Selling with owner financing

[Mark in St. Louis 0]

If I am selling a home with owner financing, when does the IRS consider it a sale? More importantly, when do I have to pay taxes on the gain.

 

Here are the parameters:

 

Closing on the home in 2 weeks.

 

I have no mortgage on the home....it's free and clear.

 

I paid well below $145,000 many years ago.

 

It has been a rental, so I've had rental income and have taken the depreciation every year.

 

Sale price is $145,000.

 

Buyer will be paying a downpayment of $10,000 at closing.

 

I am carrying back $135,000 as a 30 year note with a 5 year balloon.

 

When the buyer gets his own financing in 5 years (or before), is that the basis for the gain for tax purposes, or do I get nailed with the gain in 2 weeks when I close?

 

Thanks!

[Dave T 0]

Mark,

 

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. If you dispose of property in an installment sale, you report part of your gain when you receive each installment payment. You cannot use the installment method to report a loss.

 

As a general rule, if a sale qualifies as an installment sale, the gain must be reported under the installment method unless:

• You elect out of using the installment method
  
• You are not a qualified accrual method taxpayer
  

Caution: Dealer realty does not qualify for installment sale tax treatment. The entire profit in a dealer disposition is taxable in the year of sale, even if the property is sold with seller carried financing.

[Mark in St. Louis 0]

Dave T,

 

I'm a little foggy this morning due to having a severe cold and an overdose of NyQuil. Not to mention I'm not very tax saavy.

 

Let me see if I understand this.

 

If I close on this house today (for example).

 

The buyer hands me a check of $10,000 (downpayment).

 

I carryback a $135,000 note and get a deed of trust and promissory note and deed of trust.

 

The note has a 5 year balloon and interest only payments of $750 month. No principle reduction. That's $9000 per year in interest payments.

 

Lets say he pays for 3 full years and then gets his own loan and pays off the $135,000 principle balance.

 

This year I collect a $10,000 down payment and $8,250 in interest payments, for a total of $18,250.

 

Is that the amount I am taxed on for 2004?

 

When is it considered a sale...today, or in 3 years when the buyer pays off my $135,000 loan.

 

Man do I hate the tax code.

 

Thanks!

[Dave T 0]

If I am selling a home with owner financing, when does the IRS consider it a sale? More importantly, when do I have to pay taxes on the gain.

Mark,

 

You said that you own the property free and clear, and that you have been using it as an investment rental for a few years.

 

You pay taxes on your gain when you file your 2004 tax return (April 2005?) The IRS considers the property sold on the day you went to settlement with your buyer.

 

When the buyer gets his own financing in 5 years (or before), is that the basis for the gain for tax purposes, or do I get nailed with the gain in 2 weeks when I close?

The calculation of basis does not consider how much you owe on your mortgage loan, or whether the property is free and clear. Your basis is your initial purchase price minus depreciation allowed for when used as a rental, plus the cost of any capital improvements you made during your holding period.

 

Even though you own the property free and clear, I assume that you paid something for it, and took a depreciation expense while you had it in service as a rental property.

 

Once you have your initial cost basis, follow the instructions on the income tax form for Installment Sales. Generally, any principal payments (downpayment, installment principal payments, and balloon payment) you receive are taxed as capital gains in the year received. Interest received on your note is taxed as ordinary income in the year received. Allowed depreciation for your period of rental use is recaptured in full in the year of the sale.