On seller side of seller financing
Member since 2019 · 8 posts · 5 votes
On seller side of seller financing
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Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
2yQuote from @Justin Ake:
I have an opportunity to sell one of my properties using seller financing. I hope someone can help me navigate the pros and cons.
1. Can I still use this home’s equity for other deals while the buyer is paying it off in the next few years?
2. Can I still depreciate it until the buyer makes the final mortgage payment?
3. How are my taxes calculated and what years would I pay for the profit I make?
Never done this before so I’m flying blind and hoping someone has a few tips to help me figure this out. Thank you all!
1. No
2. Typically No
3. You are paying ordinary income rates on the interest -no way around that. Even if you charge 0% interest govt will say sorry but we charge min. based on AFR which is around 4% ish.
Not a CPA but typically start paying taxes once your basis is reached. So lets say you depreciated the value down to $50,000. Once you pass the $50,000 in principal payments from financing you are then taxed at that.
Personally unless the property cannot be financed by a bank, seller finance is not your best friend (especially in Pennsylvania where it can cost $10k to foreclose on someone and take over a year).
7e investments53 Reviews
11 Replies
- Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes2y
Quote from @Justin Ake:
I have an opportunity to sell one of my properties using seller financing. I hope someone can help me navigate the pros and cons.
1. Can I still use this home’s equity for other deals while the buyer is paying it off in the next few years?2. Can I still depreciate it until the buyer makes the final mortgage payment?
3. How are my taxes calculated and what years would I pay for the profit I make?
Never done this before so I’m flying blind and hoping someone has a few tips to help me figure this out. Thank you all!1. No
2. Typically No
3. You are paying ordinary income rates on the interest -no way around that. Even if you charge 0% interest govt will say sorry but we charge min. based on AFR which is around 4% ish.
Not a CPA but typically start paying taxes once your basis is reached. So lets say you depreciated the value down to $50,000. Once you pass the $50,000 in principal payments from financing you are then taxed at that.
Personally unless the property cannot be financed by a bank, seller finance is not your best friend (especially in Pennsylvania where it can cost $10k to foreclose on someone and take over a year).
7e investments53 Reviews - Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes2y
I think the idea of seller financing sounds better than the reality is. A well qualified buyer will not pay you much in interest. Typically you end up with a "sub-prime" borrower who is being deemed to risky for a bank to touch them. Now you dare? The only person I would seller finance to is a solid long term tenenat, who has kept the property well over the years. That at least reduces the risk of getting back a trashed house.
- Accountant · CPA Miami, FL · Member since 2022 · 192 posts · 43 votes2y
- Member since 2019 · 8 posts · 5 votes2y
Sounds like the good idea fairy got me again. Can’t tell you gentlemen how much I appreciate the feedback and giving me some pretty concise answers. Sounds like I need to walk away from this idea and think of a better one. Monday Night Margarita Madness is a great time, but not where I should be doing my tax planning apparently.
- Investor · Tucson, AZ · Member since 2017 · 208 posts · 235 votes2y
@Justin Ake - I wouldn't rule out the idea of seller financing quite so quickly. It can be a wonderful opportunity for both you and the buyer. I have personally purchased AND sold many properties with owner financing. It can be a wonderful tool to have in the right circumstances.
I'd also like to add some clarity to a couple of your questions.
1. Can I still use this home’s equity for other deals while the buyer is paying it off in the next few years?I agree with the "No" answer above, however it may not be the right question. If you sell a property with owner financing it's no longer yours to use the equity. What you do get in return is a note. You can sell the note, borrow against the note, sell part of the note, etc.
3. How are my taxes calculated and what years would I pay for the profit I make?There often is an aura of mystery around installment sales. There is only one proper way to handle this from an IRS point of view: IRS Form 6252. It's a fairly simple form and I think it should help answer a lot of questions.
We should scrutinize any seller finance deal, there absolutely is more risk than a "normal" sale. I have found when the right buyer comes along, it's a great tool for both me (as seller) and the buyer. When we decide to move forward with one, we often get a premium on the sale price of the home AND the interest rate received relative to the market rate.
