I f you’re looking to sell real estate, you may have to structure the deal to make it acceptable to the buyer. But this could work to your tax advantage.

Strategy: Arrange a year-end “installment sale.” If payments are made in the year of the sale and at least one other year, you don’t owe all the tax due on a gain. Not only does this defer tax, but it may also reduce your overall tax liability. However, you must watch out for a tax trap for sales to “related parties.” Fortunately, it’s relatively easy to avoid dire tax results.

Here’s the whole story: Under the installment sale tax reporting rules, only a portion of the gain is taxable in the year in which you receive a payment. Also, the taxable portion of the sale qualifies for favorable capital gain treatment. Currently, the maximum tax rate for most long-term capital gains is 20% (but most taxpayers will pay no more than 15%). The top rate for short-term gains is 37%. In addition, a 3.8% tax applies to the lesser of net investment income (NII), which includes capital gains, or the amount by which your modified adjusted gross income (MAGI) exceeds a threshold of $250,000 for joint filers or $200,000 for single filers. Note: These thresholds are not indexed for inflation. Thus, when you add in the NIIT, you may pay an effective federal income tax rate of up to 23.8% (20% + 3.8%) on the sale of highly appreciated long-term capital gain property in 2024. If the sale results in a short-term gain, the effective tax rate can be as high as $40.8% (37% + 3.8%). And if you throw in state income taxes, the combined effective tax rate could approach or even exceed 50%! Note also that long-term real estate gains attributable to depreciation can be taxed at a federal rate up to 25% instead of the usual 15% or 20%. For these purposes, the taxable portion of each installment payment is calculated based on the gross profit ratio. The gross profit ratio is determined by dividing the gross profit from the real estate sale by the contract price. Example: You acquired commercial real estate several years ago that now has an adjusted basis of $600,000. On December 1, you agree to sell the property for $1.5 million in five annual installments of $300,000 each. Because your gross profit is $900,000 ($1.5 million − $600,000), the taxable percentage of each installment received is 60% ($900,000 divided by $1.5 million). When you report the sale on your 2024 tax return, you’re only taxed on $180,000 of gain (60% of the $300,000 received in 2024), reducing your exposure to the 20% maximum capital gains rate and the NIIT. For simplicity, say you save the 5% capital gains differential on $100,000 of income each year. That’s a tax savings of $25,000 (5% of $500,000)—well worth the wait. Caveat: If you claimed first-year depreciation deductions for the property under the Section 179 rules or the first-year bonus depreciation rules, most or all of the gain attributable to those write-offs will be treated as higher-tax ordinary income, and those gains won’t qualify for installment sale treatment. You must recognize the full amount of those gains in the year of the sale. Plus, there’s another wrinkle in the rules. The tax law says installment sale treatment is not allowed if you sell property to a specified related party unless you can demonstrate that the deal wasn’t motivated by tax avoidance. Furthermore, if the related party resells or disposes of the property within two years, the deferred tax becomes due immediately. The definition of a “related party” isn’t limited to the usual family members like your spouse, children, grandchildren, siblings and parents. It also includes a partnership or corporation you own or an estate or trust you’re connected to. The easiest way to handle this is to ensure the related party doesn’t dispose of the property within two years. Spell it out as a requirement in the contract.

Tip: If the sales price of your property (other than farm property or personal property) exceeds $150,000, interest must be paid on the deferred tax if outstanding installment obligations exceed $5 million.