Does Seller Financing save the seller any taxes?

[Moshe Eisenberg]

Hi everyone. If a seller of a property does not plan on doing a 1031 exchange does seller financing save the seller from any capital gains taxes? Does the fact that the seller will essentially not be getting the full amount at closing but rather he'll be getting only about 25% of purchase plus monthly payments, does this help?

[Brandon Hall]

@Moshe Eisenberg No - seller financing simply spreads out the tax liability over a number of years instead of it all occurring at the time of the sale. For instance, if the seller financing is over a period of 10 years and there was a $100k profit on sale, the every year for ten years the seller will recognize $10k in cap gains. 

[Dana Whicker]

I am not a tax or legal professional but, absolutely!!!  When a seller is facing a  potentially huge tax hit for selling a house for a big one-time tax hit, they will occasionally be open to payments over time that will spread the tax hit out over a number of years.  

Sometimes, this will not actually benefit a seller nearly as much as it may seem, but the psychology of paying for example, $30k this year, vs. $1k a year for 30 years is powerful stuff.

Just hypothetical examples I'm using.  I'm not a tax or legal professional in any way and no legal advice has been offered.

[Wayne Brooks]

Cap gains would be payable on the down payment received, and on the principle received each year, along with ordinary income on the interest received.  The taxes for depreciation recapture however, would all be due in the year of the sale.

[Moshe Eisenberg]

@Brandon Hall @Dana Whicker @Wayne Brooks Thank you much! This is very helpful.  (Now I just got to learn a bit more about the depreciation recapture… ;)

[Roy N.]

Originally posted by @Brandon Hall:

@Moshe Eisenberg No - seller financing simply spreads out the tax liability over a number of years instead of it all occurring at the time of the sale. For instance, if the seller financing is over a period of 10 years and there was a $100k profit on sale, the every year for ten years the seller will recognize $10k in cap gains. 

 Brandon,

Is there not the opportunity by deferring capital gains of the vendor/seller keeping her/himself in a lower tax bracket over the course of the financing in comparison to having realized the entire transaction in a single year?

Up to your north, this can be a big benefit to carry and defer the included capital gains over a period of (up to) five years.

[Brandon Hall]

@Roy N. Absolutely, in fact that's a tax strategy often utilized by people with large capital gains that want to get out of real estate (if they wanted to stay in real estate, they'd utilize a 1031). 

My original comment was strictly speaking to the capital gains themselves. I can see how it could have been confusing as it doesn't encompass the entire picture. 

[Dana Whicker]

@Brandon Hall

Yeah, without seeing the whole picture of a deal or an individual's situation, it's almost impossible to give concise advice. my comment was not intended to counter yours.  Just a different angle that I threw out.

[Moshe Eisenberg]

thanks @Roy N.

[Daniel Dietz]

One thing that I have seen an interest in from friend who have bought with owner financing (farms in this case) is that while the owners definetly like the idea of 'delaying' the capital gains taxes, they *just as much* like the idea of getting a good return on the unpaid protion of their equity for 5-20 years. One example is a friend that bought raw farmland for 20% down, with the owner carrying the balance at about a 5% rate for 15 years... a win-win as the owner is well into retirement age and would likely put the funds into CDs at < 1%. There was about an 800K owner carry in this case... that is aproxiamtely 40K per year income instead of 8K in CDs... a BIG incentive. 

Dan Dietz