Seller Financing Tax Question

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Seller Financing Tax Question

Anthony Rega
Lender · Greater NYC Area · Member since 2023 · 18 posts · 1 vote

If a seller, who files taxes as "married filing jointly" and has owned their primary residence for over 2 years without any outstanding mortgage, wishes to sell their property for $750,000 and agrees to finance a second mortgage of $250,000 for the buyer, would they be required to pay tax on the entire $250,000 in that year? Or would they only need to pay tax on the amount they actually receive from the buyer's mortgage payments that year?

If I'm not mistaken, the Section 121 exclusion allows for a tax-free gain of up to $500,000 on the sale of a primary residence.

If a seller who is married filing jointly that is selling there primary residence own over 2 years own property free and clear and wants to sell the property for 750,000 and agrees to hold a 2nd mortgage for 250k would they need to pay tax on the 250k that year?  Or only the amount they received from new buyers mortgage payment.   

Section 121 exclusion allows up to 500k tax free on primary resident sale if Im not mistaken.   

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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
3y
Quote from @Anthony Rega:

I think you misunderstood my question.  Here is an example

No, you misunderstood my answer. It does not matter how much you sell the house for. What matters is how much was your GAIN. Example: you buy a house for 1.5 MM and sell for 2 MM. There is no tax because the gain is only 0.5 MM

You're trying to open a door that is already open. 

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y

    @Anthony Rega

    It's not $500k of the price, it's $500k of the gain.

    In other words, if they bought it for $300k and sell for $750k, their gain is $450k, and entire sale is tax-free, provided they owned it and lived there for 2 years and did not sell another home during these 2 years.

    1Reply
  • Anthony Rega
    OP
    Lender · Greater NYC Area · Member since 2023 · 18 posts · 1 vote
    3y
    Quote from @Michael Plaks:

    @Anthony Rega

    It's not $500k of the price, it's $500k of the gain.

    In other words, if they bought it for $300k and sell for $750k, their gain is $450k, and entire sale is tax-free, provided they owned it and lived there for 2 years and did not sell another home during these 2 years.


    I think you misunderstood my question.  Here is an example

    Seller married over lived over 2 years Primary filing jointly 

    home owned free and clear.  Sells house for 750k,  Not taxed on 500k Gain IRS exclusion,  the extra 250k holding a 2nd mortgage for and will be getting mortgage payments monthly so they avoid the 250k capital gain tax(only taxed on income from mortgage payments received).  Is that correct if they hold a mortgage even though sales price was 750k, netting 500k at closing and 250k is a debt to the new buyer paid back over 30 years or until refinanced and paid off?  

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  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    3y

    @Anthony Rega

    I still don't understand the hypothetical situation..  Still sounds like you aren't looking at profit for taxation...

    I THINK to your question, this is like an installment sale.  Since the sellers are getting principal payments over time, they are realizing their profit over time.  Thus, it would be taxed, or part of the sec121 exclusion, over time.

    I really don't know that much about how the installment sales or this sort of extended "installment sale," for lack of better term, is handled in detailed.  

    Again, your example still lacks the purchase / cost basis, so you need to figure your issue on the profit.  The elements you are stating don't make much any sense as presented since one can't figure out a profit.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y
    Quote from @Anthony Rega:

    I think you misunderstood my question.  Here is an example

    No, you misunderstood my answer. It does not matter how much you sell the house for. What matters is how much was your GAIN. Example: you buy a house for 1.5 MM and sell for 2 MM. There is no tax because the gain is only 0.5 MM

    You're trying to open a door that is already open. 

    2Reply
  • Anthony Rega
    OP
    Lender · Greater NYC Area · Member since 2023 · 18 posts · 1 vote
    3y
    Quote from @David M.:

    @Anthony Rega

    I still don't understand the hypothetical situation..  Still sounds like you aren't looking at profit for taxation...

    I THINK to your question, this is like an installment sale.  Since the sellers are getting principal payments over time, they are realizing their profit over time.  Thus, it would be taxed, or part of the sec121 exclusion, over time.

    I really don't know that much about how the installment sales or this sort of extended "installment sale," for lack of better term, is handled in detailed.  

    Again, your example still lacks the purchase / cost basis, so you need to figure your issue on the profit.  The elements you are stating don't make much any sense as presented since one can't figure out a profit.

    I'll try to explain better and put it in numbers and change example
    seller has 100k mortgage
    seller sells house for 800k and agrees to finance all equity over 500k as a 2nd mortgage.  in this case 200k which seller will not gain in the sale that tax year since he is financing the buyer and will be paid back over time.  

    800k sells price 
    200k 2nd mortgage
    100k payoff mortgage
    500k to seller 

    200k 2nd mortgage has no payments due that calendar year.  the next year buyer pays mortgage 2000 a month 24k yr until paid off.  

    in the case would seller be tax free on the sale and next year taxed on 24k?  
    0Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y

    @Anthony Rega

    I ran out of ways to explain it to you. Your seller already has NO TAXES. Because equity and mortgage have nothing to do with taxes. The only calculation that matters is:

    Step 1. Difference between the sales price today ($800k) and the purchase price originally. You never said what they purchased it for. If they purchased it for $600k, then they have $800k minus $600k = $200k. This is called capital gain.

    Step 2. Is this gain ($200k in our example) less than the $500k Section 121 exclusion? It is! Then there is no tax. Game over. You won!

    What you're trying to do is create owner financing in order to avoid tax. But there is nothing to avoid! You already have ZERO tax. There is NO NEED to owner-finance anything! There is no Step 3.

