Annualized Income Installment Method: Estimated Tax After a Sale
The annualized income installment method lets you pay estimated tax on a big gain when the gain actually happens, instead of pretending it was earned evenly all year. If you sell property in November, the regular method says you should have paid a quarter of the tax back in April, and it charges a penalty for the "late" earlier quarters. Form 2210 Schedule AI fixes that by computing each required payment from the income you had through the end of each period.
This matters for anyone who sells a rental, a business or land, and it matters again every year of an installment sale, because each year's principal payments bring new gain.
Who owes estimated tax on a capital gain
Estimated tax is required when you will owe $1,000 or more at filing after withholding and credits, and your payments fall short of a safe harbor (IRC §6654). Everything on the return counts toward the tax you need to prepay:
- Capital gain and §1231 gain, including gain from each installment payment
- Depreciation recapture (ordinary income, reported in the year of sale even on an installment sale under §453(i))
- Interest on a note you carry
- The 3.8% net investment income tax
The three ways to avoid the penalty
| Method | You are safe if payments cover | Best when |
|---|---|---|
| Prior-year safe harbor | 100% of last year's tax, paid in four equal parts; 110% if last year's AGI was over $150,000 ($75,000 MFS) (§6654(d)(1)(C)) | The sale year's tax is much higher than last year's |
| Current-year safe harbor | 90% of this year's tax, in four equal parts | This year's tax is lower than last year's |
| Annualized income method | 22.5%, 45%, 67.5% and 90% of the tax on income annualized through each period (Schedule AI) | Income arrived unevenly, especially late in the year |
The prior-year safe harbor is the simplest plan for a sale year. If your 2025 tax was $12,000 and your AGI was under $150,000, four payments of $3,000 protect you from any 2026 penalty even if the sale adds $60,000 of tax. You still owe the balance by April 15, 2027, but with no penalty.
The annualized method is for when you did not do that, or could not, for example because last year's tax was itself large or you did not know the sale was coming.
How Schedule AI works
Schedule AI splits the year into four cumulative periods and annualizes the income in each one:
| Period | Covers | Annualization factor | Required cumulative payment | Due date |
|---|---|---|---|---|
| (a) | Jan 1 to Mar 31 | 4 | 22.5% of annualized tax | April 15 |
| (b) | Jan 1 to May 31 | 2.4 | 45% | June 15 |
| (c) | Jan 1 to Aug 31 | 1.5 | 67.5% | September 15 |
| (d) | Jan 1 to Dec 31 | 1 | 90% | January 15 of next year |
For each period you total income and deductions through the end of the period, multiply by the factor to get a full-year equivalent, figure the tax on that, and take the percentage shown. The required installment is the smaller of that amount and the regular installment. A gain received in November only shows up in period (d), so the April, June and September installments are figured without it.
Rules from the Form 2210 instructions worth knowing:
- The IRS names this case directly: the method helps if you "had a large capital gain late in the year."
- If you use Schedule AI for any due date, you must use it for all of them.
- Most individuals are cash-method taxpayers and include income when actually or constructively received. For an installment sale, that means the date each principal payment arrives.
- Attach Form 2210 Parts I to III and Schedule AI to your return. The IRS will not apply the annualized method for you.
Simple example: a November closing
Simple example. A married couple files jointly. Their only other income is $80,000 of taxable income a year, earned evenly, with $110,000 of MAGI. On November 10, 2026 they close a cash sale of land with a $400,000 long-term gain (no depreciation). Their 2025 tax was $12,000 and their 2025 AGI was under $150,000. Figures use 2026 rates; federal tax was computed with the IRC §1(h)(1) Schedule D worksheet ordering.
| Item | Amount |
|---|---|
| Federal income tax without the sale | $9,104 |
| Federal income tax with the sale | $66,269 |
| NIIT (3.8% of MAGI over $250,000) | $9,880 |
| Total 2026 tax | $76,149 |
| 90% of 2026 tax | $68,534 |
| 100% of 2025 tax (safe harbor) | $12,000 |
Route 1, prior-year safe harbor. Four payments of $3,000 cover 100% of 2025 tax. No penalty, and the remaining $64,149 is due April 15, 2027.
Route 2, annualized method. Suppose they paid nothing for the first three quarters. Because periods (a), (b) and (c) contain only their ordinary $80,000-a-year income, the required installments for April, June and September are small, based on about $9,100 of annualized tax. The gain only drives the January 15, 2027 installment. Paying that installment on time, instead of spreading the gain's tax back across the year, can remove most or all of the penalty.
What goes wrong without either. Under the regular method, the IRS assumes 25% of the required annual payment was due each quarter, starting in April. With no payments, each quarter is short and the penalty runs on each from its due date.
Installment sales: the year of sale and every year after
An installment sale creates an estimated tax obligation every year the buyer pays you.
- Year of sale. Down payment gain, all §1245 and additional §1250 recapture (§453(i)), and any interest received. Recapture is the trap: it can be large and it is all taxed in year one, even if you received little cash. See installment sale depreciation recapture.
- Later years. Each year's principal times your gross profit percentage, plus interest. If the buyer pays monthly, income arrives evenly and the regular method usually works. If the note has an annual payment or a balloon in December, the annualized method is the better fit for that year.
- The year after a big year. The prior-year safe harbor can now be expensive: 110% of a high sale-year tax. The current-year 90% test may be far cheaper, or the annualized method may be.
How each year's gain is figured is covered in Form 6252 instructions and the installment sale guide. The trade-off between taking the gain now and spreading it is in installment sale vs lump sum.
Withholding: a useful alternative
Federal income tax withheld from wages, pensions or IRA distributions is treated as paid evenly on the four due dates unless you show otherwise (§6654(g)). That means extra withholding taken in December counts as if a quarter of it had been paid in April. Retirees taking IRA distributions can use this to cover a late-year sale without Schedule AI, but only if the extra IRA income does not create its own problems (for example, IRMAA; see capital gains and IRMAA).
States
Most states with an income tax have their own estimated tax rules and their own annualization schedule. Some also require payment or withholding at closing on real estate, for example California's Form 593 withholding and New York's Form IT-2663 for nonresident sellers (IT-2663). Check the state rule separately.
To see how much gain lands in each year of a note, run the installment sale calculator.
Bottom line
A big gain late in the year does not have to mean a penalty for the whole year. Either pay the prior-year safe harbor on schedule, or use Form 2210 Schedule AI so the tax on the gain is due with the installment for the period when the gain arrived. For installment sales, revisit the plan every year: recapture in year one, balloon years, and the year after a big year all change which method is cheapest.
Questions to ask your CPA
- Does our withholding plus estimates already meet the 100% or 110% prior-year safe harbor?
- In which Schedule AI period does our closing fall, and what is due for that installment?
- How much recapture and NIIT will be in the year of sale?
- For each year of the note, is the regular method or Schedule AI cheaper?
- Should we add withholding from a pension or IRA instead of making estimated payments?
- What does our state require at closing and in estimated payments?
Run your own numbers. Compare a cash sale, seller financing and a structured installment sale side by side, free.
Educational only, not tax, legal or investment advice. Examples are illustrative. Have your CPA or tax attorney review your facts before you act. Hans Goldstein is a licensed insurance agent (CA Insurance License #4273294) and is not a CPA or attorney. He is paid a commission only if a structured installment sale is funded; seller financing pays him nothing. Disclosures.