Zero Percent Financing & Taxes

[Matt Heider]

Full disclosure, I'm a CPA and this should not be construed as tax advice.  Please consult your personal CPA.

I did a search on this topic and didn't see much discussion, so I figured I'd chime in.  My wife and I are looking at a personal home that is specific to our wants & needs.  However, the seller doesn't like our offer.  So, I thought I would employ some of the "creative" financing strategies I've learned through BP, i.e. zero percent seller financing.  In researching this topic, I ran across §1274, which basically allows the IRS to impute interest income to the seller (based on the federal AFR rate) whether they charge interest or not on loans that exceed $250,000, or if is the sale of their personal residence.  

This had the potential to torpedo my plan since the home we're looking as is well over the $250k range.  BUT, I believe we can accomplish the same goal if we use the AFR rate as the mortgage rate, then start with the acceptable monthly payment and back into the "financed price".  Then add the down payment to arrive at total sale price.  To ensure the seller gets all of their money, put in a 100% prepayment penalty clause in the loan.  

Do any more learned members (especially other CPAs) have an idea if this could work?  Are there laws against prepayment penalties for private loans?

Thanks!

[Jay Hinrichs]

@Dominick Austria  0% financing is very real.. I have been employing that strategy as a seller since the mid 80s during the hyper inflated 18% interest rate days.

It dawned on us two says..  One I believe it was Datsun ( that's what Nissans were called in the early days for you younger folks out there) they were the first auto manufacotrer to offer 0% financing.. which of course as we know has been copied for years and years since the mid to early 80s.

Second was I had Saudi clients from San Francisco that because of religious reasons could not pay interest 

So since we owned all the properties we sold.. ( my dad was in the land business big time 300 to 500 sales a year)

WE came up with our own 0% financing and just flat killed it..  my dad sold most of his paper in those days.. so we just wiped out the PV calculator and backed into what our note buyers would pay for the given cash flow.. that turned out to be 30 months zero interest has the same note value as a 7 year 15% rate note.. shocking I know.

I have employed this over the years to sell my OREO s that I foreclosed on buy and hold investors who failed.  I have never had a zero % loan default.. NEVER.. I sell a few each year like that ..  Its a win win.  we get a valuable note.. the buyer I like it even better granted payments very high.. but they end up with a free and clear asset in 30 to 60 months .. and that is how you get wealthy in real estate free and clear .. 

PS back to the question of imputed interest by IRS yes we had to pay that..