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Installment Sale to a Related Party: The Two-Year Rule Explained

By Hans Goldstein · Updated 2026-09-27

You can sell property to a family member or a related entity on the installment method, but three rules change the math. If a related buyer resells within two years, you are taxed as if you got the resale money (§453(e)). If you sell depreciable property to an entity you control, the installment method is generally off and the gain is ordinary (§§453(g), 1239). And the note must carry at least the applicable federal rate, or part of the principal is recharacterized as interest (§§483, 1274).

None of this bans family deals. It means a family installment sale has to be a real sale, priced and documented like one, with a buyer who plans to hold.

Who counts as related

The installment rules use two different "related" lists, and which one applies depends on the rule.

For the resale rule, §453(e). A related person is anyone whose stock would be attributed to you under §318(a) (other than §318(a)(4), options), or anyone with a §267(b) relationship to you (§453(f)(1)). In practice that covers:

• Your spouse, children, grandchildren and parents (§318 family). Through §267(b), siblings and all ancestors and lineal descendants are covered too.
• Corporations and partnerships you own more than 50% of, directly or through attribution.
• Trusts and estates in which you or your family have an interest, and a trust and its grantor.

IRS Publication 537 lists these relationships in plain English under "Sale and Later Disposition" (Pub. 537).

For the depreciable property rule, §453(g). The list is narrower. "Related persons" has the §1239(b) meaning: you and an entity you control (more than 50% of the stock value, or of a partnership's capital or profits interest, counting constructive ownership), you and a trust in which you or your spouse is a beneficiary (unless the interest is remote), and an executor and a beneficiary of an estate (§1239(b), (c)). Two partnerships under common control also count (§453(g)(3)).

Notice what is missing from the §453(g) list: your child as an individual. Selling a rental to your daughter personally is a §453(e) problem (the resale rule), not a §453(g) problem. Selling it to an LLC that you control is a §453(g) problem.

The resale rule: if they resell within two years, you are taxed

Here is the rule in one sentence. If you sell to a related person on the installment method, and that person disposes of the property before you have received all your payments, the amount they realize on the second disposition is treated as received by you at that time (§453(e)(1)).

The key limits:

• The two-year cutoff. For property other than marketable securities, the rule applies only if the second disposition happens within 2 years of your sale (§453(e)(2)(A)). For marketable securities there is no cutoff; a resale any time before you are paid in full can accelerate your gain.
• The clock can pause. The two years stop running while the related buyer's risk of loss is substantially diminished by a put, another person's right to buy the property, a short sale or a similar transaction (§453(e)(2)(B)).
• A cap. The amount treated as received is the lesser of what the related buyer realized or your total contract price, minus payments you already received (§453(e)(3)).
• No double tax. Later payments on your note are not taxed again until they exceed the amount already treated as received (§453(e)(5)).
• A gift counts too. If the second disposition is not a sale (a gift, for example), the property's fair market value is used instead of an amount realized (§453(e)(4)).

Exceptions (§453(e)(6), (7)):

• A transfer after the death of either you or the related buyer is not a second disposition.
• A compulsory or involuntary conversion (such as a condemnation) is not a second disposition if your sale came before the threat of conversion.
• A sale of stock back to the issuing corporation is not a first disposition.
• The rule does not apply if you establish to the IRS's satisfaction that neither disposition had tax avoidance as a principal purpose.

Worked example: the son who flipped the fourplex

Simple example. You sell a fourplex to your son for $600,000. Your adjusted basis (including selling costs) is $250,000, so the gain is $350,000 and the gross profit percentage is 58.33% ($350,000 / $600,000). There is no mortgage and no depreciation recapture, to keep the numbers clean. He pays $60,000 down and gives you a $540,000 note, $54,000 of principal a year plus adequate interest.

Eighteen months later, after one annual payment, he sells the fourplex to a stranger for $650,000.

Your remaining note balance is also $486,000, so every later principal payment comes to you with no further gain. You still receive only $54,000 a year, but you pay tax on $283,500 of gain in the year your son sold. That mismatch between tax and cash is the whole problem.

Had he waited until after the two-year mark, the resale would not have touched you (unless his risk had been hedged in a way that paused the clock).

Depreciable property to your own entity: §453(g) and §1239

Selling a rental building, equipment or anything the buyer can depreciate to an entity you control is the harsher trap.

• No installment method. For an installment sale of depreciable property between related persons, §453(a) does not apply, and all payments to be received are treated as received in the year of sale (§453(g)(1)(A), (B)). Payments contingent in amount are counted at fair market value; if that cannot be reasonably determined, basis is recovered ratably.
• The buyer waits for basis. The buying entity cannot increase its basis before you include the matching amount in income (§453(g)(1)(C)).
• Ordinary income. Any gain on a sale of depreciable property between §1239(b) related persons is ordinary income, not capital gain (§1239(a)).
• The escape hatch is narrow. §453(g) does not apply if you establish to the IRS's satisfaction that avoiding federal income tax was not one of the principal purposes of the sale (§453(g)(2)). Pub. 537 phrases it as showing that no significant tax deferral benefit will result.

