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Disposition of an Installment Obligation: Installment Sale Taxes (2025 IRS Guide)

This guide covers “Disposition of an Installment Obligation” within installment sale taxes. The following material presents the IRS treatment of this topic, including the qualifications, exceptions, and examples in the source section. Read the rules alongside the facts of your own situation before deciding what to report, deduct, or document.

Adapted from Publication 537 (2025), Installment Sales, published by the Internal Revenue Service. This guide retains the source edition’s years, amounts, deadlines, and examples. It is guidance for that edition, not a statement that the same figures apply to every tax year.

Context for these rules

The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. The following topics are discussed.

  • Electing out of the installment method.

  • Payments received or considered received.

  • Escrow account.

  • Depreciation recapture income.

  • Sale to a related person.

  • Like-kind exchange.

  • Contingent payment sale.

  • Single sale of several assets.

  • Sale of a business.

  • Unstated interest and OID.

  • Disposition of an installment obligation.

  • Repossession.

  • Interest on deferred tax.

Disposition of an Installment Obligation

A disposition generally includes a sale, exchange, cancellation, bequest, distribution, or transmission of an installment obligation. An installment obligation is the buyer’s note, deed of trust, or other evidence that the buyer will make future payments to you.

If you’re using the installment method and you dispose of the installment obligation, generally you’ll have a gain or loss to report. It’s considered gain or loss on the sale of the property for which you received the installment obligation. If the original installment sale produced ordinary income, the disposition of the obligation will result in ordinary income or loss. If the original sale resulted in a capital gain, the disposition of the obligation will result in a capital gain or loss. If the original installment sale resulted in a section 1231 capital gain (or loss), the disposition of the obligation will result in either a long-term capital gain or an ordinary loss.

Rules To Figure Gain or Loss

Use the following rules to figure your gain or loss from the disposition of an installment obligation.

  • If you sell or exchange the obligation, or you accept less than face value in satisfaction of the obligation, your gain or loss is the difference between your basis in the obligation and the amount you realize.

  • If you dispose of the obligation in any other way, your gain or loss is the difference between your basis in the obligation and its FMV at the time of the disposition. This rule applies, for example, when you give the installment obligation to someone else or cancel the buyer’s debt to you.

Basis.

Figure your basis in an installment obligation by multiplying the unpaid balance on the obligation by your gross profit percentage. Subtract that amount from the unpaid balance. The result is your basis in the installment obligation.

Example.

Several years ago, you sold property on the installment method. The buyer still owes you $10,000 of the sale price. This is the unpaid balance on the buyer’s installment obligation to you. Your gross profit percentage is 60%, so $6,000 (60% (0.60) × $10,000) is the profit owed you on the obligation. The rest of the unpaid balance, $4,000, is your basis in the obligation.

Transfer between spouses or former spouses.

No gain or loss is recognized on the transfer of an installment obligation between spouses or former spouses if the transfer is incident to a divorce. A transfer is incident to a divorce if it occurs within 1 year after the date on which the marriage ends or is related to the end of the marriage. The same tax treatment of the transferred obligation applies to the transferee spouse or former spouse as would have applied to the transferor spouse or former spouse. The basis of the obligation to the transferee spouse (or former spouse) is the adjusted basis of the transferor spouse.

The nonrecognition rule doesn’t apply if the spouse or former spouse receiving the obligation is a nonresident alien.

Gift.

A gift of an installment obligation is a disposition. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you make the gift.

For gifts between spouses or former spouses, see Transfer between spouses or former spouses, earlier.

Cancellation.

If an installment obligation is canceled or otherwise becomes unenforceable, it’s treated as a disposition other than a sale or exchange. Your gain or loss is the difference between your basis in the obligation and its FMV at the time you cancel it. If the parties are related, the FMV of the obligation is considered to be no less than its full face value.

Forgiving part of the buyer’s debt.

If you accept part payment on the balance of the buyer’s installment debt to you and forgive the rest of the debt, you treat the settlement as a disposition of the installment obligation. Your gain or loss is the difference between your basis in the obligation and the amount you realize on the settlement.

No Disposition

The following transactions generally aren’t dispositions.

Reduction of selling price.

If you reduce the selling price but don’t cancel the rest of the buyer’s debt to you, it isn’t considered a disposition of the installment obligation. You must refigure the gross profit percentage and apply it to payments you receive after the reduction. See Selling Price Reduced, earlier.

Assumption.

If the buyer of your property sells it to someone else and you agree to let the new buyer assume the original buyer’s installment obligation, you haven’t disposed of the installment obligation. It isn’t a disposition even if the new buyer pays you a higher rate of interest than the original buyer.

Transfer due to death.

The transfer of an installment obligation (other than to a buyer) as a result of the death of the seller isn’t a disposition. Any unreported gain from the installment obligation isn’t treated as gross income to the decedent. No income is reported on the decedent’s return due to the transfer. Whoever receives the installment obligation as a result of the seller’s death is taxed on the installment payments the same as the seller would have been had the seller lived to receive the payments.

However, if an installment obligation is canceled, becomes unenforceable, or is transferred to the buyer because of the death of the holder of the obligation, it’s a disposition. The estate must figure its gain or loss on the disposition. If the holder and the buyer were related, the FMV of the installment obligation is considered to be no less than its full face value.

Using the guidance

Keep the documents that establish the dates, amounts, and circumstances described above. References to other chapters, forms, worksheets, or earlier and later sections refer to the linked IRS publication. Check the full publication and its updates before relying on a rule for a different tax year or a situation not addressed here.

Sources and further reading

The cited U.S. government text is in the public domain. Source accessed October 28, 2026. Fynoptic has organized this material for educational use and is independent of, and not endorsed by, the IRS.

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