How Does Selling a Mortgage Note Impact Taxes?

If you are a mortgage note holder, selling your note can be beneficial for a number of reasons. For starters, you no longer have to serve as the bank and collect payments from the borrower. Secondly, you can receive an ample return on your investment up front, rather than collecting it in bits and pieces. The funds you receive from selling your mortgage note can be used for essentially any purpose, such as paying unexpected medical bills, buying a new home or vehicle or settling an estate.

One question many note holders ask before selling their note is: How will selling my note impact my taxes? If you are considering selling mortgage notes, you should speak to your accountant. Your accountant will be able to explain the tax implications of selling mortgage notes in great detail. In the meantime, I've provided some ways in which selling your investment may impact your taxes. However, please note that this is not legal or tax advice.For legal or tax advice, please consult your lawyer or accountant.

Installment Sale

The basis in the note is determined by how you sell the property. When you seller finance your home, create a mortgage note and collect monthly payments from the buyer, this is considered a type of installment sale. The IRS identifies an installment sale as the sale of a property in which you receive at least one payment after the tax year in which the sale occurs. The IRS states:

You are required to report gain on an installment sale under the installment method unless you "elect out" on or before the due date for filing your tax return (including extensions) for the year of the sale.

The interest on an installment sale is reported as ordinary income, in the same way as other forms of interest income. Click here to view the IRS's full summary of selling a property using the installment sale method.

Capital Gains

When you sell your mortgage note, the amount that is above the cost basis is eligible for capital gains treatment. The basis is influenced by the method of amortization used and whether the installment sale method was used. Your accountant can calculate the basis when the property is sold.Because, mortgage notes are commonly sold at a discounted rate, they may result in a capital loss, which will decrease your tax obligation.

Prior to selling your note to a mortgage note buying firm, speak with your accountant so that you have a clear understanding of how your taxes will be affected.