1/3% of the down payment and of the principal in each later payment unless the seller elects out.

The payee has to last as long as the payments. In a 20-year structured sale held by the LLC, the LLC is the payee for 20 years. Keep it in good standing, file its returns and pay its annual California LLC tax every year. Distributing an installment obligation from a partnership to its members is generally not a taxable disposition (Treas. Reg. §1.453-9(c)(2), subject to §736 and §751), but whether the structured contract allows a change of payee is up to the assignment company, and the payments can't be accelerated or cashed out. So plan for the LLC to outlive the schedule, or choose the tenants-in-common route early so each member is their own payee.

What are the trade-offs?

Stated once. The structured payments are locked in once set and can't be accelerated or cashed out. They depend on the assignment company and the insurer behind it. There is no published IRS ruling on this specific structure, so your CPA should review it. A commission, about 4% of the amount structured and paid by the insurer, is built into the pricing. The interest in each payment, and on the note, is ordinary income. The note is a loan to the buyer behind their lender: in California a seller's purchase-money note can't be collected as a deficiency (CCP §580b), so if the buyer defaults, the sellers' remedy is the property, and a foreclosure by the first lender can wipe out the second unless the sellers cure it. A smaller note is a better note. And everything here must be written into the purchase agreement before closing.

This is education, not tax or legal advice. Work with your CPA and attorney on your own facts.

Run the structured side with your own numbers in the advanced calculator, or send Hans the deal and he will lay out the price, the note and the tax for the members' CPA and attorney.

Frequently asked

Q: Is this two installment sales, one structured and one with a note? A: No. It is one sale with one contract price and one gross profit ratio. The cash at closing, the structured payments and the note payments all carry gain at the same percentage as they are received.

Q: Is the structured part seller financing? A: No. The buyer pays that part in full at closing, and an assignment company pays the seller on a fixed schedule funded by an annuity. Only the carryback note is a loan to the buyer. See structured sale vs seller financing.

Q: What interest rate does the carryback note need? A: At least the applicable federal rate for its term, or part of the principal is treated as interest. For a five-year note that is the mid-term rate, 4.61% annual in October 2026, and the seller can use the lowest rate of the three months ending with the month the contract is signed.

Q: Does §453A apply to a farm sale over $5 million? A: Not if the property was used in the trade or business of farming. §453A(b)(3)(B) takes those obligations out of both the interest charge and the pledge rule. If the LLC leases the vineyard to an operator rather than farming it, there is no clear guidance either way, so your CPA confirms the property qualifies. For a partnership, the $5 million test is also applied member by member.

Q: Can one LLC member take cash while the others structure? A: Not cleanly inside one LLC, because the LLC is the seller and makes one installment decision. The usual path is distributing the property to the members as tenants in common well before any sale is negotiated, with a tax attorney, so each owner sells and decides separately.

What should you read or run next?

• How a structured sale shows up on the title report, escrow instructions and closing statement
• Advanced calculator
• Selling a farm or ranch with a structured sale
• Selling a vineyard and deferring capital gains
• The §453A interest charge
• Seller financing tax implications
• What is taxed in year one
• How to bring it up with your listing agent

Who wrote this?