He’ll Sell the Duplex to His Daughter for $540,000 and Take It Back in Fifteen Years of Monthly Checks. The Rent Will Pay the Note, and Most of Each Year’s Slice of Gain Will Land in His 0% Bracket

If you’ve owned a rental property for decades, such as a duplex, federal tax law lets you sell it to your child, act as the lender, and report the gain in small pieces as the monthly payments come in. This is an installment sale to a family member. It spreads one large capital gain across every year of the note, so each year’s piece can fall into the 0% long-term capital gains bracket instead of landing on a single tax return.

How Carrying the Note Yourself Splits One Big Gain Into 15 Smaller Ones

Take a seller who prices the duplex at $540,000, skips any bank loan, and accepts a 15-year note from his daughter. She collects rent from both units and uses it to make the monthly payment. Each check has three parts. The interest is ordinary income.

Part of the principal returns his original cost basis, which is tax-free. The rest is profit, taxed only in the year he receives it. If his other taxable income stays modest, that profit can fit inside the 0% capital gains range year after year.

Where the Tax Code Allows It

Under 26 U.S.C. § 453(b)(1), an installment sale is a disposition “where at least 1 payment is to be received after the close of the taxable year” of the sale. 26 U.S.C. § 1001(d) permits taxing gain “in the year in which such payment is received.”

The 0% rate comes from 26 U.S.C. § 1(h)(1)(B), which applies 0% to long-term gain that fits within taxable income that would otherwise be taxed below 25%. The IRS adjusts the ceiling for that 0% range each year for inflation.

Who Qualifies and Who Runs Out of Room

Any owner who has held real property for more than a year and receives at least one payment after the year of sale qualifies. Your child counts as a “related person” under § 453(f)(1). The stricter § 453(g) bar on installment treatment for depreciable property relies on a narrower list in § 1239(b), which covers controlled entities, certain trusts, and estates. A direct sale to an adult child falls outside that list, as sellers with large pensions, required minimum distributions, or wages will fill the 0% range first, leaving little room for the gain.

Five Steps to Set Up the Sale in 2026

1. Get an independent appraisal and sell at fair market value. Any discount counts as a gift, and the 2026 annual gift exclusion remains at $19,000 per recipient.
2. Charge interest at or above the IRS applicable federal rate (AFR) for the month of sale. A note running over 9 years must use the federal long-term rate. If the stated rate falls short, § 483 treats part of each payment as interest. For reference, the 10-year Treasury yield stood at 5.13% on October 21, 2026, though the AFR is a separate published rate.
3. Sign a promissory note and record a mortgage or deed of trust so the loan holds up as real debt.
4. File Form 6252 every year. Report the interest as ordinary income on Form 1040, line 2b.
5. Map your other income against the 0% range before the sale closes. The One Big Beautiful Bill set the 2026 standard deduction at $32,200 for joint filers and $16,100 for single filers. Interest from the note counts as ordinary income, so it fills your low brackets before the gain does and uses up 0% room.

Three Traps That Shrink the 0% Slice

Depreciation recapture is the first trap because, under § 453(i), you recognize any recapture income in the year of sale. IRS Publication 544 states this applies “even if no payments are received in that year.” After that, 26 CFR 1.453-12(a) requires that unrecaptured section 1250 gain be taken into account before other capital gain. That gain is taxed at ordinary rates capped at 25%, so it never qualifies for 0%. The early checks carry the depreciation gain, and the 0% treatment applies only after that layer is used up.

Your child’s resale is the second trap. Under § 453(e), if a related buyer sells the property within 2 years, the seller is treated as receiving the resale proceeds at that point.

Medicare premiums are the third. Installment gain counts toward the modified adjusted gross income Medicare uses to set surcharges. In 2026, the standard Part B premium of $202.90 a month rises to $284.10 once income goes above $109,000 for single filers or $218,000 for joint filers. IRMAA is one of several income-linked rules that quietly drain retirement accounts, and we outlined the rest in a free guide to the traps retirees hit most often.

The IRS sets new AFRs each month for the following month, so check the current long-term rate before signing the note.

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