Gross Profit Percentage on an Installment Sale (Worked Examples)
The gross profit percentage is the share of every principal dollar you receive that is taxable gain: gross profit divided by contract price. Multiply each year's principal payments by it and you have that year's installment sale income; the rest is a tax-free return of your basis. Interest on the note is separate and fully taxable.
The formula is one line. The work is in getting gross profit and contract price right, especially when there is a mortgage, depreciation or a later price change. This page shows each case with numbers. To see the percentage applied year by year, use the installment sale calculator.
The formula in one line
Gross profit percentage = gross profit / contract price
These are the same numbers that appear on Form 6252: gross profit on line 16, contract price on line 18, and the percentage on line 19, entered as a decimal rounded to at least four digits (for example, 0.5400). See our Form 6252 instructions for the full walk-through.
Selling price vs contract price vs gross profit
Three terms, defined in IRS Pub. 537 and Temp. Reg. §15a.453-1(b):
| Term | What it is |
|---|---|
| Selling price | Everything the buyer gives up for the property: cash, the face of the note, the value of other property, any existing debt the buyer pays, assumes or takes subject to, and any of your selling expenses the buyer pays. Interest is excluded. |
| Installment sale basis | Your adjusted basis, plus selling expenses (commissions, attorney fees), plus any depreciation recapture taxed in the year of sale. |
| Gross profit | Selling price minus installment sale basis. For your main home, minus any gain you exclude under §121. |
| Contract price | Selling price, minus debt the buyer assumes or takes subject to, plus any of that assumed debt that exceeds your installment sale basis. |
The buyer's note is not a payment when you receive it, but its full face counts in the selling price and contract price. Payments on it are what you apply the percentage to.
Example 1: no debt
Simple example. You sell investment property for $500,000. Adjusted basis is $200,000 and selling expenses are $30,000. No loan on the property. The buyer pays $100,000 down and the rest over time.
| Line | Amount |
|---|---|
| Selling price | $500,000 |
| Installment sale basis ($200,000 + $30,000) | $230,000 |
| Gross profit | $270,000 |
| Contract price (no assumed debt) | $500,000 |
| Gross profit percentage | 54% |
| Gain on the $100,000 down payment | $54,000 |
| Gain on each later $100,000 of principal | $54,000 |
Every $100,000 of principal carries $54,000 of gain and $46,000 of basis recovery. When the last payment arrives, you will have reported exactly $270,000, the whole gross profit.
Example 2: the buyer assumes your mortgage
Now the buyer takes over your existing loan. Debt the buyer assumes is not a payment to you (up to your basis), so it comes out of contract price. The gross profit stays the same, but it is spread over fewer "payment" dollars, so the percentage rises.
Simple example. Same property, same $270,000 gross profit. The buyer assumes your $150,000 mortgage, pays $50,000 cash and signs a $300,000 note.
| Line | Amount |
|---|---|
| Selling price | $500,000 |
| Mortgage assumed | $150,000 |
| Contract price ($500,000 - $150,000) | $350,000 |
| Gross profit percentage ($270,000 / $350,000) | 77.14% |
| Gain on the $50,000 cash in year 1 | $38,571 |
| Gain on the $300,000 note as it is paid | $231,429 |
Total gain is still $270,000. The assumption just packs it into fewer dollars.
Variant: the debt exceeds your basis
If the assumed debt is larger than your installment sale basis, the excess is treated as a payment in the year of sale, and the same excess is added back to contract price (Temp. Reg. §15a.453-1(b)(2)(iii), (b)(3)(i)).
Simple example. Same property, but you refinanced before the sale and the buyer assumes a $300,000 loan. Your installment sale basis is $230,000. The buyer pays $50,000 cash and signs a $150,000 note.
| Line | Amount |
|---|---|
| Selling price | $500,000 |
| Mortgage assumed | $300,000 |
| Excess of mortgage over basis ($300,000 - $230,000) | $70,000 |
| Contract price ($500,000 - $300,000 + $70,000) | $270,000 |
| Gross profit percentage ($270,000 / $270,000) | 100% |
| Year-1 payments ($50,000 cash + $70,000 deemed) | $120,000, all gain |
| Later principal on the $150,000 note | $150,000, all gain |
A 100% percentage means there is no basis left to recover; every principal dollar is gain. This is why a cash-out refinance before a sale can surprise sellers. A related trap: a loan paid off at closing out of the buyer's money is a year-of-sale payment, not an assumption. See installment sale with a mortgage.