I'm going to rant for a moment to try and unpack my thinking. Banks are stupid! Here is an extreme example but I think it proves the point. A good friend and colleague of mine was working with a home buyer a couple of years back. The buyer is a dentist with $200,000 to put down on a house and had a FICO score of over 800. He has been a dentist for over 10 years. 18 months prior he purchased a dental practice from a retiring colleague. He was trying to buy a $600k home with conventional financing and could not qualify. Why? - He had to have owned the business for at least two years. It's far harder to qualify for conventional loans if you're a business owner or self-employed and that equals opportunity.
When I look at doing a potential owner finance deal the most important thing for me is skin in the game. Generally at least 15-20% down is the magic number I'm looking for. It's far more unlikely someone will walk away from that, and if they do, that's a lot of "hurt money". Also, be well aware of "Dodd-Frank Act" if you ever intend to do more than 1 seller financed transaction per year.
- Member since 2019 · 8 posts · 5 votes2y
Mr. Kiel,
Wow! that’s a true testament to the idea of knowing the right questions to ask. The thought of selling the note but never occurred to me, and I never even thought of it as an additional asset. I’ve been googling the process now which again seems to take me into a whole new layer of how to think about the transaction and waste him manipulated to my advantage. when you have time, would you be able to explain some of your tips and tricks that you’ve learned from selling the note? Sounds like you have some of that next level experience that many of us beginners and those of us in the mainstream way of thinking have never dealt with. - Investor · Philadelphia, PA · Member since 2016 · 69 posts · 34 votes2y
Also don't forget, as the seller...if you seller finance your house you'd be deferring the capital gains tax so you're not getting hit with that big lump sum if you sold it conventionally. You'll also save on real estate agent commissions. Just food for thought.
- Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes2y
1) If you sell with seller financing, the deed will be in the buyers name, not yours. So you cannot use that property as collateral for a loan.
2) Again, the house is not your name anymore so there are no depreciation benefits.
3) From my understanding (and I'm not a tax guy so double check this with someone who is) is that your taxable income would be calculated based on the capital gains over and above your initial purchase/capital improvements and recaptured depreciation (for a SFR, the property, not land, depreciates 1/27.5th each year) but the amount you lend back would not be taxable until you receive that income. (Thus you would be taxed on the interest payments and whenever it gets paid off; but again, double check this with an accountant.)
What might work better for you given what you're looking to do is a lease option. Just know that buyers rarely exercise that option.
- Member since 2019 · 8 posts · 5 votes2y
George & Andrew,
Thank you. Again, throwing out extra options that don’t readily come to mind. This really helps me build the back up plans as I enter negotiations and try to make this transaction beneficial for both sides. I really feel like the more options I can give to the buyer, the more I can make him comfortable and feel more in control of the transaction. Keep both sides happy and it helps build a reputation that people want to work with. Thank you gentlemen. - Investor · Tucson, AZ · Member since 2017 · 208 posts · 235 votes2y
@Justin Ake - The world of notes may be as fascinating as real estate. There are many books, groups, seminars, etc. on the topic and you can really go down the rabbit hole on the subject. In short you can buy or sell notes at a discount or premium to "face value". You can sell part of the monthly payment (think $1000 monthly split in half). You can sell part of the term of the note (say you're retiring in 5 years, sell the first 5 years of a 30 year note and get the back 25 years - this one can be an amazing wealth builder). I have a friend of mine that uses multiple strategies inside of a Roth 401(k) and has turned a small amount into millions over the last 10 years. A little knowledge and creativity can go a long way!
"The most expensive thing you can have is a closed mind"
- Investor · Tucson, AZ · Member since 2017 · 208 posts · 235 votes2y
@Justin Ake let me expand a bit more on the power of selling a partial. Let's say you sell a property and end up with a $100,000 note at 8% interest for 30 years. That calculates out to $733.76 per month. What if you sell the first 5 years of the note payments for $36,000?
The buyer gets the right to $733.76 per month for 60 months (total return of $39,095.73 to be exact). You get $36,000 now. That's a 8.221% rate of return for the buyer of the partial. After 5 years you get the remainder of the note back or 300 more payments at $733.76 and the note is still worth a bit over $95k - $95,069.86 to be precise.
Year Interest Principal Ending Balance 1 $7,969.81 $835.36 $99,164.64 2 $7,900.48 $904.70 $98,259.94 3 $7,825.39 $979.79 $97,280.15 4 $7,744.06 $1,061.11 $96,219.04 5 $7,655.99 $1,149.18 $95,069.86
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