Down payment that just covers year-one tax: $0. Recapture income is taxed in the year of sale under Section 453(i); the rest of the gain follows the gross profit ratio, unrecaptured 1250 gain first. Engine: federal, state, NIIT and AMT at 2026 law. Ignores selling costs, interest income and estimated tax timing. Education only.
How it works, in plain English
An installment sale lets you report gain as the buyer pays you. Section 453(i) carves one piece out of that deferral: recapture income. That is the amount that would be ordinary income under Section 1245 or Section 1250 (or the matching part of Section 751 for a partnership interest) if the whole price were paid in the year of sale. It is reported in full in the year of the sale, whether or not you received a dollar.
- Step 1. Figure the recapture on Form 4797, Part III, as if it were a cash sale.
- Step 2. Report that recapture as ordinary income in the year of sale (Form 4797, Part II).
- Step 3. Add the recapture to your basis for the installment computation. Only the gain above the recapture goes through Form 6252 and is taxed as payments arrive.
The basis step matters. Because the recapture has already been taxed, it is added to basis so the same dollars are not taxed twice. That lowers the gross profit percentage on every later payment.
What counts as recapture, and what does not
Counts: Section 1245 recapture
Gain on Section 1245 property is ordinary income up to the depreciation taken. That covers machinery, equipment, vehicles, furniture and fixtures, most purchased intangibles amortized under Section 197, and amounts expensed under Section 179 or bonus depreciation. It also covers the components a cost segregation study moved out of a building into 5-year and 7-year personal property. Those fast write-offs come back as year-1 ordinary income on a sale.
Counts: Section 1250 additional depreciation
For real property, Section 1250 recaptures only additional depreciation: depreciation in excess of straight line. Land improvements and other Section 1250 property depreciated with an accelerated method or bonus depreciation can produce it. Buildings placed in service after 1986 are depreciated straight line, so a plain building sale usually has no Section 1250 recapture income at all.
Does not count: unrecaptured Section 1250 gain
Straight-line depreciation on a building creates unrecaptured Section 1250 gain, taxed at a maximum 25% federal rate. It is not recapture income under 453(i), so it is spread with the payments like other gain. Treas. Reg. 1.453-12 says it is taken into account first, before the 20% gain, as installment payments come in. So early payments on a building sale carry the 25% layer.
A related trap
A sale of depreciable property to a related party can be all ordinary income under Section 1239, and Section 453(g) generally denies the installment method for those sales. See the related-party installment sale analysis.
Who it fits, and who it does not
- Hits hardest: owners of trucking, construction, manufacturing, medical and dental practices, restaurants and other equipment-heavy businesses, especially after years of Section 179 and bonus depreciation.
- Hits hard: real estate owners who ran a cost segregation study and took bonus depreciation on the reclassified components.
- Hits lightly: sellers of a straight-line building, raw land or a business whose value is mostly goodwill. Most of their gain spreads.
- Does not apply: a sale with no depreciable property, or gain that is all capital gain on assets never depreciated.
The more of the price that is allocated to depreciated equipment, the bigger the year-1 bill. Buyers usually want more price on equipment (faster write-offs for them); sellers usually want more on goodwill. The purchase price allocation on Form 8594 is where that is decided, and both sides should file consistent numbers.
Worked example (engine-computed)
Assumptions (illustrative): married filing jointly, tax year 2026, no other income, seller materially participated in the business (so no net investment income tax on the sale gain). Asset sale of an operating business for $3,000,000, no selling costs shown. Equipment: allocated price $900,000, original cost $1,200,000, depreciation taken $1,000,000, adjusted basis $200,000. Goodwill: allocated price $2,100,000, basis $0.
- Section 1245 recapture: $700,000 (the lesser of the $1,000,000 depreciation or the $700,000 equipment gain).
- Basis for the installment computation: $200,000 + $700,000 recapture = $900,000.
- Gross profit: $3,000,000 minus $900,000 = $2,100,000. Gross profit percentage: 70%.
- So 70 cents of each principal dollar is long-term capital gain, and the $700,000 is taxed in year one regardless.
| Year-1 result | Federal tax (no state tax) | Federal plus California |
|---|---|---|
| Cash sale, all $3,000,000 at closing | $611,110 | $933,665 |
| Installment sale, $0 down | $171,269 | $228,184 |
| Installment sale, $300,000 down (10%) | $213,269 | $291,341 |
| Installment sale, $600,000 down (20%) | $255,269 | $358,157 |
| Down payment that just covers year-1 tax | about $199,149 | about $288,921 |
Read the second row twice: with no down payment, the seller owes $171,269 of federal tax in year one with zero cash received. That is the federal tax on the $700,000 of recapture alone. In California the state adds about $56,900 more.
Later years. With 20% down and a $2,400,000 note paid $240,000 a year, each year carries $168,000 of capital gain (70% of $240,000). If the note bears 6% interest (an assumption; the rate must be at least the applicable federal rate), year two also has $144,000 of interest income. The engine puts federal tax for year two at $41,576, including $2,356 of net investment income tax on the interest, with no state tax.
Engine: yearTax with r1245, ltcg and activeBusiness, 2026 brackets from Rev. Proc. 2025-32. State results depend on state rules and change with your facts.
