Tax implications for owner financing

3 Replies

Hi all.  I was wondering if someone could explain the tax implications for both sides of an owner financing deal for a rental property?  I am just starting to research this financing strategy and I'm wondering how much the length of payment benefits a seller in terms of capital gains tax.  In addition, is there any difference from a conventional mortgage regarding interest payment write offs for the buyer?  Any input is appreciated!

@Brandon Craig

The seller pays taxes on interest income and the buyer can deduct the interest he/she pays. 

It doesn’t matter from a tax perspective if it is a bank or individual. 

I am not sure about the length time question. You can do it however it makes sense to both parties. Interest rate, amortization schedule, balloon payments, pre-payment penalties, adjustable rate vs fixed rate, assumesbility, personal guarantee, primary residence laws if not a business loan, servicing, etc are all items that need to be addressed. If this is your first loan get an attorney on your team. 

I always liked selling places and financing them because on every one of the 30 or so that I did I sold the house for ABOVE MARKET price. When people answer an ad that reads; XYZ neighborhood, 3/2/2, owner will finance with $3,000 down". You're attracting the kind of buyers that walk into a car dealer and just ask what their monthly note is.

NOTE: The last one I did was almost 20 years ago, in Texas and was for a $59,000 sales price. So $3,000 wasn't too out of line at 5%. 

I liked doing it because I had quit my salaried job which allowed me to work on my rentals while collecting my salary and I realized that Texas' weird tax set up, no personal income tax but they more than make up for it property tax, and UNREGULATED homeowner's insurance rates were crimping my style as a landlord.

@Brandon Craig

It's fairly simple. The buyer gets to deduct interest just as if it was a bank mortgage. If he is an investor, he also gets to depreciate the full cost of the property, as if it was purchased for cash.

The seller receives interest and principal. Interest is always taxable when received. From principal part, a fixed percentage is considered a tax-free return of the investment, and the rest is taxable capital gain.

The tax effect for the seller is that he spreads his capital gain tax over the length of the loan. Not evenly though: it is a fixed % of the principal portion. So, a large down payment also creates a corresponding capital gain in the first year.

Another way to say it: the seller pays capital gain taxes as he receives payments, as opposed to everything at once.

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