Guide

How Installment Sales Work When You Seller-Finance a Home

When you sell a home and carry the financing yourself, you usually don't owe tax on the whole gain in the year of sale — you recognize it gradually, as payments arrive. That arrangement is called an installment sale. Here's how the math works and what records you need to keep.

This guide is general information, not tax advice. Installment sales have exceptions and edge cases — confirm how the rules apply to your sale with a CPA or tax professional.

Why installment sales exist

Sell a house for cash and you may owe tax on your entire gain that year. Seller-finance the same house, and the IRS generally lets you spread the gain across the years you actually receive principal — that's the installment method (reported on Form 6252). For many sellers this is a core reason to carry the note: steady income, and the tax bill arrives in pieces alongside the payments instead of all at once.

The key number: gross profit percentage

Everything hinges on one ratio, set at the time of sale. Your gross profit is roughly the sale price minus your basis in the property (what you paid plus improvements, minus depreciation taken) and selling expenses. Divide gross profit by the contract price and you get the gross profit percentage — the slice of every principal dollar you receive that counts as taxable gain.

How each payment splits three ways

Every payment your buyer makes contains up to three different things for tax purposes, and they're treated completely differently. Interest is ordinary income, taxed in the year received — it is not part of the installment calculation at all. The principal portion then splits by the gross profit percentage: that fraction is recognized gain, and the remainder is a tax-free return of your own basis. This is why keeping a clean amortization schedule matters so much — you cannot do the split without knowing exactly how much of each payment was interest versus principal.

A worked example

Say you sell a rental house for $300,000 that you own with a $200,000 basis, and you carry the full note. Your gross profit is $100,000 and your gross profit percentage is roughly 33%. In a year where your buyer pays $12,000 of principal and $15,000 of interest, you'd recognize about $4,000 of gain (33% of the principal), treat about $8,000 as tax-free return of basis, and report the $15,000 of interest as ordinary income. Real sales add wrinkles — selling expenses, assumed mortgages, and depreciation recapture (which is generally recognized in the year of sale, not spread out) — which is exactly where a CPA earns their fee.

The records you need to keep

To file Form 6252 each year, you or your preparer needs: the sale price, your basis and selling expenses (fixed at closing), and — every single year — the total principal and total interest actually received that calendar year. Note that's cash-basis: what arrived during the year, not what was scheduled. A payment due December 28 but received January 3 belongs to the new year. Sloppy payment records are how installment sale reporting goes wrong.

Keeping the numbers straight

You can track all of this by hand: an amortization schedule (our free amortization calculator will generate one), a log of every payment received with its date, and a running principal/interest split. LoanLoop automates the bookkeeping side: mark a loan as a seller-financed installment sale, enter your sale price and cost basis, and it computes the gross profit percentage and allocates every recorded payment between interest, return of basis, and gain — including in year-end summaries your CPA can work from. For the broader record-keeping picture, see how to track a seller-financed loan.