By Joe Wallin | April 2026 | ~7 min read
When you sell a business, real estate, or a large block of stock, the gain typically hits your tax return in a single year. Under Washington's new 9.9% income tax, that can mean a six- or seven-figure state tax bill on top of your federal liability.
But there is a well-established technique that can help: the installment sale. By spreading the recognition of gain over multiple years, you may be able to stay below Washington's $1 million threshold in some years — or at least reduce the amount of income exposed to the 9.9% rate in any single year.
This is not a new concept. Installment sales have been part of the tax code for decades. But Washington's income tax — with its hard $1 million threshold and flat 9.9% rate above that line — makes installment planning more valuable than ever for Washington residents.
How Installment Sales Work
Under IRC Section 453, if you sell property and receive at least one payment after the tax year of the sale, you can generally report the gain using the installment method. Instead of recognizing the entire gain in the year of sale, you recognize a proportionate share of the gain as each payment is received.
Each payment you receive is treated as consisting of three components: return of your basis (not taxed), gain (taxed at applicable rates), and interest income (taxed as ordinary income). The ratio of gain to total payments — called the "gross profit ratio" — determines how much of each payment is taxable gain.
This is important because Washington's income tax starts with federal AGI. If the installment method reduces the amount of gain included in your federal AGI in any given year, it also reduces your Washington taxable income for that year.
The Washington Income Tax Angle
Washington's 9.9% tax applies to income above $1 million. The threshold is binary: income below $1 million is not taxed; income above $1 million is taxed at a flat 9.9%.
This creates a powerful incentive to spread large gains across multiple tax years. Consider two scenarios for a founder selling a business for a $5 million gain:
Lump-sum sale (all gain in Year 1):
- Federal AGI in Year 1: $5.5 million (including $500K of other income)
- Washington taxable income: $4.5 million (above the $1M threshold)
- Washington tax: $445,500
Installment sale over 5 years ($1M gain per year):
- Federal AGI each year: $1.5 million ($1M installment gain + $500K other income)
- Washington taxable income each year: $500,000
- Washington tax each year: $49,500
- Total Washington tax over 5 years: $247,500
The installment sale saves $198,000 in Washington income tax — purely through timing. The total gain is the same. The total federal tax may be similar (depending on bracket effects). But the Washington tax is dramatically lower because less income sits above the $1 million line in any given year.
If the seller's other income were lower — say $300,000 — and the installment payments were structured to keep total AGI at or below $1 million, the Washington tax could be zero.
When Installment Sales Work
The installment method is available for most sales of property where at least one payment is received after the close of the tax year. This includes sales of businesses (asset sales), sales of real estate, sales of partnership interests, and private stock sales in certain circumstances.
The installment method is not available for sales of publicly traded stock or securities, sales of inventory, and sales of depreciable property to related parties (special rules apply).
For founders, the most common use case is an asset sale of a business or a sale of a partnership/LLC interest where the buyer pays over time — either through a seller note, an earnout, or a structured installment arrangement.
Structured Installment Sales: Removing the Credit Risk
The traditional objection to installment sales is credit risk: you are extending financing to the buyer, and if the buyer defaults, you may never receive the full purchase price.
A structured installment sale (SIS) solves this problem. In a SIS, the buyer's payment obligation is assigned to a third-party assignment company (typically an insurance company affiliate), which funds the installment payments from its own assets. The seller receives guaranteed periodic payments from a creditworthy institution, not from the buyer.
The IRS has recognized that properly structured installment sales qualify for installment method treatment under Section 453, even when payments come from a third party. The seller defers gain recognition just as they would in a traditional installment sale, but without the risk that the buyer fails to pay.
For large exits — $5 million and above — a structured installment sale is worth serious consideration. The combination of federal deferral benefits and Washington income tax savings can be substantial.
The Capital Gains Tax Interaction
Remember that Washington also has a separate capital gains tax (enacted in 2021, upheld by the state Supreme Court in 2023). The capital gains tax is 7% on long-term capital gains exceeding $270,000 (indexed for inflation).
Installment sales can help manage the capital gains tax as well, by spreading long-term capital gains across multiple years and potentially keeping gains below the threshold in some years.
However, the two taxes have different bases and different thresholds, so the optimization is not always straightforward. You need to model both taxes together with your CPA.
For more on the capital gains tax, see Washington's Capital-Gains Tax and QSBS: A Founder's Guide.
Installment Sales and the PTE Election
If the asset being sold is held by a pass-through entity (S corp, partnership, or LLC), there is an additional planning layer. The gain from the sale flows through to the owners, and if the entity has made the PTE election, the entity-level tax on that gain is deductible for federal purposes.
Combining an installment sale with the PTE election can produce a double benefit: the installment method reduces the amount of gain subject to Washington tax in any given year, and the PTE election reduces the effective rate on whatever gain is recognized from 9.9% to approximately 6.2%.
Using the example above — $5 million of gain spread over 5 years through a pass-through entity with the PTE election — the effective Washington tax could drop from $247,500 (installment only) to approximately $155,000 (installment plus PTE election). Compare that to $445,500 for a lump-sum sale without the PTE election.
QSBS and Installment Sales
If the stock being sold qualifies as QSBS under Section 1202, the analysis changes. QSBS gains (up to $10 million or 10x basis) are excluded from federal AGI entirely, which means they are also excluded from Washington's income tax base.
If the full gain qualifies for the Section 1202 exclusion, an installment sale provides no additional Washington tax benefit — the gain is already excluded.
But if only a portion of the gain qualifies for QSBS treatment (because the gain exceeds the $10 million / 10x basis cap), an installment sale can help manage the non-excluded portion. Spreading the taxable gain over multiple years keeps each year's AGI lower and may reduce Washington tax.
For more on QSBS planning, see our Complete Guide to QSBS & Section 1202.
Key Considerations and Risks
Imputed interest. The IRS requires installment sales to carry a minimum interest rate (the Applicable Federal Rate, or AFR). If the stated interest is below the AFR, the IRS will recharacterize a portion of the principal as interest — which is ordinary income, not capital gain.
Depreciation recapture. If the property being sold has depreciation recapture under Section 1245 or 1250, the recapture income must be recognized in the year of sale, regardless of the installment method. Only the gain above recapture qualifies for installment treatment.
The "pledge rule." If you receive an installment note and pledge it as collateral for a loan, the net proceeds of the loan are treated as a payment on the installment obligation, triggering gain recognition. This limits your ability to borrow against the note without accelerating tax.
State tax rate changes. Spreading gain over multiple years means you are exposed to the risk that Washington increases its income tax rate (which history suggests is likely). A 9.9% rate today could be higher in future years.
Time value of money. Deferring gain is generally beneficial (a dollar of tax paid later is worth less than a dollar paid today), but the benefit must be weighed against the credit risk, opportunity cost, and complexity of the installment structure.
What to Do Now
If you are contemplating a sale of a business, real estate, or a significant asset position in the next few years, model the installment sale option now. The key inputs are your expected AGI in each year (including the installment payments), the $1 million Washington threshold, the capital gains tax threshold, and whether the PTE election or QSBS exclusion applies.
The planning window is before you sign the purchase agreement. Once the deal terms are set, the installment structure needs to be baked in. Retrofitting installment treatment after closing is generally not possible.
For a comprehensive look at Washington tax planning strategies, see our Washington State Taxes guide and Tax Planning Guide for High Earners.
This post is for informational purposes only and does not constitute legal or tax advice. Consult with a qualified tax professional regarding your specific circumstances.
