Tax Implications of Seller Financing via Note

[Ezra Nugroho]

Hi all,

I just read this related topic on tax implications of Subject To: 

http://www.biggerpockets.com/forums/51/topics/1303...

My question is what are the tax implications of seller financing that is done via the creation of a note, both for seller and the buyer?

Let's just create the following hypothetical transaction with easy numbers:

Seller owns a property free and clear, selling it for $100k. Buyer pays $40k down, and the rest will be paid via sellers financing at 5% interest on a 10 year note, 20 year amortizations with a balloon payment at the end.

Is it correct to assume that:

1. The $40k down is subject to capital gain on the year of closing.

2. The 5% interest is considered a regular interest income. Buyer can deduct this part. What about the portion of the payment that goes to the principal ?

3. When the balloon payment is paid, this is considered as capital gain on the year of the payment. 

Correct? Absolutely wrong?