What Happens to an Installment Note When the Seller Dies
When the seller of an installment note dies, the note passes to the estate or heirs and the payments keep coming, but the tax does not disappear. The unpaid gain is income in respect of a decedent (IRD): there is no step-up in basis on the note, and whoever receives it reports the gain as each payment arrives, exactly as the seller would have (§§691(a)(4), 1014(c)). Property held until death, by contrast, gets a new basis equal to its value at death, and its built-in gain is never taxed.
That difference is one of the most important estate questions for any seller over 60 thinking about a note.
The note passes to heirs; the tax does not disappear
Four rules do the work:
- No disposition at death. Transmission of an installment obligation at death is not a disposition that triggers the deferred gain; §691 governs instead (§453B(c)). Nothing is reported on the decedent's final return because of the transfer.
- IRD. The excess of the note's face over the seller's basis in it is treated as an item of income in respect of a decedent (§691(a)(4)).
- No step-up. The basis step-up at death does not apply to property that is a right to receive IRD (§1014(c)).
- Same treatment as the seller. In the IRS's words, "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" (Pub. 537, "Transfer due to death").
So the same gross profit percentage, the same character (unrecaptured §1250 gain first, then long-term capital gain), and ordinary interest income all carry over to the heirs.
Two exceptions that do trigger tax. If the note is canceled, becomes unenforceable, or is transferred to the buyer because of the holder's death, that is a disposition, and the estate must figure its gain. If the holder and buyer were related, the note's value is treated as no less than its full face amount (Pub. 537; §691(a)(5)). That is the self-canceling note problem, covered below.
Heirs keep reporting the gain as payments arrive
Each year a payment comes in, the heir (or the estate, until the note is distributed) reports:
- Gain: principal received times the gross profit percentage, on Form 6252. Pub. 537 notes that an heir reporting IRD may not have all the information the form asks for, and should attach a statement with as much detail as possible.
- Interest: ordinary income, as received.
- Character: long-term if the seller's gain was long-term; that stays true for the heir.
Worked example: seller dies after year three
Simple example. A seller sells a rental for $1,500,000. Her installment sale basis is $500,000, so gross profit is $1,000,000 and the gross profit percentage is 66.67%. She takes $300,000 down and carries a $1,200,000 note, $120,000 of principal a year for ten years, plus interest. No recapture, for simplicity.
She receives the down payment and three annual payments, then dies.
| Amount | |
|---|---|
| Principal she received (down payment + 3 x $120,000) | $660,000 |
| Gain she reported during life ($660,000 x 66.67%) | $440,000 |
| Principal still owed at death | $840,000 |
| Gain still inside the note (IRD) ($840,000 x 66.67%) | $560,000 |
| Step-up on the note at death | None |
| Gain her children report over the next seven years | $560,000, about $80,000 a year |
Now compare two ways her family could have ended up:
| Same seller, simple example | Heirs receive | Built-in gain the heirs will pay tax on |
|---|---|---|
| Sold on the note, died after year 3 | $840,000 of remaining note payments | $560,000 |
| Kept the rental, died holding it (worth $1,500,000 at death) | A building with a $1,500,000 basis | $0 (erased by the §1014 step-up) |
The note also cannot be undone. Once the sale closes, the family is on the IRD path.
The §691(c) deduction for estate tax paid
If the note was included in a taxable estate and federal estate tax was paid on it, the heir who reports the IRD gets an itemized deduction for the estate tax attributable to it (§691(c)). That softens the double hit of estate tax and income tax on the same dollars.
In practice, most families will not use it. The 2026 basic exclusion is $15,000,000 per person (§2010(c)(3)), so most estates owe no federal estate tax, and with no estate tax there is no §691(c) deduction. The IRD income tax still applies.
Cancelling the note at death (SCIN)
A self-canceling installment note is written to cancel automatically when the seller dies. It is a family estate-planning tool: the unpaid balance is meant to leave the estate. Three cautions:
- Income tax. Cancellation because of the holder's death is a disposition. The estate figures the gain, and if seller and buyer were related, the note's value is treated as no less than its face (Pub. 537; §691(a)(5)). The deferred gain does not vanish with the note.
- Valuation and gift tax. The note must carry a premium (in price or interest) for the cancellation feature. In CCA 201330033, IRS Chief Counsel said the §7520 actuarial tables did not apply to value the notes in that case, that the seller's medical history had to be considered, and that a note worth less than the stock sold meant a gift.
- Related-party rules. A SCIN is almost always a family sale, so the related-party installment sale rules apply too.
