Tax implications for owner financing

[Brandon Craig]

Hi all.  I was wondering if someone could explain the tax implications for both sides of an owner financing deal for a rental property?  I am just starting to research this financing strategy and I'm wondering how much the length of payment benefits a seller in terms of capital gains tax.  In addition, is there any difference from a conventional mortgage regarding interest payment write offs for the buyer?  Any input is appreciated!

[Michael Plaks]

@Brandon Craig

It's fairly simple. The buyer gets to deduct interest just as if it was a bank mortgage. If he is an investor, he also gets to depreciate the full cost of the property, as if it was purchased for cash.

The seller receives interest and principal. Interest is always taxable when received. From principal part, a fixed percentage is considered a tax-free return of the investment, and the rest is taxable capital gain.

The tax effect for the seller is that he spreads his capital gain tax over the length of the loan. Not evenly though: it is a fixed % of the principal portion. So, a large down payment also creates a corresponding capital gain in the first year.

Another way to say it: the seller pays capital gain taxes as he receives payments, as opposed to everything at once.