Tax implications of seller financing on small apartment building

5 Replies

I am in negotiations with the seller of a small apartment building (6 units).  The seller has owned the property for a long time and it is fully depreciated.  However, before we put pen to paper he is trying to figure out the best way to defer his tax liability.  He does not need the money from the property immediately and we have agreed to terms for seller financing that include the following:

purchase price: $140,000
interest rate: 7%
term: 15 years

If we proceed with the transactions given the above terms, what kinds of tax liability would he have?  Is there some other way we should be looking at this transaction to ease the tax burden?  

This is the first of many potential deals with this seller so I am trying to do my homework and make this first one go as smoothly as possible.

If any other details are needed, please let me know!

Thanks!

Well, I'm not a tax adviser, but here's how I've come to understand installment sales' effect on taxes.

Early on, like any mortgage, most of your payments are interest.  Print off an amort schedule. He will claim the interest received and it's taxed at ordinary income rates.  If you're younger, receiving more than $600 in interest per year jacks up child tax credits and other deductions.  To him it may not matter.  I do all I can to avoid receiving more than $600 in interest per year, personally.

If he paid $70k for the property, half of the principle buy-down on the amort schedule will be getting his cost-basis back, half will be long-term cap gain.  But, he needs to recapture depreciation, so remind him of that.   That's what you paid minus accumulated depreciation deducted over the years to get to the actual cost-basis.  In my example, his cost-basis may drop to $35k and skew my 50% ratio example above.   

Maybe you could pay to consult a competent tax person and provide a sample tax effect to your seller since you may be doing multiple seller-carries together @Jacob Sharp !  BTW, in this rate environment, I have been paying 6%, but I have many references and haven't missed a payment ever.  Good luck!

Sounds like I am not going to get through this without some aid from at least a CPA and probably an attorney.

Thanks for the information everyone!

Originally posted by @Jacob Sharp :

I am in negotiations with the seller of a small apartment building (6 units).  The seller has owned the property for a long time and it is fully depreciated.  However, before we put pen to paper he is trying to figure out the best way to defer his tax liability.  He does not need the money from the property immediately and we have agreed to terms for seller financing that include the following:

purchase price: $140,000
interest rate: 7%
term: 15 years

If we proceed with the transactions given the above terms, what kinds of tax liability would he have?  Is there some other way we should be looking at this transaction to ease the tax burden?  

This is the first of many potential deals with this seller so I am trying to do my homework and make this first one go as smoothly as possible.

If any other details are needed, please let me know!

Thanks!

 He needs to look at a 1031 exchange. 

But with your installment agreement that is almost impossible.

How long has he held it?  That will make a big difference, Under certain conventions you must recapture 100% of the depreciation in the first year of the installment sale. That would mean a large tax bill depending upon what he acquired it for.

Consider a Master lease with the option to purchase giving him time to find a replacement property for a 1031 exchange.

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