Seller Finance Question: P&I Vs Principle Reduction Payments

[Hadar Orkibi]

** Seller Finance Question** HI Guys, Im working on possible deal and the seller is willing to finance 85% of the price. His reason is that he doesn't want to pay income Tax or depreciation recovery. (Sold a business and have high income this year) We agreed on: 5% P&I, 10Y Balloon, and 25y Amort.

My Questions is: What if I suggest to him that we do SAME Amount of PAYMENTS BUT principle reduction payments and Not have interest component. this way i pay the property off faster. Would that way have any "worse" Tax implications on him?  Thanks In advance for your help!

[Ashish Acharya]

@Hadar Orkibi , 

Got it. I have seen people do Zero percent interest loan. It is not illegal. It's just that the seller's side has to compute interest component with they do taxes. 

When selling straight out seller pays-

-capital gain tax 

-depreciation recapture tax at max 25%

-net investment income tax at 3.8 percent if his MAGI greater than 200k. Next year, when his income is lower, the installment sale ( seller's financing) could possibly avoid this tax for him. Most people also do sellers financing to avoid this tax.

With Installment sale, seller pays same taxes but in smaller chunks each year with total yearly payment. Not to get too technical, but the depreciation recapture is front-loaded before seller will pay capital gain tax rate.  Meaning all the depreciation have to be recaptured (possibly at 25%) first he can recognize lower capital gain. If his MAGI is less than 200k each year after this year, he will avoid 3.8% NIIT tax mentioned above. 

Let me know if that helps.