All Forum Posts by: Leon D.

Steven,

Legal implications for the seller avoiding declaring taxable income would of course be serious, but that doesn't mean the seller wouldn't do so. I was merely laying out possible scenarios that would motivate a seller to issue a personal loan without official documentation.

As for deducting the interest, here's a succint version of my position I found on bankrate.com: "Your primary residence gets the benefits of many tax breaks, including the popular mortgage-interest deduction. A mortgage on a second home is also eligible for the interest write-off, as long as loans on both houses don't exceed $1 million. You also need to make sure you use the second house enough for it to qualify as a personal vacation retreat.

Go beyond these two holdings, and you'll find the tax treatment of real estate decidedly different.

When you own rental property, the IRS classifies that as a passive investment.

In general, the tax code views passive activities as those in which you do not, in the words of the IRS, "materially participate" in the investment. So wouldn't earnings from stocks or mutual funds, for example, be passive since the investor has no direct control of the company actions that affect its stock value? No. The IRS defines this as investment income.

Owning a rental property, however, is a passive activity, even if you're actively running and managing the property. And you can't claim the investment-interest deduction if the money is related to a passive activity."

The short answer is, depends. How is the seller financing set up?

That is to say, if the financing is a personal loan between you and the seller (regardless of any sort of paperwork the two of you signed), then the interest is NOT deductible, regardless of what the loan proceeds are used for. Parties may do this for any number of reasons, maybe the parties are less than arm's length, or the seller doesn't want to report the interest income to the IRS, etc.

If the seller financing is part of the purchase contract (as it should be, for everyone's peace of mind), with all its terms and conditions laid out between a distinct buyer and distinct seller, then the interest probably WOULD be deductible, and the the seller would report the income as taxable.