    The error that you insist on making is comparing the $500k tax exclusion to the $800k selling price. No, you compare it to the GAIN, which is only $200k (assuming they bought the property for $600k originally) 

    Their remaining mortgage and equity do NOT change anything tax-wise.

    Now, if you create owner financing here anyway, for some reason OTHER than tax savings (once again, because there is simply no tax, so nothing to save!) - then the only tax you owe is on the INTEREST portion of each payment as these payments are received.

    1Reply
  • Anthony Rega
    OP
    Lender · Greater NYC Area · Member since 2023 · 18 posts · 1 vote
    3y
    Quote from @Michael Plaks:

    @Anthony Rega

    I ran out of ways to explain it to you. Your seller already has NO TAXES. Because equity and mortgage have nothing to do with taxes. The only calculation that matters is:

    Step 1. Difference between the sales price today ($800k) and the purchase price originally. You never said what they purchased it for. If they purchased it for $600k, then they have $800k minus $600k = $200k. This is called capital gain.

    Step 2. Is this gain ($200k in our example) less than the $500k Section 121 exclusion? It is! Then there is no tax. Game over. You won!

    What you're trying to do is create owner financing in order to avoid tax. But there is nothing to avoid! You already have ZERO tax. There is NO NEED to owner-finance anything! There is no Step 3.

    The error that you insist on making is comparing the $500k tax exclusion to the $800k selling price. No, you compare it to the GAIN, which is only $200k (assuming they bought the property for $600k originally) 

    Their remaining mortgage and equity do NOT change anything tax-wise.

    Now, if you create owner financing here anyway, for some reason OTHER than tax savings (once again, because there is simply no tax, so nothing to save!) - then the only tax you owe is on the INTEREST portion of each payment as these payments are received.


     Got it🤦‍♂️ im forgetting orginal pruchase price.  They purchased for 50k originally 35 years ago.   selling for 600k so 550k is what we base the gain on.  

    0Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    3y

    @Anthony Rega

    Maybe its from being "a seasoned mortgage professional with over 20 years of experience."  Although, I don't see 20 yrs of mortgage experience on your Linkedin profile.  
    But, maybe think back to when your profile looks to have started out with equity trading.  Your taxable profit is based on your cost basis, perhaps enhanced by margin...

    Similar for real estate.  Without a cost basis, there is no way to determine a taxable profit.

    Well, if you ever want to chat, send me a private message.  Maybe that will help.

    0Reply
  • Anthony Rega
    OP
    Lender · Greater NYC Area · Member since 2023 · 18 posts · 1 vote
    3y
    Quote from @David M.:

    @Anthony Rega

    Maybe its from being "a seasoned mortgage professional with over 20 years of experience."  Although, I don't see 20 yrs of mortgage experience on your Linkedin profile.  
    But, maybe think back to when your profile looks to have started out with equity trading.  Your taxable profit is based on your cost basis, perhaps enhanced by margin...

    Similar for real estate.  Without a cost basis, there is no way to determine a taxable profit.

    Well, if you ever want to chat, send me a private message.  Maybe that will help.

     I understand now,  I was forgetting most important part orginial purchase price🤦‍♂️ 

    0Reply
  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    3y

    @Anthony Rega

    The Gain and lending (providing a loan) on the home are two separate things

    You will pay interest income (taxed at ordinary rates) on the interest you receive.

    Your cpa will set your basis to determine if you exceed it, have an exemption and how the gains are taxed

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y
    Quote from @Anthony Rega:

     Got it🤦‍♂️ im forgetting orginal pruchase price.  They purchased for 50k originally 35 years ago.   selling for 600k so 550k is what we base the gain on.  


    And you probably have $0 tax even with these numbers. 

    To your original $50k purchase price you add all improvements made to the house during 35 years (new roof, kitchen or bathroom remodeling, new HVAC, new floors etc) - which probably was $50k or more.  

    And you also subtract closing costs from $600k. So the final spread is almost certainly below $500k.

    2Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    3y

    @Michael Plaks "You're opening a door that's already open."    Classic.  I will use that👍

    2Reply
  • Account Closed
    CPA · NY · Member since 2023 · 891 posts · 157 votes
    3y

    In the scenario you described, the seller, who is married and has owned their primary residence for over 2 years, can potentially benefit from the Section 121 exclusion, which allows for a tax-free gain of up to $500,000 on the sale of their primary residence. Here's how it works in your situation:

    1. Sale of the Property for $750,000: If the seller sells the property for $750,000, and they meet the criteria for the Section 121 exclusion, they may exclude up to $500,000 of the gain from their taxable income. This means they could potentially have a tax liability on the remaining $250,000 in gain.
    2. Second Mortgage of $250,000: If the seller agrees to finance a second mortgage of $250,000 for the buyer, they wouldn't have to pay tax on the entire $250,000 upfront. Instead, they would pay tax on the gain they receive from the buyer's mortgage payments as they are received.
    3. Tax on Received Payments: The seller would need to report the interest portion of the payments received from the buyer as income for tax purposes. The principal portion of the mortgage payments is a return of their investment and isn't taxed. So, they would only pay tax on the interest portion of the payments they receive in a given year.

    It's important to keep accurate records of the interest received, as this is the taxable portion. If the seller's total gain from the sale of their primary residence is below $500,000, and they report the interest income correctly, they may not have any additional tax liability related to the sale of their home.

    As tax laws can be complex and subject to change, it's advisable for the seller to consult with a tax professional or accountant to ensure they are in compliance with current tax regulations and to optimize their tax situation based on their specific circumstances.

    1Reply
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