Sell with seller financing note questions

[Joe Bourguignon]

I’m consIderIng selling a rental SFR with seller financing and have a couple of questions. - who do I need to write the note (originate?) - can I use some percentage of that note as collateral for getting another loan? - what are the tax implications of selling with seller financing; do I get to only pay taxes on how much the buyer pays me per year or the whole amount of my profit? - can I 1031 exchange somehow or does that not work with seller financing? Thanks! -joe

[Dave Foster]

@Joe Bourguignon, There actually is a way to combine a 1031 with an owner carry note.   I'll tag @Dave Van Horn and @Marian Smith to explain.

In order to completely defer all tax you must purchase at least as much as you sell.  And you must use all of the proceeds from the sale in the next purchase.  In an owner carry situation the proceeds would be the cash down payment and the note.  These go into the exchange account.  The note is actually made payable to the QI.  

At some point in time before your purchase you replace the note with cash from any source.  It could be other reserves, equity from another property, a stock sale, or a loan from an individual (for that matter you could even sell the note on the open market).  The cash or source doesn't matter, only that cash replaces the note in the exchange acct.  Once that happens you now have enough cash in the exchange account to complete the 1031.  Meanwhile outside the exchange you now own a note that you in essence paid par for.  So there is no profit in the note and all payments would be tax free except for the interest portion.

Easy example - Sell a $100K property into a 1031 with $20K cash down from the buyer and $80K in a note that you agree to carry.  The $20K cash and $80K not all go into the exchange acct.  Before your purchase you replace the $80K note with $80K cash.   Now your exchange account has enough cash ($100K) to complete the exchange.  And outside the exchange you have a note for $80K that you "paid" $80K for.  So there is no profit in the note and you only pay tax on the interest that accompanies each payment.

So the bottom line is that you can make an advantageous sale and do a 1031 with complete tax deferral and generate future tax free regular income.  Not a bad trifecta!