An installment sale is a type of sale where a property owner can sell a piece of property or asset while the buyer spreads out the payment for that asset over time. In a traditional sale, the owner of the property would expect to be paid outright, but an installment sale gives the buyer longer to pay and has the benefit of lowering capital gains taxes or federal income tax for the seller.
The Internal Revenue Service states that an installment sale is one in which the seller receives at least one payment after the initial tax year of the sale. For example, if you sell your property in October and take two payments, one in October and one in January, then that’s an installment sale.
Why would a seller want an installment sale?
The best reason for an installment sale is the tax savings. Depending on how long the installments are stretched out, you may save on your taxes for one, two or more years, reducing your capital gains tax rate during those tax years.
By taking installments, you can reduce your adjusted gross income, which may help you stay at a lower tax rate overall. Additionally, each installment will be taxed in the year when it’s received, which helps you reduce the amount of tax owed at the end of each year. One caveat to that logic is that if you are considered a “Dealer” in real estate under I.R.C. Section 1221, all gain is recognized at the time of the sale, and is taxed as ordinary income.
Sellers also sometimes use installment sales to offload a property that’s been difficult to sell. The installment process may open the door for buyers who could not otherwise afford the purchase.
Are there any reasons not to want to have an installment sale?
The primary reason not to have an installment sale is that you’ll have to calculate how much you receive in gains and profits each year from the installments. Additionally, you won’t get all of the profits upfront, which is what some people want.
An installment sale may be right for you, but you should look into the legal implications before deciding. Speaking to a real estate attorney can help you learn more.