Taxes for selling Note?

Question

Hello and thanks ahead of time for any answers you can share!

I hold a first mortgage note on a single family home. When I go to sell it to a broker, do I have to pay taxes on the sale? The note is 3 years in to a ten year contract, and I will be receiving about 30k less than what the note is worth at this time for the buyout of the note.

Kevin Danikowski · Answer

Hello, I know i'm revisiting an old thread, but I have a related question. I'm about to purchase a 6 unit from a seller who wants to retire. They are going to pay capital gains tax on over $400,000. They aren't too interested in seller financing unless it sweetens the deal for them. I was thinking, maybe if they agree to seller finance at a better rate than my current lender, and then sell the note for say 10% off the principal, do they pay taxes on that note since it's at a loss? Or do they pay capital gains since the note is considered all profit? My gut feeling is this won't work, but it's worth asking about. Any thoughts?

Steven Hamilton II · Answer

@Will W, Yes, you will have to pay taxes on any profit, if there is a net loss as you say, it will be a capital loss reported on Schedule D. Your loss deduction will be limited to a net capital loss in any given year of 3k.

Will W. · Answer

Sorry to be so confusing. To clarify, I sold my house for 650k to the buyer, ie the borrower. I paid off my mortgage at that time with cash from the buyer. The remaining amount of the mortgage is the balance after the buyer paid the equivalent of my mortgage in cash, and the buyer took on the remaining balance of the sale price as a note to me. In other words, I paid off my mortgage and instead of walking away with the money leftover from the home sale, I conveted that cash into a note and have been making interest off of said note. This is even a better deal for the note buyer, right?

Dion DePaoli · Answer

First, as Bill pointed out and is not made clear in your second post. If this home is Seller financing, you may have to make some accounting adjustments. The price you paid for the home, not the loan balance has more affinity to your taxation. You mention, "I funded the deal with cash from the sale of my personal home.", which I take to mean you simply purchased the house. That is different than funding a loan. So if you bought the home for $200k and then Seller Financed it for $335k the calculation is against your $200k not the $335k. In that case, selling the loan for $240 is not a loss in simple terms. If the difference between you capital costs and the note are reported like an Original Issue Discount, which takes that difference and treats it like unrealized interest, then this is not going to be all that straightforward. Some of that difference would have been required to be realized during your holding of the note so far. This means it may be hard to simply sit down and figure out simple math on the general taxation without involving IRS rules. (code for you need a CPA) You mention this, "So when I sell this mortgage to a note buyer, and he pays me say 220k for it, ie the principal balance at that time, does that 220k get taxed?" This is worded poorly as details in this unfold. In your second post, you mention the Unpaid Principal Balance (UPB) is $260k. You mention the loan is being sold at a discount to the UPB of $220k. If you ask about being taxed on your Cost Basis, no you are not, you are taxed on the gain/loss. What has arisen is that the $260k (UPB) is not your cost basis anyway, assuming you purchased the house for less than you mortgaged the house for. That is what your CPA will have to help you with. You mention, "I am taking a 40k loss on the note because I am taking less than what the note is worth. Sorry not 30 tp clarify. Do you all think that is a good offer on the note too? 220k on a 260k note at a 4% rate?" Your loss may not be $40k with the Seller finance situation. The $260k loan at 3.85% sold at a 15% discount is a good deal for the Note Buyer. You might be able to sell for a little more based on the yield there but that also may have barriers with a willing buyer seeing how much you paid and stand to gain from said sale.

Will W. · Answer

Thank you for the responses so far. To give you more info... if this helps anyone... I am the lender, the person who bought the house from me is the borrower. I funded the deal with cash from the sale of my personal home. The mortgage or loan was in the amount of 335,000.00, at this point we are 28 months in, with a monthly payment of 3,357.37. The term of the loan is ten years at a fixed rate. 28,000.00 has been paid to me in interest via these monthly payments that also include payment toward the principal. The principal balance is now around 260,000.00 So when I sell this mortgage to a note buyer, and he pays me say 220k for it, ie the principal balance at that time, does that 220k get taxed? I am putting my money back into the bank and out of this note, so to speak. Closing and broker costs will be paid by the note buyer too. I am taking a 40k loss on the note because I am taking less than what the note is worth. Sorry not 30 tp clarify. Do you all think that is a good offer on the note too? 220k on a 260k note at a 4% rate? thank you so much for your replies, thety are appreciated!

Tom Goans · Answer

@Will W., It is wise to seek advice from a licensed tax professional. You have not provided near enough information to provide a remotely accurate response. It would be a very economical and wise decision to seek the advice of a licensed professional whom you can meet with and will take the time to review all of your specific information and then provide you with options catered to your specific needs.

Dion DePaoli · Answer

Not tax advice. The difference between the net sale proceeds and the cost basis (at sale) of the note will be reported as income (gain/loss). I don't fully understand what the $30k less actually is. If that is principal, and you are selling for less than your current capital basis then the difference will be a loss. If that is future interest, then you didn't realize that interest as income so it does not get reported. There are details that matter to this in regards to how you funded the deal, how you hold the asset, etc. The best answer will come from a CPA that knows those details.

Bill Gulley · Answer

No and yes. You'll have interest income that needs to come out of proceeds first to the day you sell. That's interest income due with your taxes when you file. If this was a seller financed note then you sell at a discount you'll need to adjust to the sale to the amount collected and pay the gain on the sale, again when you file your taxes. If it was a cash loan made you have a loss, again an issue at the time you file and you still have the interest income as mentioned above. There are special provisions for uncollected debts, so you need to see your tax advisor but there is not tax due from you from a note sale at the time of that sale. You may have transfer taxes in your state (don't know) that may be based on amounts collected from a sale, if such taxes exist they may be due when you collect that lump sum. Ask your tax advisor. Taxes aren't my thing, might get @Steven Hamilton II on that. :)