Example 3: selling expenses and recapture added to basis
On depreciated property, §1245 recapture (for example on appliances or cost-segregated components) is taxed in full in the year of sale, whether or not you receive any cash (§453(i)). To avoid taxing it twice, the recapture is added to your installment sale basis. On Form 6252 it goes on line 12, from Form 4797, Part III.
Simple example. Same $500,000 sale, $200,000 adjusted basis, $30,000 selling expenses, no debt, but the depreciation schedule shows $40,000 of §1245 recapture.
| Line | Amount |
|---|---|
| Selling price | $500,000 |
| Installment sale basis ($200,000 + $30,000 + $40,000) | $270,000 |
| Gross profit | $230,000 |
| Contract price | $500,000 |
| Gross profit percentage | 46% |
| Recapture taxed in year 1 (ordinary income) | $40,000 |
| Installment gain over the life of the note | $230,000 |
Total gain is still $270,000: $40,000 now as ordinary income plus $230,000 as the payments arrive.
One more nuance. The percentage is fixed, but the kind of gain inside each payment is not. Straight-line building depreciation (unrecaptured §1250 gain, taxed at up to 25%) is not recapture income, so it stays in the gross profit, and Reg. §1.453-12 takes it out of the earliest payments first. See installment sale depreciation recapture.
When the percentage changes: a price reduction
The gross profit percentage generally stays the same for every payment. The exception is a later reduction in the selling price, for example after a dispute over the property's condition. If you reduce the price but do not cancel the rest of the buyer's debt, it is not a disposition of the note; you refigure the percentage for the remaining payments using Worksheet B in Pub. 537.
Worksheet B works like this: reduced selling price, minus adjusted basis, selling expenses and recapture, gives the adjusted gross profit. Subtract the installment income you already reported. Divide what is left by the remaining payments.
Pub. 537's own example: land with a $40,000 basis sold for $100,000, so $60,000 of gross profit and a 60% percentage. The seller received $20,000 down and one $20,000 installment and reported $12,000 of gain on each, $24,000 in total. The price is then cut to $85,000, with three remaining payments of $15,000.
| Worksheet B line | Amount |
|---|---|
| Reduced selling price | $85,000 |
| Adjusted basis + selling expenses + recapture | $40,000 |
| Adjusted gross profit | $45,000 |
| Installment income already reported | $24,000 |
| Gain left to report | $21,000 |
| Future installments | $45,000 |
| New gross profit percentage | 46.67% |
Each remaining $15,000 payment now carries $7,000 of gain. Total gain reported: $24,000 + $21,000 = $45,000, which matches the reduced gross profit.
If instead you accept less than face value to settle the note, or forgive part of it, that is a disposition of the obligation under §453B with its own gain or loss computation. See what happens when the buyer defaults or pays early.
Quick reference
| Situation | Effect on contract price | Effect on gross profit % |
|---|---|---|
| No debt | Equals selling price | Gross profit / selling price |
| Buyer assumes debt under your basis | Reduced by the debt | Higher |
| Buyer assumes debt over your basis | Reduced, then excess added back | Rises to 100% |
| Loan paid off at closing from buyer's funds | Not reduced (payoff is a year-1 payment) | Unchanged |
| §1245 recapture | Unchanged | Lower (recapture added to basis) |
| Main home, §121 exclusion | Unchanged | Lower (excluded gain removed from gross profit) |
| Later price reduction | Refigured | Refigured for remaining payments (Worksheet B) |
If the note carries too little interest, part of each payment is imputed interest, which lowers the contract price before you apply the ratio.
Your books may show the same sale differently; see installment method accounting for book vs tax.
Bottom line
The gross profit percentage turns a sale into a per-dollar tax rate on principal. Get the inputs right: include selling expenses and year-one recapture in basis, take assumed debt out of contract price, and watch for debt above basis, which pushes the percentage to 100% and creates a year-one payment. The installment sale guide covers the rest of the rules, and the calculator applies the percentage to your own payment schedule.
Questions to ask your CPA
- What is my installment sale basis, including selling expenses and year-of-sale recapture?
- Is the buyer assuming my loan, taking subject to it, or paying it off at closing?
- Does any assumed debt exceed my basis, creating a deemed payment in year one?
- How much unrecaptured §1250 gain is in the gross profit, and in which years will it come out?
- If the price is renegotiated later, will you refigure the percentage with Worksheet B?
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.