Title Transfer for Seller Financing

6 Replies

Hi,

My brother and I are currently in the process of buying a house from my parents. It is a duplex located in the Cleveland Ohio area. My parents do not want to pay capital gains on the property at the moment but are looking to get the property off there hands soon. We are looking to do seller financing with this property (my brother and I are in collage and were unable to get a good loan from any banks). With seller Financing, would by parents have to pay capital gains tax on the property? Also do we need a title transfer before we start the seller financing process? 

This is our first property so we have been doing a lot of research. We could not find find anything about this question that we had online. If someone could help up out on this question that would be awesome!

Thanks a Ton!

Ask your accountant but from my experience they only pay capital gains on what they receive. So if you make monthly payments of $500 with $400 principal and $100 in interest then at the end of the year they would have $1200 of interest income and a possible capital gain of $4800 depending on their basis in the property.

They can elect to either pay the tax on the gains all up front, or pay the tax on the gains in each year that you make the payments to them -- This is called an installment sale...  https://www.irs.gov/publications/p537

Also, you could have your parents look into doing a 1031 exchange, if they are open to reinvesting their money in another real estate venture (this basically just defers the tax on the gains to a future date, when/if the new property is sold... unless they do a 1031 again, which could allow them to defer the taxes basically forever if done over and over). Could be any type of real estate in any location. If they are considering eventually moving someplace else this could be a good move... do a 1031 exchange to buy a condo in Scottsdale, rent it out for a couple of years, then eventually move into it.

Finally, you did not mention if your parents live in the duplex now... I am assuming they don't. But if they do, and have lived there at least 2 years, then up to $500K of the gain will be tax free most likely. (Which, in Cleveland means all of the gain would probably be tax free, unless it is some very high end duplex in Ohio City or Tremont or something perhaps.)

Originally posted by @Mark Krusinski jr. :

Hi,

My brother and I are currently in the process of buying a house from my parents. It is a duplex located in the Cleveland Ohio area. My parents do not want to pay capital gains on the property at the moment but are looking to get the property off there hands soon. We are looking to do seller financing with this property (my brother and I are in collage and were unable to get a good loan from any banks). With seller Financing, would by parents have to pay capital gains tax on the property? Also do we need a title transfer before we start the seller financing process? 

This is our first property so we have been doing a lot of research. We could not find find anything about this question that we had online. If someone could help up out on this question that would be awesome!

Thanks a Ton!

 There are two ways people do seller financed deals.

  1. Title transfers to buyer immediately and seller records a mortgage on the property in the same way a traditional bank would. This is the best option for the buyer as the seller would need to go through a foreclosure process in the same way a bank would if the buyer defaults. I have never and would never buy a property on seller financing unless this method is used. The other method as listed below has some serious pitfalls for the buyer.
  2. Title doesn't transfer to buyer imminently. Instead a land contract is drafted. Buyer makes payments to seller much like a tenant would make to a landlord. This is good for the seller as the seller can actually take the property back in a much easier fashion. Similar to a tenant eviction if a certain amount of equity payments have yet to be paid. This is a troublesome deal for the buyer as the seller still holding title can technically take out mortgages or liens on the property without the buyers knowledge. Buyer needs to do another title search prior to title transfer. Issue is if when that happens previously undisclosed liens are discovered buyer is pretty screwed as they've already paid a ton of money to the seller. This way of selling is really tough on the buyer. Seller holds all the cards.

@Mark Krusinski jr.

Talk to a CPA as the interest front the loan would be taxed at ordinary income and the principal would not be taxed as capital gains until they reached their basis. Basis I believe would be determined by acquisition cost minus depreciation so there would be a low cost basis for the loan.

If they discount the price then eventually you will be the ones who pay the capital gains on it.

Definitely get a cpa involved.