California Installment Sale Tax: Withholding, Moving and the FTB

How California taxes an installment sale

California adopts the federal accounting rules, including the installment method of Section 453, through Revenue and Taxation Code (R&TC) 17551. The mechanics match the federal return you already know from our guide to installment sale tax: each dollar of principal you collect carries the same gross profit percentage, and that slice of gain is reported in the year you receive it. Interest on the note is reported separately as it is paid.

The difference is the rate. California has no lower capital gain rate. The FTB taxes capital gains as ordinary income, on the same schedule as wages, topping out at 12.3%, plus a 1% surtax (the Mental Health Services Tax, R&TC 17043) on taxable income over $1,000,000. That is the 13.3% top rate you hear about. Because the schedule is progressive, spreading a large gain over several years often moves much of it out of the top brackets and, for many sellers, below the $1 million surtax line in every year. That is the core of seller financing taxes in California: same gain, smaller slices, lower average rate.

Form 593 withholding: 3 1/3% of each principal payment

R&TC 18662 lets the FTB require withholding on dispositions of California real property, and subdivision (e)(3)(E) applies it separately to each principal payment on an installment sale. The Form 593 instructions spell out how it works:

• At closing: escrow withholds 3 1/3% of the down payment and sends it to the FTB with Form 593, Form 593-V and a copy of the promissory note.
• After closing: the buyer withholds 3 1/3% (or the alternative rate you elected) from the principal portion of every later payment, including a balloon or early payoff, and remits it with a new Form 593 by the 20th day of the month after each payment. Interest is not subject to this withholding.
• Alternative withholding calculation: instead of 3 1/3% of the price, you can elect withholding equal to your applicable tax rate times the estimated gain (Part VI of Form 593). When basis is high, this cuts withholding sharply.
• Exemptions: include a sale of a principal residence that qualifies under Section 121, a sale of $100,000 or less, a sale at a loss or zero gain, and a qualifying 1031 exchange. You certify the exemption on Form 593 under penalty of perjury.
• Electing out: if you report the entire gain in the year of sale, you can ask the FTB in writing to release the buyer from withholding on later payments. The FTB approves or denies within 30 days, and the buyer keeps withholding until it approves.

Withholding is a prepayment, not an extra tax. Each amount withheld is a credit on your California return for the year it was withheld. Put the withholding duty, the Form 593 copy to you, and a 60-day notice to the FTB if terms change into the note itself, so the buyer cannot claim surprise.

Worked example: a California resident, cash vs a 10-year note

Assumptions (engine run): land held for investment, sold in 2026 for $2,000,000 with an adjusted basis of $500,000, so the gain is $1,500,000 and the gross profit percentage is 75%. Selling costs are ignored. Married filing jointly, California residents for every year, $120,000 of other ordinary income each year. Note option: $400,000 down at closing and a $1,600,000 note at 6% for 10 years, level annual payments of $217,389, first payment in 2027. Six percent is above every October 2026 applicable federal rate (mid-term 4.61%, long-term 5.22%, Rev. Rul. 2026-19). Tax is the extra tax the sale causes, from the installmentsalecalculator engine, using the engine's 2025 California schedule and 2026 federal tables held flat for later years. The California column is tax on the gain only; interest is shown separately below.

Over the life of the note, California tax on the gain is about $23,700 lower than the cash sale, and most of it is paid years later. Federal tax on the gain falls too: with federal income tax and the 3.8% net investment income tax added, the gain costs $386,180 on the note against $507,290 for cash in this example. The $573,887 of interest the buyer pays you is extra income, taxed every year it is received; the engine puts the combined federal and California tax on that interest at about $161,100 over the 10 years. To test your own price, basis and terms, run your numbers.

Withholding totals exactly 3 1/3% of the price either way ($66,667). On the note, the down payment year withholding ($13,333) is less than half of that year's California tax on the gain, so expect an estimated payment or a balance due with the return.

Moving out of California after the sale

Many sellers plan to leave California and collect the note somewhere with no income tax. FTB Publication 1100 explains what moves with you and what does not:

• California real property: gain is sourced where the property sits. A former resident who sold a California building or land on a note keeps paying California tax on the gain in every payment, for the life of the note, on a nonresident return.
• Intangible property (stock, and other intangibles sourced by residence): gain is sourced to your state of residence when you sold. Sell while a California resident and the installment gain stays California income after you move.
• Interest on the note: sourced to where you live when you receive it. Once you are a bona fide nonresident, California stops taxing the interest, even on a note from a California property sale.
• Out-of-state property sold while a resident: if you sold, say, Washington land while living in California and then moved away, later installment gain is not taxed by California.

So timing matters. Moving before you sign, with a genuine change of domicile, is a different result from moving after. Our state residency change before a sale analysis covers what the FTB looks for when it audits a move.

Large notes: California's own Section 453A interest charge

If the sales price is over $150,000 and your installment notes from the year's sales exceed $5 million at year end, federal Section 453A charges interest on the deferred tax. California adopts that rule and adds its own: R&TC 17560(e) increases the California tax by an interest charge figured the federal way, using California's top rate (12.3% under R&TC 17041) as the deferred tax rate. The federal exceptions carry over, because the California charge applies only to obligations Section 453A covers, so farm property and personal-use property are outside it. California also follows the Section 453A(d) pledge rule: borrowing against the note is treated as a payment. See the Section 453A interest charge and the pledge rule.

1031 exchanges, boot and FTB 3840

California follows 1031 exchanges, but if you exchange California property for property in another state, you must file FTB 3840 every year until the deferred California gain is recognized, and California taxes that gain when the replacement property is later sold. If the buyer pays part of the price with a note (boot), that piece can be reported on the installment method, and Form 593 withholding applies to the boot when it is paid. See 1031 boot for how the two rules fit together.

Selling a home in California on a note

California adopts the Section 121 home sale exclusion (R&TC 17152 makes only small changes): up to $250,000 of gain, or $500,000 for a married couple filing jointly, if you owned and lived in the home for two of the last five years. A sale that qualifies is exempt from Form 593 withholding. Gain above the exclusion is taxed by California as ordinary income, and if you carry a note, only that excess gain is spread over the payments. Seller financing on a home also brings consumer lending rules for the note itself, so use an attorney who drafts these regularly.

How Hans helps

The $5,000 Big Sale Tax Analysis models a California installment sale year by year, federal and California together, next to a cash sale, a 1031, a move before closing and the other deferral paths, with a written recommendation. Get the full Big Sale Tax Analysis.

Get the full Big Sale Tax Analysis

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