Installment Sale Calculator

The calculation itself

The installment method spreads gain across the years payments arrive rather than reporting all of it in the year of sale. What controls the split is a single ratio: gross profit divided by contract price, called the gross profit percentage.

Gross profit is the selling price less your adjusted basis, less selling expenses, less any depreciation recapture. Contract price is the selling price less any mortgage the buyer assumes — money you never receive cannot be part of what you are being paid.

Every dollar of principal you then collect carries that percentage as taxable gain. The rest is return of capital and is not taxed at all.

In practice

A $500,000 sale against a $200,000 basis with $25,000 of selling costs produces $275,000 of gross profit. With no mortgage assumed, the contract price is the full $500,000 and the gross profit percentage is 55%.

A $100,000 down payment at closing therefore carries $55,000 of taxable gain, not $100,000. At a 20% capital gains rate that is $11,000 of tax in the year of sale, against $55,000 if the whole gain had been reported at once.

The remaining $400,000 becomes a note. At 6% over ten years the level payment is $54,347.18, of which $24,000 is interest in the first year and the balance is principal carrying gain at the same 55%.

Across the full ten years the gain recognised comes to exactly $275,000. Deferral changes when the tax is paid, never how much gain there is.

The mortgage rule almost everyone gets wrong

If the buyer assumes debt, that debt comes out of the contract price, which raises the gross profit percentage — the same gain now rides on fewer dollars of payment.

But when the assumed mortgage exceeds your basis plus selling costs, the excess is treated as a payment received in the year of sale even though no cash changed hands. You have been relieved of more debt than you had invested, and the tax code treats that relief as proceeds.

On a $100,000 sale with a $40,000 basis, $5,000 of costs and a $60,000 mortgage assumed, the excess is $15,000. Contract price becomes $100,000 − $60,000 + $15,000 = $55,000, and the gross profit percentage comes out at exactly 100%.

That is the correct answer rather than an error. Every dollar you receive from that point is gain, because the debt assumption has already returned your entire investment. Omitting the add-back would produce a percentage above 100%, which is the usual sign the calculation has gone wrong.

Recapture does not defer

Depreciation you took against ordinary income comes back as ordinary income in the year of sale, in full, regardless of how little cash you received that year.

This is the surprise that ruins seller-financed deals structured with a small down payment. A property with $80,000 of accumulated depreciation and a $20,000 down payment can generate a recapture bill larger than the entire first-year payment.

Recapture also increases the subtraction from selling price, so it lowers the gain available to defer one dollar for one. It moves gain out of the installment method and into the year of sale rather than adding to the total.

Where the figure deceives

Interest is not gain. It is ordinary income each year, taxed at your ordinary rate, and it never runs through the gross profit percentage. Applying the percentage to a whole payment overstates the gain and the tax substantially.

Deferral is not free either. You are extending unsecured credit to the buyer, and a default returns the property in whatever condition it is then in, with the tax already paid on payments received. The interest rate on the note is compensation for that risk, not a bonus.

And later dollars are worth less. Discounting the after-tax payments back to today is what settles whether deferring beat taking the cash — at a high enough discount rate, the lump sum wins even after the larger tax bill.

Acting on it

Calculate the year-of-sale tax before agreeing the down payment, and make sure the down payment covers it. Recapture plus the gain on the down payment is the floor.

Compare the present value of the after-tax installment stream against the after-tax lump sum at a discount rate that reflects what you would do with the money. If they are close, take the cash — the certainty is worth the difference.

Model the buyer defaulting in year three as well as the deal running to term. If that scenario is unacceptable, the structure needs more security rather than a higher rate.

This is arithmetic, not tax advice. Related-party sales, dealer property, and the interest charge on large deferred balances all have their own rules that no calculator can apply for you.