How to size the down payment
The year-1 tax has two parts: tax on all the recapture, plus tax on the gross profit percentage times the down payment. A down payment covers the bill when:
Down payment ≥ tax on (recapture + gross profit % × down payment)
Because the recapture is taxed no matter what, the recapture tax is the floor. In the example, any down payment under about $199,149 (federal only) or $288,921 (with California) leaves the seller paying tax out of pocket. Practical rules:
- Compute the recapture first, from the actual depreciation schedules and the agreed allocation.
- Ask for at least enough cash at closing to pay the year-1 federal and state tax, plus estimated tax timing for that year.
- Add a cushion. A larger down payment also gives the buyer more at stake, which protects the note.
- Pay attention to estimated taxes. Recapture is income in the quarter of the sale, so plan the safe harbor payments.
The estimator on this page runs the same math. For the full side-by-side, see compare scenarios and the variables explorer.
Where it goes on the forms
| Form and line | What goes there |
|---|---|
| Form 4797, Part III (line 31) | Recapture figured as if fully paid in the year of sale |
| Form 4797, Part II | Recapture reported as ordinary income in the year of sale |
| Form 6252, line 5 | Selling price |
| Form 6252, lines 8 to 10 | Cost basis, depreciation allowed or allowable, adjusted basis |
| Form 6252, line 12 | Income recapture from Form 4797, Part III |
| Form 6252, line 13 | Adjusted basis plus selling expenses plus recapture |
| Form 6252, lines 16 and 19 | Gross profit and gross profit percentage (after recapture) |
| Form 6252, line 24 | Installment sale income for the year (payments times line 19) |
For a multi-asset business sale, the IRS treats it as a sale of each asset. Form 8594 reports the allocation, and many preparers file separate Forms 6252 by asset class. IRS Publication 537 includes a worked business-sale example.
IRS stance and audit risk
This is settled law, not a planning strategy with gray areas. Section 453(i) has been in the Code since 1984. The audit exposure is in execution:
- Leaving recapture on the installment schedule. A common error is spreading all the gain, including the recapture. The IRS adjusts it back into the year of sale, with interest and possible penalties.
- Allocation fights. Seller and buyer Forms 8594 that do not match invite review. An allocation that pushes value away from equipment needs support, such as an appraisal.
- Missed recapture on cost-segregated components. Reclassified assets must be tracked and recaptured as Section 1245 property.
- Unrecaptured Section 1250 ordering. Reg. 1.453-12 requires the 25% gain first. Reporting it last understates early-year tax.
Costs and fees
The rule itself has no fee. The cost is cash: tax due in year one before the buyer has paid much. Other costs are ordinary deal costs: a purchase price allocation study or equipment appraisal if values are contested, your CPA's preparation of Forms 4797, 6252 and 8594, and legal fees to document and secure the note. A modest prepayment of estimated tax can avoid an underpayment penalty for the year of sale.
How it compares with a Section 453 installment sale
This is not an alternative to a Section 453 installment sale. It is a limit inside one. Compared with a cash sale, the installment method still defers the capital gain portion, which in the example is $2,100,000 of the $2,800,000 total gain. What it does not defer is the $700,000 of recapture. Other paths treat recapture differently:
- 1031 exchange: real property only after 2017. Recapture on the building is generally deferred along with the gain when like-kind real property is acquired, but equipment and other personal property no longer qualify.
- Opportunity Zones: Section 1245 and 1250 recapture cannot be deferred into a qualified opportunity fund.
- Electing out: taxes everything in year one; sometimes useful when year one is a low-income year.
- Seller financing terms: the down payment, security interest, UCC lien on business assets and personal guarantee from the buyer's owners protect the note whose tax you have partly prepaid.
What to know
Recapture is taxed in the year of sale no matter how little the buyer pays at closing, so a low down payment can leave you paying tax from other funds. If the buyer later defaults, you have already paid tax on recapture you may never collect; for personal property there is no Section 1038 repossession relief, so the result runs through bad debt and repossession rules. Price allocation drives the bill, and it must match the buyer's filing. Your CPA should confirm the recapture from the actual depreciation records before the deal terms are set.
Frequently asked questions
Is depreciation recapture taxed in the year of an installment sale?
Can I spread unrecaptured Section 1250 gain on an installment sale?
How does recapture change the gross profit percentage?
How big should my down payment be?
Does cost segregation make recapture worse on an installment sale?
Is recapture subject to the net investment income tax?
Can I avoid recapture by selling stock instead of assets?
Sources
- IRC 453, including 453(i) (Cornell LII)
- IRC 1245 (Cornell LII)
- IRC 1250 (Cornell LII)
- Treas. Reg. 1.453-12 (Cornell LII)
- IRS Publication 537, Installment Sales
- IRS Publication 544, Sales and Other Dispositions of Assets
- About Form 6252 (IRS)
- Instructions for Form 4797 (IRS)
- About Form 8594 (IRS)
- IRC 751 (Cornell LII)
Last reviewed October 3, 2026. Education only, not legal or tax advice.
Keep comparing
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ReadSeller financing
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ReadElecting out of the installment method
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ReadSection 453A interest charge
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ReadKnow your number before you sign.
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