Capital Gains on Seller Note

I wasn’t sure whether to post here or in the Financing section. My question revolves around the capital gains treatment for seller financing. I have a seller who might be interested in seller financing but is afraid of paying capital gains taxes on the entire sale amount. I asked for 36 month financing at $2500 per month with a balloon at the end. The PP is $450,000. She refused because of the above. Can someone explain the tax treatment on this type of sale? Are taxes paid on monies as she receives them or all upon sale? BTW, the properties are listed on MLS with realtors involved.

Seller financing is taxable as an installment sale note under Section 453 of the Internal Revenue Code. Essentially, the capital gain is taxed on a pro-rata basis as the principal payments are made, so the majority of the capital gain would be taxed at the time the balloon payment is made in the year in which the 36th payment is made.

Is this investment property or a primary residence for the owner/seller? If it is investment property, he/she could do a 1031 exchange with the note, although it is not an easy structure.