The drawbacks of installment sales

February 15, 2008

An installment sale is one way to postpone some of the tax on a real estate gain. I like that idea, but what are the potential downsides?

In your Feb. 1 issue, you mentioned that an installment sale is one way to postpone some of the tax on a real estate gain. I like that idea, but what are the potential downsides?

Since a portion of your profit remains locked up in the property until the buyer pays the last installment, the resulting loss of liquidity limits your options. So you'll want to make sure there's no chance that you'll need the proceeds sooner. You may also face an "opportunity cost" if you later learn that you could have earned more by skipping the installment sale, paying the 15 percent tax on your gain, and reinvesting the remainder in another property. An installment sale also involves potential hassles. If the buyer gets behind on his payments or defaults on the purchase, for instance, you'll either have to hound him yourself or hire an attorney to collect your money or reclaim the property. Finally, if the law changes before an installment sale is completed and the tax rate rises, you'll end up paying more tax than expected on a portion of your profit.