Tax Implication and Other Things to Consider

[Dan V.]

Me and my wife are planning to purchase her mom's house. She used to live in the house and now lives with us for about 2 years now so the property still qualifies as primary residence. She is open to seller financing the house and we would like to make sure that I covered all the necessary requirements for this type of transaction and to minimize any tax implications on her end as well. The plan is to give her 10% downpayment and the balance is seller financing. Tax basis is $215K, we will buy it for $200K with 10% downpayment and 90% seller finance (30 year amortization) with a balloon payment option within 5 years. She only received social security income, no other income.

1. How will the installment sales impact capital gains? 

2. What if we made the balloon payment in year 5, will she be paying capital gains in proportion to the proceeds she received at that time or will the sale of primary residence still apply since technically she qualifies for it when she sold it?

3. What is the minimum interest rate we can charge for the seller financing without causing any red flag with the authorities?

4. Any other things I need to consider in this type of transaction tax-wise or compliance-wise?

Thank you very much, any input will be much appreciated.