Tax Help of Seller Financing Deal

[Brendon Kerrigan]

Hi BP Community!

Trying to do my first seller financing deal and the owner is open to the idea, but has 1 concern that I didn't have an answer for off hand. If I buy the property tomorrow, and the owner carries the mortgage, would he recognize the capital gains in 2020, therefore owe taxes by April? Or would the capitals gains be recognized when I pay the amount in full, which would be sometime in the fall of 2021, therefore payout of taxes wouldn't occur til april 2022?

Also, this property is in a trust, are there any issues doing a seller financed deal within a trust?

Thank you

[Bob Norton]

@Brendon Kerrigan With a seller financing deal (also known as an installment sale), the seller will receive part of the sale price each year, plus interest.  The seller will pay income tax on any interest received during the year and capital gains tax on the portion of the gain they received each year.  

For example, let's say you purchased a property with seller financing for $100k and $10k down and you will pay off the loan over 10 years.  The seller originally purchased the property for $50k, so the seller has a $50k gain, or 50% of the purchase price.  The seller will pay capital gains tax on $5k, 50% of the down payment, in the year you purchase the property and will spread out the remaining $45k of the gain on the sale over the 10 years that you make payments.  In each subsequent year, the seller will pay capital gains tax on 50% of the principal he received from you, plus income tax on any interest you pay him.

So, in your case, the seller will pay tax on the gain included in the down payment you make in 2020, which will be due in April 2021.  And, will pay the balance of the capital gains tax owed in April 2022, when you pay off the loan in 2021. 

Installment sales for trusts are calculated the same way.

[Brendon Kerrigan]

@Bob Norton thanks Bob! And there won’t be any issues legally if a trust does seller financing? (As opposed to an individual)

[Bob Norton]

@Brendon Kerrigan The legal issues for a trust selling a property is the same as an individual selling a property.  The trustee will have to sign on behalf of the trust.  I'm assuming that the seller you mentioned is also the trustee of the trust.  

You will need to sign a promissory note and a mortgage to the trust, just as you would an individual.

Make sure the sale is closed properly with a real estate attorney or title company.

[Brendon Kerrigan]

@Bob Norton

Awesome thank you - I plan to use a title company for sure!