Installment sale vs. 1031 exchange vs. opportunity zone fund: three ways to defer capital gains tax on a property sale

The three routes side by side

Each route answers a different question. The installment method: do you want to be paid over time and taxed as the cash arrives? A 1031 exchange: do you want to stay in real estate and carry the whole gain into the next property? An opportunity zone fund: do you want cash out now, defer tax on just the gain, and make a new long-term investment?

Installment sale: the gross-profit math, with recapture up front

An installment sale is any sale with at least one payment after the year of sale (Publication 537). Each year you report installment sale income equal to the payments received, excluding interest, times the gross profit percentage: gross profit divided by contract price. Interest on the note is ordinary income, and a note with inadequate stated interest has interest imputed.

Depreciation changes the picture. All §1245 recapture, and the “additional depreciation” on §1250 property, is ordinary income in the year of sale whether or not you received a payment. Only the gain above that recapture goes on the installment method, so the gross profit is the capital gain, not the total gain. Then, under Reg. §1.453-12, unrecaptured §1250 gain (straight-line depreciation on a building, taxed at a maximum 25%) is taken into account first: the first gain dollars of each payment are 25%-rate gain until that bucket is used up.

Take a building sold for $1,500,000 with an adjusted basis of $900,000, $100,000 of §1245 recapture on cost-segregated components, and $300,000 of straight-line depreciation on the structure. The gain is $600,000. Year of sale, with a $300,000 down payment and the rest on a note:

1. Ordinary recapture: $100,000, reported now.
2. Gross profit for the installment method: $600,000 − $100,000 = $500,000. Contract price $1,500,000. Gross profit percentage 33.3%.
3. Installment income on the $300,000 payment: $100,000, all of it unrecaptured §1250 gain at 25% because the $300,000 bucket is not yet exhausted.
4. Each later $300,000 payment produces another $100,000 of gain: two more years at 25%, then two at the long-term rate.

Electing out of the installment method reports the entire $600,000 in the year of sale, which can be better in a year with capital losses to absorb it.

§453A interest on large installment notes

When the sale price exceeds $150,000 and your nondealer installment obligations outstanding at year end exceed $5 million, §453A charges interest on the deferred tax: the deferred tax liability, times the applicable percentage, times the underpayment rate (7% for the fourth quarter of 2026). It is charged every year the notes stay outstanding and is not deductible by individuals. A seller holding $8 million of notes is paying for the deferral.

1031 exchange: 45 and 180 days, boot and recapture

Since 2018, §1031 applies only to real property held for business or investment. In a deferred exchange a qualified intermediary holds the proceeds; related parties and your own agents cannot act as intermediary. You must identify replacement property within 45 days after the relinquished property is transferred and receive it within 180 days, or by the due date of your return including extensions, whichever comes first, so a late-October sale needs an extension to get its full 180 days.

Gain is recognized to the extent of boot: cash or other property you receive, and net liabilities relieved (debt on the old property that is not replaced by debt on the new one). Recapture is triggered only to the extent of gain recognized, so a fully balanced exchange defers the §1245 and §1250 recapture along with everything else, and basis carries over to the replacement property, adjusted for boot and gain recognized. Related-party exchanges carry a two-year holding rule, and Form 8824 is filed for the two following years.

The cost is that every dollar of proceeds has to go back into real estate. Taking $200,000 out of the sale above is $200,000 of recognized gain: $100,000 of ordinary recapture, then $100,000 at 25%.

Opportunity zone fund: invest only the gain, five-year deferral, ten-year exclusion

A qualified opportunity fund takes a different slice. Only the gain is invested, within 180 days, and the eligible gain is capital gain or qualified §1231 gain; ordinary recapture is not eligible and is taxed in the year of sale. Unrecaptured §1250 gain is capital gain and can go in. In the example, $500,000 goes to the fund, $1,000,000 stays with you, and the $100,000 of recapture is taxed now.

For investments made after December 31, 2026, the amended §1400Z-2 defers the invested gain until the earlier of a sale or five years after the investment. At five years your basis in the fund interest rises by 10% of the deferred gain, or 30% in a qualified rural opportunity fund, so that slice is never taxed. Hold at least ten years and elect, and your basis becomes fair market value on the sale date, so the fund’s growth is excluded, if you sell before the thirtieth anniversary; after that, basis is fair market value on the 30-year date. The 180-day window is unchanged; related-party sales are excluded.

Investments made before 2027 are on the original schedule: the deferral ends on the earlier of a sale or December 31, 2026, included on the 2026 return, with the ten-year exclusion still available for dispositions through December 31, 2047. A gain realized late in 2026 whose 180-day window reaches into 2027 can be invested in January under the new rules (see the QOF guide). A fund interest is not real property, so you cannot 1031 into a QOF, but the boot from an exchange, or the gain from a failed one, can go in; see opportunity zone vs. 1031.

This worksheet covers the year of sale. The capital gains deferral calculator runs all three routes over the life of the note, the replacement property and the fund, including the five-year inclusion and ten-year exclusion.

The 2026 rates that drive the numbers

Rev. Proc. 2025-32 sets the 2026 long-term capital gain brackets. The 2027 figures had not been published as of October 2026.

On top of these: unrecaptured §1250 gain is taxed at a maximum 25%; collectibles and §1202 gain at a maximum 28%; the 3.8% net investment income tax applies to the lesser of net investment income or modified AGI over $250,000 (joint), $125,000 (separate) or $200,000 (single and head of household), and is not indexed. Ordinary recapture is taxed at ordinary rates, with the 37% bracket starting above $768,700 joint and $640,600 single.

State treatment differs. California, Massachusetts, Mississippi and North Carolina do not conform to §1400Z-2 for personal income tax, so an opportunity zone deferral does not work there for state purposes; Alabama, Arkansas, Hawaii and New York conform in part. Washington has a 7% excise on long-term capital gains over its standard deduction, with real estate sales exempt. Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas and Wyoming have no capital gains tax.

Choosing

• Paid over time, recapture now: installment sale. Watch the $5 million §453A line and the note’s interest rate.
• Stay in real estate with everything deferred: 1031 exchange. The 45-day identification clock is the usual point of failure.
• Cash out, a new investment, part of the gain forgiven: opportunity zone fund, investing after December 31, 2026. The capital gain goes in; the recapture does not.
• Combine them: exchange the property and put the boot into a QOF, or take an installment note and invest the gain from the down payment.

Fund sponsors who receive deferred gains can track each investor’s 180-day window, five-year inclusion and ten-year exclusion in FundTaxes, alongside the 90% test. See the real estate fund plan.

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