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Updated about 1 year ago on . Most recent reply presented by

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Joshua Aycock
  • Investor
  • Stillwater, MN
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Tax Implications for Seller in Seller-Financed Deal?

Joshua Aycock
  • Investor
  • Stillwater, MN
Posted

What are the tax implications for the seller in an owner-financed deal? 

I've identified an off-market property that I'd try to get seller financing on. They've held the property for a couple decades, and would likely have a significant capital gains tax liability if they were to sell it on the open market. 

If they write a seller financed note, would they still need to pay that capital gains tax? 

My thinking: seller financing represents a debt owed to the seller. Therefore, it's an installment sale. I am thinking that they wouldn't have to pay cap gains tax on the "sale" because they'd be earning interest income on the loan payments. There would be a separation between principal return and interest payments. 

Similar thinking of how taxes would work at a traditional bank: they pay tax on only the interest earned, not on the principal repaid. 

Can someone check my thinking/understanding of seller-financed tax implications? 

Thanks in advance!

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Michael Plaks
#1 Tax, SDIRAs & Cost Segregation Contributor
  • Tax Accountant / Enrolled Agent
  • Houston, TX
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Michael Plaks
#1 Tax, SDIRAs & Cost Segregation Contributor
  • Tax Accountant / Enrolled Agent
  • Houston, TX
Replied

@Joshua Aycock

The first question is whether they're selling their personal residence. If so, they receive $500k tax-free capital gain after living there for 2 years. So they may have no tax benefits from owner-financing in this case. 

If it's their investment property, then part of each principal payment is a tax-free return of principal, the other part is taxable. How it is taxable is quite complicated. Usually, but not always, owner-financing can reduce the seller's capital gain taxes. It can even backfire on them in some cases.

Interest is always taxable, no matter what else is in play.

Whatever their situation is, you should never give tax advice to the sellers and thus accept liability for such an advice. Tell them to consult their own accountant about their tax implications. You can just mention that it might be possible to reduce their taxes with owner-financing.

Also, read this older thread: https://www.biggerpockets.com/...

  • Michael Plaks
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