Structured installment sale vs 1031 exchange: how each one handles the tax
By Hans Goldstein, EA, founder, Retirement Literacy Foundation · Updated
Admitted to practice before the IRS.
Two different ideas
A 1031 exchange (IRC 1031) keeps your money in real estate. A qualified intermediary holds the sale proceeds, you name replacement property within 45 days and close within 180, and the gain is postponed. Your old basis carries into the new property, so the tax waits there until a later taxable sale, or disappears if the property is held until death and gets a stepped-up basis.
A structured installment sale takes your money out of real estate. The buyer pays the full price at closing, but before closing you agree to receive your share as scheduled payments from a third-party assignment company, which funds them with a contract from a life insurance company. Because you never had the cash, the gain is reported under the installment method (IRC 453) as payments arrive.
A worked example
Assumptions: a married couple filing jointly, $60,000 of other ordinary income each year, no state income tax. They sell a rental for $1,000,000 with an adjusted basis of $400,000 after $200,000 of depreciation. The gain is $600,000: $200,000 of unrecaptured Section 1250 gain and $400,000 of long-term capital gain.
| Cash sale | 1031 exchange | Structured sale, 10 years | 1031 plus structured sale of $300,000 | |
|---|---|---|---|---|
| Tax on the gain in the first year | $113,313 | $0 | $5,462 | $2,731 |
| Tax on the gain, all years | $113,313 | $0 now, $600,000 postponed | $25,089 | $23,999, plus $300,000 postponed |
| Part from depreciation recapture (up to 25%) | $37,028 | Postponed | $24,000 | $23,999 |
| Part from the 3.8% NIIT | $15,580 | $0 | $0 | $0 |
| Interest earned in the payments, and tax on it | None | None | $358,681, taxed $72,028 | $107,603, taxed $12,911 |
| What the seller ends up with | $886,687 cash after tax | Another property | $135,868 a year for 10 years | A $700,000 property plus $40,760 a year |
Figures are the federal income tax and 3.8% net investment income tax added by the sale, computed with 2026 federal brackets (IRS Rev. Proc. 2025-32) held flat for every payment year, standard deduction applied, no state tax. The 6% payout rate is an assumption for illustration, not a quote or an offer.
Depreciation recapture
The $200,000 of depreciation taken over the years is taxed at your ordinary rate, capped at 25% (IRC 1(h)(6)). In an installment sale it is reported first, before the rest of the gain (Treas. Reg. 1.453-12). Depreciation on equipment and other Section 1245 property is different: it is taxed in the year of sale even when payments are spread (IRC 453(i)). See the guide to unrecaptured Section 1250 gain.
Does the interest change the answer?
The payments include interest, and interest is taxed as ordinary income. A fair comparison lets the cash seller invest the after-tax proceeds at the same 6% and pay tax on that interest too. On that basis, after 10 years the structured seller has $1,541,473 and the cash seller $1,490,370, a gap of $51,102. A higher return on the invested cash would narrow it or reverse it.
Combining the two
A seller who wants some real estate but not all of it can exchange part of the proceeds and take the rest as a structured sale. The part not reinvested is boot, taxed up to the gain (IRC 1031(b)); if it is paid in installments arranged before closing, it is reported as it arrives (IRC 453(f)(6)). Here, $300,000 of boot would add $56,208 of tax as cash at closing, or $23,999 spread over 10 years.
Costs and risks to weigh
- It must be arranged before closing. Once the seller or the intermediary has the cash, the gain cannot be spread.
- It cannot be undone. The payments cannot be sped up, sold or borrowed against; a pledge is treated as a payment (IRC 453A(d)).
- Credit risk. The payments depend on the financial strength of the insurer behind the assignment company.
- Built-in costs. The payout rate already reflects the issuer's costs and any sales commission, so compare it with what you could earn yourself.
- Large sales. Installment obligations over $5,000,000 at year end can trigger an interest charge on the deferred tax (IRC 453A).
- At death. Remaining payments go to beneficiaries, and the gain in them is still taxable to them (IRC 691); there is no step-up.
- A 1031 has its own risks: strict deadlines, pressure to overpay for a replacement, and staying a landlord.
Gray areas
Reasonable tax professionals disagree on these points. Both views are shown; neither is a recommendation.
Is the seller in constructive receipt?
One view: If the buyer's obligation is assigned to a third party under terms signed before closing, and the seller has no right to the funds, the installment method applies. Constructive receipt requires money the seller could draw on (Treas. Reg. 1.451-2).
The other view: No revenue ruling or regulation addresses this structure by name, so the IRS could argue the seller had the economic benefit of the cash at closing.
Common ground: The terms must be set before closing, and the seller must not hold, pledge or direct the funding asset.
How is boot gain split in a combined deal?
One view: Treat recognized boot gain as recapture first, up to the depreciation taken. The example above uses this conservative view.
The other view: Allocate the recognized gain pro rata between recapture and long-term gain, which lowers the tax.
Common ground: The boot is taxable up to the gain either way; only the rate mix differs.
Related guides: 1031 vs DST vs installment sale and suspended passive losses when you sell.
Frequently asked questions
What is a structured installment sale?
An installment sale where the buyer pays in full at closing and a third-party assignment company makes the scheduled payments to the seller. The gain is reported under IRC 453 as payments arrive.
Do I need to buy another property?
For a 1031 exchange, yes, within 45 days to identify and 180 days to close. A structured installment sale needs no replacement property.
Can a failed 1031 exchange be turned into a structured sale?
Only if the structured terms were in place before the seller had a right to the money. After the intermediary releases the funds, it is too late.
Is depreciation recapture spread too?
Straight-line depreciation on a building (unrecaptured Section 1250 gain) is spread and reported first. Section 1245 recapture is taxed in the year of sale (IRC 453(i)).
Are the payments taxed?
Each payment has three parts: tax-deferred return of basis, gain taxed as capital gain or recapture, and interest taxed as ordinary income.
What happens if the seller dies during the payments?
The payments continue to the beneficiaries, who pay tax on the remaining gain as it arrives (IRC 691). There is no step-up in basis on it.
Sources
- IRC 1031, like-kind exchanges (Cornell LII)
- IRC 453, installment method (Cornell LII)
- Treas. Reg. 1.453-12, unrecaptured Section 1250 gain in installment sales (eCFR)
- IRC 453A, interest charge and pledge rule (Cornell LII)
- Treas. Reg. 1.451-2, constructive receipt (eCFR)
- IRC 1(h)(6), unrecaptured Section 1250 gain (Cornell LII)
- IRC 1411, net investment income tax (Cornell LII)
- IRC 691, income in respect of a decedent (Cornell LII)
- IRS Publication 537, Installment Sales
- IRS Rev. Proc. 2025-32, 2026 inflation adjustments
Links checked October 26, 2026. This guide is general education from a nonprofit. It is not tax, legal or investment advice for your situation, and nothing here is an offer to sell any product. Rules change; confirm current law with your own tax professional before you act.