Seller Financing A Home We Bought With 1031 money - tax impact

5 Replies

I'm trying to find out the tax implications of a seller finance I'm considering. We just bought a home a few weeks using primarily 1031 money from a home we just sold. We bought this home as a rental but found out that the HOA won't to allow us to rent. As such, we're considering selling it using seller financing. Here are the details:

  • We bought a house in February 2017 for $58,000.
  • We rented it for a year and then sold it in March 2018 for $109,000. We did about $8k of rehab.
  • We put $52k related to the deal in a qualified intermediary for a 1031.
  • We pulled the $52k out and bought anther investment home with cash for $72,500 last month.
  • The HOA won't let us rent it, so we're looking at selling the home.
  • We essentially entered into a contract to sell the home at $105k but with this deal, we'd have to owner finance it.
  • Terms:
    • Sells price $105k
    • Down: $5k
    • Interest 7%
    • 10 year term
  • I'm trying to figure out the tax implications of this transaction. Most importantly (i think), I'm trying to determine if my holding period would begin with the purchase of the $58k home we bought last year, or if it would change to the home we bought last month. I assume this would create a big difference on my tax liability since it would be cap gain vs ordinary income. Maybe I'm way off.
  • I understand the interest would be ordinary income, but I'm trying to figure out how the gain from the two different properties would be handled. One home would have only been owned for a couple months and the other just over a year.

Any help would be very much appreciated. 

I an no expert, but if I understand correctly, in the end, you would own a note for $100K. I believe the holding period would start with the note transaction. You could either hold the note for the long-term passive income, or season it for a few months to a year and sell it, leveraging that ~$90K into the next deal...

One of my favorite proverbs (26:14)   "As a door turns on it's hinges so a sluggard turns on his bed".  I wish @Bob B. .  Oh how I wish :)

@Skyler Massey , I'd go back to your 8824 that was filed on your last tax return by your account.  That should have reported the basis in the new property.  It is that basis that you need to be concerned with.  Just from 10000 feet it looks like your gain will be just about what it was from the sale of the first property minus the $3K of loss your taking on this sale.

The convention is that holding periods are tacked together when determining tax status.  So my guess is your accountant will let you treat it all as capital gain (interest on the note excepted off course).

When you accept a note as part sale you will pay all of the tax but it will be prorated as you receive payments.  A portion of each payment is allocated to return of principle, gain and interest.

Most importantly you will recapture all depreciation in the year of your installment sale.

Didja know know that in the event that you found yourself needing to do a 1031 there is a way to combine a 1031 exchange with an owner carry note?  That scenario should be a little further down your priority list but it's there is need arises.

Thanks for the help @Dave Foster , @Bob B. , and @John-David Herlihy ! I'm just trying to determine whether I should offer seller financing or not. 

It looks like my basis in the property I'm selling is about $67k -- $47 basis from 1031 property + 20k cash to buy new place (if I'm doing that right). So if I understand correctly, I'd most likely have a capital gain of $38k (105-67) that I would have to pay over 10 years. In addition, I'd have to pay taxes at my ordinary rate on the interest I receive from the note. Does that sound right?

So maybe I'm over simplifying, but I'd have to recapture about $1,500 of depreciation in 2018 at 25%. I'd have to pay 3,800 of cap gains per year for 10 years. And I'd have to pay my ordinary rate on interest every year for 10 years (about $1,700).

Does it look like I'm missing anything major?