Zero Percent Financing & Taxes

8 Replies

Full disclosure, I'm a CPA and this should not be construed as tax advice.  Please consult your personal CPA.

I did a search on this topic and didn't see much discussion, so I figured I'd chime in.  My wife and I are looking at a personal home that is specific to our wants & needs.  However, the seller doesn't like our offer.  So, I thought I would employ some of the "creative" financing strategies I've learned through BP, i.e. zero percent seller financing.  In researching this topic, I ran across §1274, which basically allows the IRS to impute interest income to the seller (based on the federal AFR rate) whether they charge interest or not on loans that exceed $250,000, or if is the sale of their personal residence.  

This had the potential to torpedo my plan since the home we're looking as is well over the $250k range.  BUT, I believe we can accomplish the same goal if we use the AFR rate as the mortgage rate, then start with the acceptable monthly payment and back into the "financed price".  Then add the down payment to arrive at total sale price.  To ensure the seller gets all of their money, put in a 100% prepayment penalty clause in the loan.  

Do any more learned members (especially other CPAs) have an idea if this could work?  Are there laws against prepayment penalties for private loans?

Thanks!

Thanks Dominic. To me the wording looks like it would be defined personal residence on the seller’s end. I guess I left out an important fact that the sellers are currently renting out the property and I’m not sure if they’ve lived there 2 out of the last 5 years.

@Matt Heider I understand now. Sorry I thought your post said it was the sellers primary. In that case I would agree with backing into the finances price. I don’t believe there is such a thing as zero percent financing. If you have zero percent financing you always end up paying more of a sticker price anyways. I’m not sure if the seller will have to issue the buyer a 1098 for the mortgage interest each year either. I would assume yes but need to look more into it. Also depending on my tax bracket I would not want to reclassify part of my capital gains to ordinary income as interest. Did you consider this? The AFR is around 3% right now.

@Dominick Austria   0% financing is very real.. I have been employing that strategy as a seller since the mid 80s during the hyper inflated 18% interest rate days.

It dawned on us two says..  One I believe it was Datsun ( that's what Nissans were called in the early days for you younger folks out there) they were the first auto manufacotrer to offer 0% financing.. which of course as we know has been copied for years and years since the mid to early 80s.

Second was I had Saudi clients from San Francisco that because of religious reasons could not pay interest 

So since we owned all the properties we sold.. ( my dad was in the land business big time 300 to 500 sales a year)

WE came up with our own 0% financing and just flat killed it..  my dad sold most of his paper in those days.. so we just wiped out the PV calculator and backed into what our note buyers would pay for the given cash flow.. that turned out to be 30 months zero interest has the same note value as a 7 year 15% rate note.. shocking I know.

I have employed this over the years to sell my OREO s that I foreclosed on buy and hold investors who failed.  I have never had a zero % loan default.. NEVER.. I sell a few each year like that ..  Its a win win.  we get a valuable note.. the buyer I like it even better granted payments very high.. but they end up with a free and clear asset in 30 to 60 months .. and that is how you get wealthy in real estate free and clear .. 

PS back to the question of imputed interest by IRS yes we had to pay that.. 

@Jay Hinrichs I understand that zero percent financing is very real. But there is still a risk associated with it. I was implying that when you have zero percent financing that you pay a higher price to make up for the “zero interest”. I’ve never done a zero percent financing deal so please correct me if I am wrong. I always believe that while something may say zero or free that isn’t always true when you delve deeper!

Originally posted by @Dominick Austria :

@Jay Hinrichs I understand that zero percent financing is very real. But there is still a risk associated with it. I was implying that when you have zero percent financing that you pay a higher price to make up for the “zero interest”. I’ve never done a zero percent financing deal so please correct me if I am wrong. I always believe that while something may say zero or free that isn’t always true when you delve deeper!

certainly can be.. but In my case props are sold at market value..  you cant do 30 year no interest though it has to be 48 months or less to back into your note value if you needed to sell it.. 

Originally posted by @Japher Kalule :

@Jay Hinrichs I'm really interested in learning more about how you structure your zero percent interest financing. We might be able to do business together.

we only use it on seller carry back  ( IE we own the asset and sell it) we dont offer it as a financing product