A SCIN belongs with an estate attorney who drafts them regularly, not in an ordinary sale.
Go deeper: the self-cancelling installment note (SCIN), on Big Sale Tax.
Structured sale payments after death (beneficiary)
In a structured installment sale, the buyer pays in full at closing and an assignment company takes on the obligation to pay the seller, usually funded by a fixed annuity it owns (some programs use a funding agreement instead). The payments depend on the assignment company's ability to pay, the schedule is fixed, and a commission is built into the pricing. It relies on the general installment rules, with no published IRS ruling on this specific assignment structure, so have your CPA review it. See the structured installment sale guide.
At death:
- The payments continue on the original schedule to the named beneficiary, under the terms of the contract.
- The tax continues too. The unpaid gain is IRD, with no step-up, and the beneficiary reports it as payments arrive.
- The schedule stays fixed. The payments cannot be commuted, accelerated or borrowed against, so the remaining payments cannot be cashed out to pay estate tax. A client with a taxable estate needs liquidity from somewhere else.
- Beneficiary designations matter. In a community property state, a payment right bought with community property is usually community property too, and naming someone other than your spouse may need written consent. Check the designation when the structure is set up.
A seller-financed note has the same tax result at death, plus one more variable: whether the buyer keeps paying your heirs.
Compare: holding the property until death (step-up)
For some older owners, the better estate result is to not sell at all:
- Step-up. Property owned at death takes a basis equal to its value at death (§1014(a)). The built-in gain and the depreciation recapture are never taxed.
- Community property. In California and other community property states, both halves of community property step up at the first spouse's death (§1014(b)(6)). Joint tenancy gets only a half step-up. For a married California couple, "hold until death" means hold until the first death. The Waterfall Strategy covers the details in step-up in basis on rental property.
- Suspended passive losses. On the other side of the ledger, suspended losses are deductible at death only to the extent they exceed the step-up; the rest are lost (§469(g)(2)). An owner with large stuck losses and many years ahead may do better selling and letting the gain use them.
The book's chapter on the "swap till you drop" plan runs this comparison with numbers: 1031, borrow and hold vs an installment sale. The short version: the step-up does the heavy lifting, and the older and less healthy the owner, the more it is worth.
Run a note in the installment sale calculator to see how much gain would still be inside it at each year, then read the complete installment sale guide.
For sales to a grantor trust as an estate freeze, see intentionally defective grantor trust (IDGT).
A note that cancels at death is covered in depth in our guide to the self-cancelling installment note (SCIN).
Go deeper: step-up in basis at death: when holding beats selling, on Big Sale Tax.
Bottom line
An installment note outlives its seller, but so does the tax. The heirs get the payments and the IRD, with no step-up. A self-canceling note does not escape the income tax, and a structured sale's payments go to the beneficiary on schedule but cannot be cashed out. If holding the property until death is a realistic plan, compare it against the sale before you sign, because the step-up is the one benefit a note can never get back.
Questions to ask your CPA
- If I die in year 3 of this note, how much gain will my heirs still owe tax on?
- Is my estate large enough to owe federal estate tax, and would §691(c) help my heirs?
- Is my property community property, joint tenancy or separate property, and how much would step up at the first death?
- How much of my suspended passive loss would survive at death under §469(g)(2), compared with using it on a sale now?
- Who is the named beneficiary on the note or structured sale, and does my spouse need to consent?
- Is a self-canceling note or a sale to family worth discussing with my estate attorney, or is holding simpler?
Installment sale + 1031 + ILIT: when is it a slam dunk?
For a large estate, a 1031 exchange, an installment sale and a trust-owned life insurance policy (an ILIT) can work together. It tends to win when most of these are true (2026 figures: the federal estate tax exemption is $15,000,000 per person, $30,000,000 for a married couple):
- Your estate is clearly over the line: a projected estate tax bill of $10,000,000 or more.
- You are married, age 50 to 60, in preferred health or better. At 75 or older, single, or in a rated health class it usually does not win.
- One separate property has stuck (suspended) passive losses at least as big as its gain.
- That property earns little: low cap rate, slow growth.
- You would sell or borrow anyway, or you do not have the cash on hand to pay the premiums.
Four or five true? Run the numbers. Enter your own estate and ages in the estate tax strategy calculator on Big Sale Tax. Estimates from published rates, not a quote or advice; your CPA and attorney decide.
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 an Enrolled Agent, admitted to practice before the Internal Revenue Service, and a licensed insurance agent (CA Insurance License #4273294). He 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.