seller financed wrap - how should the gains be taxed?

5 Replies

Hello,

I've asked several CPA's, and gotten varying opinions. Wondering if anyone feels they have fully vetted this subject and come to a definitive answer.

Situation: purchase a property subject to the underlying lien, and then sell with owner financing, wrapping the note that was taken sub-to.

For tax purposes, can it be considered an installment sale, and therefore the gains amortized over the life of the loan, or is this a sale of an investment property, and therefore all the gains will be taxed the year you sold the property?

Thanks!

@Brad Denkhaus not sure I can wrap my head around your scenario but to keep it simple. The IRS is not going to let both parties write off interest without paying tax on the payment received. So if you are paying a mortgage payment to the seller with interest then the seller then he has to claim that interest payment as taxable income. If he is then making his mortgage payment to the mortgage company then he can write off his interest. I would really get yourself a very good accountant like I have here in Pittsburgh. You do not want to raise any red flags with the IRS and have them asking for an audit. Not fun

Originally posted by @Brad Denkhaus :

Hello,

I've asked several CPA's, and gotten varying opinions. Wondering if anyone feels they have fully vetted this subject and come to a definitive answer.

Situation: purchase a property subject to the underlying lien, and then sell with owner financing, wrapping the note that was taken sub-to.

For tax purposes, can it be considered an installment sale, and therefore the gains amortized over the life of the loan, or is this a sale of an investment property, and therefore all the gains will be taxed the year you sold the property?

Thanks!

 I do those kinds of transactions in Austin. I have to provide a 1098 Mortgage Statement to the buyers.

I use Texas Title – Ceshker Group, they can fill you in the other details depending on how you do your taxes.

Perhaps I need to clarify and spell out the situation more clearly.

I purchased a property subject to the underlying lien in Oct. 2017.  I then rehabbed the property, and in December 2017, marketed and sold the property with "owner financing"; creating a new mortgage for the buyer that wraps the note I took sub-to.  So, they pay me, I pay the underlying mortgage, and I make the spread each month (it is not the spread I have a question on). 

There was profit made between my basis (note taken sub-to + rehab costs + closing costs, etc), and the sales price to my end buyer that I hold the note on.  

I am trying to identify if the profit is taxed as a sale of an investment property, and therefore subject to short term capital gains tax that is all due for the year sold, or if it can be treated as an installment sale, and therefore spread out over the term of the note I created.

@Brad Denkhaus

I would look at this as two separate transaction. 

1) You buying a property in an installment sale. You are the buyer. you are paying the interest each month on your Sub to.  No tax implication for you. You can deduct the interest on this note as it is related to your investment activity. 

2) You rehabbing and selling a property is another activity. It is most likely considered a flip activity ( There might be an argument that this might not be a flip if you dont regularly flip house- makes a difference- read on). Flip activity is not qualified for Installment sale. So even though you sold under seller financing, you have to recognize the entire gain in the year of sale. Since the tax deadline is already gone, I am interested to know what you did.  If it was not flip, you qualify for installment sale. 

@Ashish Acharya

Thank you for your input. I ended up treating it as an installments sale, which resulted in $5K less tax paid for 2017 than had I recognized the entire gain. Although I'm involved in REI every day, 99.9% of my daily activities are running acquisitions for Texas Home Offers, and so flipping homes myself is not a regular activity.

Again, thanks for your input.

Brad