Deferring Capital Gains Taxes Through Installment Sales

Selling property through an installment sales plan can enable a taxpayer to defer the payment of capital gains taxes much like a 1031 Property Exchange allows them to do. A gain on an installment sale is calculated the same way as a gain on a normal sale of real estate except that the tax burden gets spread over the length of the installment sales contract. The gain is calculated as follows;

Gross Sales Price

-Cost of Sale

= Net Sales Price

-Adjusted Book Value

Capital Gain

The installment sales provision in the tax law was originally created to enable people to purchase property that could not afford to purchase it all at once. By allowing them to purchase it over a period of time, the seller of the real estate only receives part of the proceeds from sale in the first year. This creates the possibility that the seller could owe more taxes in the year of sale than they received as sales proceeds from the buyer. Since this was a possibility, the installment sales provision was created and sellers now only have to pay taxes as installment proceeds are received.

With this possibility, installment sales can be structured so that the seller can postpone portions of their tax liability. This can be utilized to the sellers advantage if structured properly. For instance, a seller could structure the deal so that they would receive more of the sales proceeds during a year that they are also recognizing substantial losses from other investments. Another way a seller can benefit from an installment sale is by structuring the deal so that they receive more of the sales proceeds in years when they are in a lower tax bracket and less of the sales proceeds in years when they are on higher tax brackets. This can be particularly advantageous to sellers that are close to retirement.