Dealing in Notes
A question popped up this week as a few colleagues and I were discussing seller financing and the idea of providing seller financing to homeowners and investors. The discussion leads to important points that if you are considering selling with owner financing you have to read. It could save you thousands of dollars.
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When to Originate a Note…
If you are an active investor buying properties and holding onto them for the long term you can make the occasional sale on seller financing and not be affected by some of the parameters we are going to discuss. Therefore, if you are a buy and hold investor, this is good information to know and avoid. With that being said, if you are an active investor engaged in the wholesale of properties or the fix and flip model you are under different government guidelines, ie you are considered a dealer of real estate and as such you are subject to different taxation on properties you own and re-sell on owner financing. As a dealer in real estate you have to realize the gain on the sale in the year of the transaction. What that means is, say you purchase a property for $25,000 and after extensive marketing and no offers you decide to seller at $40,000 with seller financing. The logic in this approach is you will make your return over time and you will get income on the property without the hassles of property management. Unfortunately, the government states that you must realize that $15,000 on your next tax return, so even though you have not earned the $40,000 in cash, you have to pay the tax on it. Pretty scary huh?
When you buy a performing note…
Here is a unique twist to the same scenario. Say you are a dealer in real estate and you purchase performing notes ie you buy someone else’s seller financed note. If you own that note and for some reason it stops performing and you have to sell the property all over again, you can resell with owner financing. You can do this without taking the same tax hit that you would have in the above example even if you are a dealer. This scenario gives dealers in real estate the opportunity to provide seller financing and sell properties at the price they are hoping to sell at.
Now these three scenario’s are not meant to act as tax advice but rather experiences that I have seen. I wanted to put this article together knowing that seller financing is becoming more popular in this economy. My goal is to create awareness and get investors to ask these questions to their CPA’s so they are not surprised when it is too late.
Photo Courtesy: Nikcname