Ashish is correct. You will be able to recognize only a portion of the gain in the first year and will recognize the rest as you receive income over the next 5 years. Not only does this defer taxes, it can potentially save taxes as well.
Capital investments held for more than one year are subject to preferential tax rates. Long-term capital gain rates for the 2022 tax year are the following:
From Nerdwallet
Say you have a Single tax filing status, no other income (ignoring the interest you'd receive from the loan) and we'll ignore the standard deduction. If your basis in the property is $450k, you'd have a total gain on sale of $175k (assuming the $625k purchase price). Your gain is apportioned as you receive income. If you sold December 31st of 2022, you would receive $315k in the current tax year and no principal payments. The gain you would recognize in 2022 is (315,000/625,000) = 50.4% * 175,000 = $88,200. Looking at the tax brackets above, $41,675 would be taxed at 0% and (88,200 - 41,675) = $46,525 would be taxed at 15%. For easy math, let's say you receive $5,000 payments monthly for 5 years with $3,500 related to principal, and will receive a $100k balloon payment at the end (this is not how the math actually works, but again, just to simplify). You would recognize $42k/year in principal for 2023 - 2026, and $42k plus the $100k balloon payment in 2027 (for a total of $142k). Your capital gain for years 2023 - 2026 would be (42,000/625,000) = 6.72% * 175,000 = $11,760. The final year you would recognize (142,000/625,000) = 22.72% * $175,000 = $39,760.
In the scenario above, your capital gains would all be within the 0% tax bracket for years 2023 - 2027. Alternatively, if you were to recognize that whole gain in 2022 (though it would be slightly smaller since the cash offer was less), a much larger portion would be taxed in the 15% tax bracket.
There are a other factors to consider and that impact this scenario, including -
- Depreciation recapture, if you've been depreciating the property
- The terms of the loan (you'll recognize more capital gain each year if amortized over, say, 7 years vs. 30)
- With a land contract you'd be receiving interest in addition to the payment of principal. While that means more income, it would also be taxed at ordinary rates, not preferential rates
- Your tax filing status
- Your standard or itemized deductions and other income. My example above did not consider either. If we layer in a $12,550 standard deduction and the ((5,000 payment - 3,500 principal) * 12 months) = $18,000 interest your "ordinary income" would be $18,000 - $12,550 = $5,450. This would "push up" your capital gain and reduce the amount allowed to be taxed at 0% by the $5,450 of ordinary income every year
I hope this example helped clarify what the articles were trying to communicate. Whether the owner financing is a "good deal" for you or not depends on the terms of the sale and your goals. I would make sure you're lined up with a good financial advisor or financially-cable realtor who can help you analyze your options (on that note, this is not financial advice!). I've seen several incorrectly filed installment sale forms as well, so be sure to work with a CPA who understands these transactions as well. It can get messy if not done properly.
Best of luck!
