Selling Farmland on Contract: Installment Sale Tax and the Catch

How a farm installment sale works

In a farm or land installment sale, the buyer pays part of the price at closing and the rest over time, with interest. Two forms are common:

• Land contract (contract for deed, installment land contract). The seller keeps legal title until the contract is paid. The buyer takes possession, farms the land, pays the property tax and holds equitable title. The deed is delivered at the last payment.
• Deed with a note and mortgage (or deed of trust). Title passes at closing, and the seller holds a first-position lien.

For tax, both are installment sales under IRC 453 once the benefits and burdens of ownership pass to the buyer, even though, under a land contract, the deed has not been delivered. You report gain as principal arrives, using a gross profit percentage, and report interest as ordinary income. The general rules are on installment sale tax and seller financing taxes.

Farm property and the Section 453A exemption

For most large sales, Section 453A adds an interest charge when more than $5 million of installment notes from the year's sales are still owed at year end, and it treats borrowing against a note as a payment. IRC 453A(b)(3)(B) exempts any installment obligation arising from the disposition "of any property used or produced in the trade or business of farming," as defined in Section 2032A(e)(4) and (5).

The engine shows the size of that difference. On an $8,000,000 note with $7,200,000 of deferred capital gain at a 7% underpayment rate, a non-farm seller would owe a $37,800 interest charge for the year. The same note on farm property: $0. That lets farm sellers carry larger notes over longer terms. See the Section 453A interest charge analysis.

Two cautions. The exemption is for property used or produced in farming; a cash-rent landlord whose land is held mainly for appreciation should have the CPA confirm the land qualifies. And the farmhouse is separate: it may qualify for the Section 121 home exclusion, and personal-use property is separately exempt from 453A.

Land vs buildings vs equipment

A farm sale is a sale of each asset, so allocate the price.

Selling equipment at an auction and the land on contract can keep the year-one recapture out of the contract. See depreciation recapture on an installment sale.

Worked example (engine-computed)

Assumptions (illustrative): married couple filing jointly, tax year 2026, $60,000 of other ordinary income, retired farmers whose gain is not subject to net investment income tax (material participation in five of the last ten years), federal tax only (including alternative minimum tax where the engine finds it). Bare farmland sold for $3,000,000, basis $300,000, no selling costs. Land contract: $600,000 down, $2,400,000 balance at 6% interest, $160,000 of principal a year for 15 years. Gross profit percentage: 90%.

Spread over 16 years, the tax on the gain is $234,360 against $512,800 in one cash year, because more of the gain lands in the 15% bracket. The contract also pays $1,152,000 of interest, which is taxed as ordinary income (and adds net investment income tax in some years); a cash seller would not have that income at all. Engine: yearTax, 2026 brackets from Rev. Proc. 2025-32. To test other terms, run your numbers.

Section 1062: farmland sold to a qualified farmer

The One Big Beautiful Bill Act (P.L. 119-21, section 70437) added IRC 1062. If you sell qualified farmland property to a qualified farmer, you can elect to pay the federal income tax attributable to that gain for the year of sale in four equal annual installments, the first due with that year's return. It applies to sales in tax years beginning after July 4, 2025, so 2026 sales for calendar-year sellers. The requirements, from the statute:

• The land was used by you as a farm, or leased to a qualified farmer for farming, for substantially all of the 10 years before the sale.
• It is subject to a covenant or other enforceable restriction limiting it to farm use for 10 years after the sale, and a copy goes with the return.
• The buyer is an individual actively engaged in farming under the Food Security Act definition.
• The election is made by the return due date. A late installment or the seller's death accelerates the rest.

In the cash-sale case above, the $512,800 of federal tax on the land gain includes $12,760 of alternative minimum tax. The election covers regular income tax, so the remaining $500,040 could be paid in four installments of $125,010. That changes when you pay, not when the gain is income: brackets, Medicare premiums and other income-based tests still see the whole gain in year one, and the election does not reach alternative minimum tax, net investment income tax or state tax. A land contract changes when the gain is recognized, which is usually worth more. IRS guidance on the election is still limited, so confirm the mechanics with your CPA.

Interest, family sales and state rules

The interest is taxable

Interest on a land contract is ordinary income each year. The passive activity regulations use a farmland installment sale as their example of interest that is portfolio income (Temp. Treas. Reg. 1.469-2T(c)(3)(iv)), and it generally counts as net investment income. The rate must be adequate under Sections 483 and 1274, measured against the applicable federal rate; see seller note interest and the AFR.

Selling to family

IRC 483(e) caps the test rate at 6%, compounded semiannually, for land sold by an individual to a family member, on up to $500,000 of sales between those individuals per calendar year. Above that, normal AFR rules apply. If a related buyer resells within two years, Section 453(e) can accelerate your gain; and buying through the child's entity can create related-party issues for depreciable improvements. See the related-party installment sale analysis. If the farm may instead pass at death, compare holding for the step-up and Section 2032A special use valuation.

State rules

States differ. Iowa lets a seller subtract the net capital gain on real property used in a farming business after 10 years of material participation and 10 years of ownership, or on a sale to a relative (Iowa Code 422.7). Other states tax the gain as ordinary income, and state law decides whether a defaulted land contract is ended by forfeiture or must be foreclosed like a mortgage.

Protecting the seller on a land contract

• Down payment that covers year-one tax, including any equipment or structure recapture, and gives the buyer equity at stake.
• Recorded contract or mortgage so later creditors and buyers see your interest.
• Terms: interest at or above the AFR, amortization, any balloon, acceleration and due-on-sale, default and cure periods, prepayment.
• Covenants: buyer pays property tax, keeps the land in good farming condition, keeps buildings covered against casualty loss with you named as loss payee and does not remove timber or improvements without consent.
• Personal guarantee from the owners if the buyer is an entity, plus annual financial statements.
• Repossession: if you take the land back, Section 1038 limits the gain you recognize on real property repossession. See when the buyer stops paying.

IRS stance, costs and how it compares

Farm installment sales rest on settled law: IRC 453, the farm exemption in 453A(b)(3)(B), and the dealer rule exception for property used or produced in farming. Audit risk is in execution: recapture left on the installment schedule, a price allocation that understates equipment, and inadequate interest. Costs: attorney fees to draft and record the contract, title work, an appraisal where needed, and your CPA's Forms 6252 and 4797 each year.

Compared with a 1031 exchange, a land contract ends your management of land and gives you a payment stream instead of new property. Compared with a cash sale, it defers gain and adds interest income in exchange for buyer risk. To see every path side by side, Get the full Big Sale Tax Analysis.

Get the full Big Sale Tax Analysis

Frequently asked questions