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Christian Ehlers
Agent
  • Real Estate Agent
  • NH & MA
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Seller Finance Payoff Tax Question

Christian Ehlers
Agent
  • Real Estate Agent
  • NH & MA
Posted Nov 22 2022, 07:09

Hey BP, been learning a lot about seller finance, subject to, and all that good stuff.

Just want to confirm something here.

When seller financing vs traditional sale, one of the perks to the seller is that they don’t take the full purchase price as their gain in year 1, so they save a lot on taxes by taking their payment over time.

So if for example I buy a property on seller financing, and then sell it or refinance after 5 years, the original seller would be fully paid off, so they would then have to pay taxes on all of that gain at that time correct?

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Kerry Baird
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  • Rental Property Investor
  • Melbourne, FL
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Kerry Baird
Pro Member
  • Rental Property Investor
  • Melbourne, FL
Replied Nov 22 2022, 20:47

@Christian Ehlers,  they pay taxes on the capital gain they receive in the year they receive it.  If they had $100k a year in GAINS, then they get taxed on that much a year.  Capital gain is the amount over their purchase price.

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Basit Siddiqi
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Basit Siddiqi
Pro Member
  • Accountant
  • New York, NY
Replied Nov 24 2022, 15:39

Those who sell properties via seller financing pay tax over the period of when they receive the proceeds.

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Replied Nov 24 2022, 16:06
Quote from @Christian Ehlers:

Hey BP, been learning a lot about seller finance, subject to, and all that good stuff.

Just want to confirm something here.

When seller financing vs traditional sale, one of the perks to the seller is that they don’t take the full purchase price as their gain in year 1, so they save a lot on taxes by taking their payment over time.

So if for example I buy a property on seller financing, and then sell it or refinance after 5 years, the original seller would be fully paid off, so they would then have to pay taxes on all of that gain at that time correct?

 Christian,

Great question! I too have been spending a lot of time exploring seller financing. I have found this video to be the best complete explanation with real examples. 

https://www.youtube.com/watch?...

That said, it neglects to answer our question; what tax does the seller pay when they receive a balloon payment to pay off the loan in year X?

Below are my thoughts based on what I've read but would appreciate a CPAs opinion!

I do not believe the balloon payment is taxed as Capital Gain since it is not the result of the sale of an asset. Capital Gain only applies to the sale price paid at closing. Any interest paid to seller over the course of the loan, after closing, would be taxed as ordinary income.

Happy Thanksgiving!

Tony

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Replied Nov 25 2022, 05:52
Quote from @Tony Montano:
Quote from @Christian Ehlers:

Hey BP, been learning a lot about seller finance, subject to, and all that good stuff.

Just want to confirm something here.

When seller financing vs traditional sale, one of the perks to the seller is that they don’t take the full purchase price as their gain in year 1, so they save a lot on taxes by taking their payment over time.

So if for example I buy a property on seller financing, and then sell it or refinance after 5 years, the original seller would be fully paid off, so they would then have to pay taxes on all of that gain at that time correct?

 Christian,

Great question! I too have been spending a lot of time exploring seller financing. I have found this video to be the best complete explanation with real examples. 

https://www.youtube.com/watch?...

That said, it neglects to answer our question; what tax does the seller pay when they receive a balloon payment to pay off the loan in year X?

Below are my thoughts based on what I've read but would appreciate a CPAs opinion!

I do not believe the balloon payment is taxed as Capital Gain since it is not the result of the sale of an asset. Capital Gain only applies to the sale price paid at closing. Any interest paid to seller over the course of the loan, after closing, would be taxed as ordinary income.

Happy Thanksgiving!

Tony

IRS Publication 537, Installment sale appears to apply

https://www.irs.gov/publicatio...

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Kerry Baird
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  • Rental Property Investor
  • Melbourne, FL
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Kerry Baird
Pro Member
  • Rental Property Investor
  • Melbourne, FL
Replied Nov 25 2022, 11:21

@Tony Montano, I was thinking of coming back and being more precise in my answer, especially about what exactly "capital gains" consists of.  Thanks for finding that video.  Enrolled agents will always do a better job explaining tax matters than I can as a plain ol' investor.  

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Replied Nov 25 2022, 12:04
Quote from @Kerry Baird:

@Tony Montano, I was thinking of coming back and being more precise in my answer, especially about what exactly "capital gains" consists of.  Thanks for finding that video.  Enrolled agents will always do a better job explaining tax matters than I can as a plain ol' investor.  

@Kerry Baird we’re all learning together!