Tax implications of seller financing properties and business structure

[Luke Moore]

I was listening to a podcast this morning and the hosts were discussing the origination of a seller financed loan on property that they own to either hold or sell as a performing note. 

I have a rental property that has substantial equity, but raising taxes, insurance, and expenses are squeezing my margin. I was thinking about selling the rental through 1031 exchange into a lesser valued property and originating a seller financed loan to get on the other side of the deal. What are the tax implications of this type of transaction if I hold the note vs. sell the note, and how do I best manage this? LLC, S-Corp? Any advice with this type of transaction?

[Dave Foster]

@David M., I was just trying to keep it 10,000 ft.  Now you've got me dive bombing into the deep weeds :). I actually have an entire video on this and a chapter in the book.

The jist of it is that the cash proceeds and the owner carry note go into the 1031 account so they are not taxed as boot.  They must be used in the purchase of the new property.  But it's going to be tough if not impossible to get a seller to accept the owner carry note as part payment.  So, instead, the exchanger brings in money and replaces the note in the exchange account with cash.  Now the 1031 account has all cash and they can complete their exchange no problem.

And... outside their exchange account they have a note for the property they sold.  They "paid" (the swap with the exchange account) face value for it so there is not profit in the note other than the interest that comes in.