A common version: an owner sells the building his operating company occupies to a new LLC he owns with his spouse, hoping to take cash out over time. Both the ownership test and the depreciable property test are met. The result is year-one recognition of the whole price, taxed as ordinary income.

Sales to a grantor trust (IDGT), at a high level

Estate planners sometimes have a client sell property to an intentionally defective grantor trust for a note. For income tax, the grantor is treated as owning the trust's assets, so the exchange of the property for the trust's note is not recognized as a sale (Rev. Rul. 85-13, as described in Rev. Rul. 2007-13). For estate tax, growth after the sale can sit outside the estate.

Three things to know before treating it as an exit:

• It is not a taxable sale, so it releases none of the property's suspended passive losses and spreads no gain. Nothing is being deferred on the installment method because nothing was recognized.
• No step-up at death for trust assets that are not in your gross estate (Rev. Rul. 2023-2).
• It is estate planning. With a 2026 basic exclusion of $15,000,000 per person (§2010(c)(3)), most families do not need it. That work belongs with an estate attorney.

Interest rate minimums and gift issues

The note needs adequate stated interest. The stated principal cannot exceed the imputed principal amount computed at the applicable federal rate, compounded semiannually (§1274(b)(2)(B), (c)(2)); §483 covers smaller sales and others that §1274 does not reach. If the rate is too low, part of each principal payment becomes interest: less capital gain, more ordinary income. See our guide to seller financing interest rates and the AFR.

A family land break. For a sale of land by an individual to a family member (§267(c)(4): siblings, spouse, ancestors, lineal descendants), the discount rate used under §483 cannot exceed 6%, compounded semiannually, for up to $500,000 of sales price between those individuals in a calendar year. It does not apply if either party is a nonresident alien (§483(e)). When the AFR is above 6%, this lets a parent charge a child less on a land sale.

Price below value is part gift. If you sell to a child for less than fair market value, the difference is generally a gift. For 2026 the annual exclusion is $19,000 per recipient (Rev. Proc. 2025-32); larger gifts use up lifetime exclusion and need a gift tax return.

Forgiving payments is not free. Many parents plan to "forgive a payment every year." Canceling or forgiving an installment obligation is a disposition of it. If the parties are related, the obligation's fair market value is treated as no less than its full face value, so you recognize the deferred gain on the forgiven principal (§453B(a), (f); Pub. 537, "Cancellation" and "Forgiving part of the buyer's debt"). The forgiveness is generally a gift as well.

Suspended losses stay stuck. A sale to a related party under §267(b) or §707(b)(1) does not release the activity's suspended passive losses; they wait until the property leaves the related group (§469(g)(1)(B)).

Self-canceling notes and private annuities (briefly)

Two older estate-planning tools show up in family sales:

• A self-canceling installment note (SCIN) cancels at the seller's death. The IRS has challenged SCINs on valuation: in CCA 201330033, Chief Counsel said the §7520 actuarial tables did not apply to value the notes in that situation, that the seller's medical history had to be considered, and that a note worth less than the property transferred meant a gift. Cancellation at death is also a disposition for income tax purposes (Pub. 537, "Transfer due to death"). See what happens to an installment note at death.
• A private annuity (property for a family member's promise to pay you for life). Proposed regulations from 2006 would tax the full gain up front on any exchange of property for an annuity contract (Prop. Reg. §1.1001-1(j)). They are still proposed, not final, but they signal the IRS position.

Both belong with an estate attorney who uses them often, not in a do-it-yourself family sale.

Reporting: Form 6252 Part III

You report the sale on Form 6252 in the year of sale and each year you receive a payment. For a sale to a related party, you also complete Part III (the related party questions) for the year of sale and the two years after, unless you received the final payment during the year. You may have to file the form each year until the debt is paid off, whether or not a payment arrived that year (Pub. 537, "Reporting an Installment Sale"). If your related buyer resold, Part III is where the second disposition is reported.

Want to see the effect of a family note before you draft it? Run a seller-financing scenario in the installment sale calculator, then read the complete installment sale guide and the Form 6252 instructions walkthrough.

Family notes also need an adequate rate; our applicable federal rate (AFR) guide shows which AFR applies.

If the family member is buying a home, selling a house to a family member covers the gift of equity and part-gift, part-sale rules.

For estate-planning sales to a grantor trust, see how an intentionally defective grantor trust (IDGT) works.

Bottom line

A family installment sale works when it is a real sale: a fair price, adequate interest, a written note, and a buyer who holds the property for at least two years. It fails when the family buyer flips the property, when the buyer is your own entity and the property is depreciable, or when the plan is to quietly forgive the payments. Each of those turns deferred gain into current tax, sometimes with no cash to pay it.

Questions to ask your CPA

• Is my buyer a related person under §453(f)(1), under §1239(b), or both?
• Is the property depreciable in the buyer's hands, so that §453(g) and §1239 apply?
• What is the AFR for this note's term, and does the §483(e) 6% land rule help us?
• If the buyer might resell, how long must they hold to be outside §453(e), and does anything pause the clock?
• Is any part of this sale a gift, and do we need a gift tax return?
• What happens to my suspended passive losses on this property if I sell to family?
• Would holding the property until death, for the step-up, leave my family better off than this sale?

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.