When a client sells a business or appreciated real estate, the first question for the CPA is usually the same: How much goes to the IRS, and when? A structured installment sale (SIS) answers the “when” by spreading the gain over a schedule of payments instead of recognizing it all at closing.
Once a seller’s installment obligations for the year top $5 million, Section 453A imposes an annual interest charge on the deferred tax. Its pledge rule, which reaches much smaller sales, also limits how a seller can borrow against the payments.
How an SIS works
As I covered in an earlier article, the buyer in an SIS pays the full purchase price at closing. The seller receives any cash portion directly. The deferred portion goes to an assignment company, which assumes the buyer’s obligation to make the installment payments and funds it by purchasing an annuity from a highly rated life insurer. The seller receives payments on a fixed schedule and reports gain as each payment arrives under Section 453. Each payment also includes interest, which is taxed as ordinary income.
Two features protect the deferral. The seller does not own the annuity, and the seller should be only an unsecured creditor. A note secured by cash or a cash equivalent is treated as a payment received (Treas. Reg. §15a.453-1(b)(3)(i)), which would defeat the purpose. Because no published IRS ruling addresses the SIS structure directly, CPAs should review the transaction documents and any tax opinion before relying on them.
When the Section 453A interest charge applies
Section 453A applies to nondealer installment obligations from sales of property priced above $150,000. The interest charge, however, applies only if the aggregate face amount of those obligations that arose during the tax year and remain outstanding at year-end exceeds $5 million. Neither threshold is indexed for inflation. For sales by partnerships and S corporations, the $5 million test is applied, and the interest is computed, at the partner or shareholder level (Notice 88-81). Farm property and an individual’s personal-use property are exempt.
The calculation has three components:
- Deferred tax liability. The unrecognized gain at year-end times the maximum rate for that type of gain, which is 20% for most long-term capital gain. The 3.8% net investment income tax is not included.
- Applicable percentage. The face amount of the year’s obligations above $5 million, divided by their total face amount. The percentage is fixed in the year of sale.
- Interest rate. The Section 6621(a)(2) underpayment rate for the month in which the tax year ends. For a calendar-year 2026 sale, that is the December rate, which the IRS has set at 7% for the fourth quarter.
Multiply the three together to get the charge. It is not prorated, so a sale that closes in December bears a full year’s charge. It recurs each year an obligation remains outstanding at year-end. Individuals cannot deduct it, because it is treated as personal interest.
A worked example
A client sells the stock of a closely held corporation for $12 million, has a $2 million basis and defers the entire price through an SIS. Because it is a stock sale, the full $10 million gain is long-term capital gain, with no recapture to recognize up front.
- Deferred tax liability: $10 million × 20% = $2 million
- Applicable percentage: $7 million ÷ $12 million = 58.3%
- First-year interest charge: $2 million × 58.3% × 7% ≈ $81,700
That is about 4.1% of the deferred tax in the first year, and the dollar amount declines as payments reduce the unrecognized gain. The question for the client is whether the after-tax return earned on the deferred tax inside the payment stream exceeds that cost. Stress-test the answer against changes in the underpayment rate, which resets quarterly, as well as the payment term and the client’s future tax rates.
Planning around the $5 million threshold
The most direct lever is deal size. The charge applies only to the deferred tax attributable to obligations above $5 million. Keeping the year’s total installment obligations, including any separate seller note, at or below $5 million and taking the balance in cash avoids the charge entirely.
Other approaches call for caution. In TAM 9853002, the IRS treated spouses as separate taxpayers for the threshold, but a technical advice memorandum is not precedent. Genuinely separate sales that close in different tax years are tested separately. Splitting a single transaction artificially, however, invites challenge under the step-transaction doctrine and the IRS’s anti-avoidance authority in Section 453A(e).
The pledge rule
Under Section 453A(d), if a seller uses an installment obligation to secure a loan, or enters any arrangement that lets the borrower satisfy the debt with it, the net loan proceeds are treated as a payment, up to the unpaid contract price. The rule applies to any covered sale above $150,000, regardless of the $5 million threshold. Sellers should plan on not borrowing against the payments and settle their cash needs before closing.
Steer clients away from so-called monetized installment sales, in which the seller borrows against the sale proceeds. IRS Chief Counsel rejected the design in CCA 202118016. In 2025 the Justice Department sued a promoter in federal court in Idaho to bar it from selling the arrangement, alleging it had sold about 386 of them. Proposed regulations issued in 2023 (REG-109348-22), still pending, would make it a listed transaction. The IRS also put the arrangement on its “Dirty Dozen” list of tax scams each year from 2022 through 2024.
A newer funding option: the funding agreement
Traditionally, the assignment company funds the buyer’s obligation with an annuity. Because the assignment company is not a natural person, it must use an immediate annuity to avoid annual tax on the annuity’s buildup under Section 72(u). As a result, traditional SIS payments must start within one year of purchase and follow a level schedule.
At least one carrier now offers an alternative. MetLife’s Structured Installment Sale Flex Agreement (SIS-FA) funds the obligation with a funding agreement instead of an annuity. The carrier’s position is that because a funding agreement is not an annuity, the Section 72(u) constraint does not apply. According to the carrier, the SIS-FA allows:
- payment start dates tailored to the seller, rather than within one year;
- a single deferred lump sum or a series of payments; and
- payments that increase annually.
For an owner who does not need the money for years, such as one planning for retirement income, the flexibility lets the seller time gain recognition to years when the client expects lower income.
For a sale above $5 million, though, two costs grow with the length of the deferral:
- Section 453A. Until payments begin, the unrecognized gain does not decline, so the full interest charge recurs every year. In the earlier example, a 10-year deferred start would cost about $817,000 in interest charges if the rate stays at 7%.
- Original issue discount. If interest accrues during the deferral instead of being paid at least annually, the seller may owe tax on interest not yet received. The cash-method election that avoids this (Section 1274A) is limited to $5,330,500 of stated principal for 2026, an amount indexed annually, so ask how interest is stated.
Pre-closing checklist
- Model a lump-sum sale and an SIS with the Section 453A charge side by side.
- Confirm the client’s liquidity needs and that the client has no plans to pledge the payments.
- Take enough cash at closing to cover the recapture tax, any state tax due up front and the first year’s Section 453A charge.
- For a funding-agreement SIS, project the Section 453A charge and any OID over the full deferral period.
- Bring the SIS consultant in before the purchase agreement is signed.
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Sean Whitehead is a structured settlement consultant and the founder of StructuredSales.org (https://structuredsales.org/).
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Tags: closing, firm, installment sale
