A land contract is an installment sale, so the seller reports the gain as the principal payments come in, not all in the year of the sale, unless the seller elects out. The statute is Internal Revenue Code 453, the form is IRS Form 6252, and the plain-language guide is IRS Publication 537. Interest the buyer pays is ordinary income, reported separately. Who pays the county property tax is a contract term, and in most land contracts it is the buyer.
This is general information, not tax or legal advice. A CPA or tax attorney can confirm how it applies to you.
For how the contract itself works, see how a land contract works.
How does the IRS treat a land contract sale?
Section 453(a) of the Code says income from an installment sale is taken into account under the installment method, "except as otherwise provided." An installment sale is a disposition of property where at least one payment arrives after the close of the tax year of the sale (453(b)(1)). Publication 537 names the buyer's side directly: the obligation to pay you "can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt."
Three limits are worth knowing before you count on it:
- It is the default, not a choice. Unless you elect out, the installment method applies (453(a), (d)).
- Dealers are out. Section 453(b)(2)(A) excludes dealer dispositions, and Publication 537 says the dealer rule covers "real property held for sale to customers in the ordinary course of a trade or business." A person who buys and sells land as inventory should not assume this page applies to them.
- Losses are out. If you sell at a loss, you cannot use the installment method.
How do you split each payment into basis, gain and interest?
Three numbers set the pattern, and then every payment follows it. All three definitions come from Publication 537.
- Gross profit is the selling price minus your adjusted basis for installment sale purposes. Basis for a purchase is generally its cost; selling expenses such as commissions and attorney fees are added to it.
- Contract price is the selling price minus any mortgage the buyer assumes (plus any amount by which assumed debt exceeds your basis). On a cash-down land contract with no debt assumed, it equals the selling price.
- Gross profit percentage is gross profit divided by contract price. It stays the same for the life of the contract.
Each year, take the payments you received that year, subtract the interest, and multiply by the gross profit percentage. That product is your installment sale income, the gain. The rest of each principal payment is a tax-free return of your basis.
Here is the formula run on hypothetical numbers, not a real sale: a parcel with a $20,000 basis sold for $60,000, selling expenses of $1,500, $6,000 down and the $54,000 balance financed at 8% over 120 months.
| Item | Amount |
|---|---|
| Adjusted basis for installment purposes ($20,000 + $1,500) | $21,500 |
| Gross profit ($60,000 - $21,500) | $38,500 |
| Gross profit percentage ($38,500 / $60,000) | 64.17% |
| Monthly payment on $54,000 at 8%, 120 months | $655.17 |
| Year 1 principal received, including the $6,000 down (12 payments) | $9,674.83 |
| Year 1 gain reported (64.17% of principal) | $6,208.02 |
| Year 1 return of basis | $3,466.81 |
| Year 1 interest, ordinary income | $4,187.20 |
| Year 2 principal / gain / interest | $3,979.84 / $2,553.73 / $3,882.19 |
Over ten years, the $60,000 of principal produces the full $38,500 of gain, and the rest is the $21,500 basis coming back. The interest is on top. The land contract calculator produces the payment and balance for your own numbers, and the character of the gain, short or long term and at what rate, is covered in capital gains tax on a land sale.
How is the interest taxed?
As ordinary income, reported separately from the gain. Publication 537 says you "must report interest as ordinary income," and that interest is generally not part of the down payment. If the contract carries little or no interest, the IRS can treat part of each later payment as interest anyway under the unstated interest and original issue discount rules, even when the agreement does not call it that. A land contract at 0% is not a tax-free land contract.
One rule that sounds scary and rarely applies: the separate interest charge on deferred tax kicks in only if the sale price is over $150,000 and your total nondealer installment obligations outstanding at year-end are over $5 million, and it excepts farm property (Publication 537).
Can you elect out of the installment method?
Yes. Section 453(d) lets you elect to have the installment method not apply, which means you report the entire gain in the year of sale even though most of the money arrives later. In the example above, that is the full $38,500 in year one against $9,674.83 of principal actually received. The note's value is the issue price, which for a note with adequate stated interest is its principal.
How to elect: do not report the sale on Form 6252. Report it on Form 8949, Form 4797, or both. The election has to be made by the due date, including extensions, of the return for the year of the sale; if you file on time without it, an amended return filed within six months of the due date, marked "Filed pursuant to section 301.9100-2," still works. Once made, it can be revoked only with IRS approval (453(d)(3)).
Why would anyone do that? Some sellers want the gain in a year when they have losses to absorb it. That is a CPA question with real numbers, not a rule of thumb.
Who pays property tax on a land contract?
Whoever the contract says, and the contract almost always says the buyer. Michigan Legal Help puts it plainly: the buyer is in charge of repairs and paying property taxes in most land contracts. Wisconsin Law Help says taxes and insurance are usually the buyer's responsibility and that missing them is a default. Ohio's statute for contracts on property with a dwelling requires a clause making the buyer responsible from the contract date unless the parties agree otherwise (ORC 5313.02(A)(15)).
Three things the seller should still do, because you are on the title until the last payment:
- Make the contract say who pays, when proof of payment is due, and that you may pay and add it to the balance.
- Ask for the paid receipt each year.
- Know your state's reassessment rules. Michigan, for example, uncaps taxable value after a land contract transfer, covered in our Michigan land contract guide.
The state-specific rules are in our Wisconsin land contract guide and Ohio land contract guide.
What happens for tax purposes if the buyer defaults and you take the land back?
Publication 537 has mandatory rules for repossessed real property, and they undo the original sale's tax treatment. You keep essentially the same adjusted basis you had before the sale. The gain you report is the total payments you received minus the gain you already reported, capped at the gross profit on the original sale less the gain already reported and your repossession costs (court costs, legal fees, recording and lien clearance). The gain keeps its original character, capital or ordinary.
On the hypothetical above, if the buyer defaulted after year one, the payments received were $9,674.83 of principal and the gain already reported was $6,208.02, so the gain on repossession is $3,466.81 before repossession costs, and you have the land back at its old basis. The rules apply only if the repossession protects your security, the obligation came from the original sale, and you pay the buyer no extra consideration, unless the contract provided for it or default is imminent.
Does depreciation or recapture matter on bare land?
No. Land is not depreciable (Publication 946), so there is no depreciation to recapture when you sell vacant land. If the parcel has a rental building on it, that building is a separate question.
FAQs
What IRS form do I use to report a land contract sale?
Form 6252 for the installment method, with the gain carried to Form 8949 or Schedule D. If you elect out, you skip Form 6252 and report the full gain on Form 8949, Form 4797, or both.
Do I pay capital gains tax all at once on a land contract?
Not unless you elect out. Under the installment method you report gain each year in proportion to the principal you receive, and interest is ordinary income each year.
Who pays property taxes on a land contract?
The contract decides. In most land contracts it is the buyer, but the seller is on title until payoff, so keep the right to pay and add to the balance.
Do I owe tax on the interest from a land contract?
Yes, as ordinary income. If the contract has too little stated interest, the IRS can treat part of the payments as interest under the unstated interest rules.