Tax Implications for Seller who is owner financing personal home

[Steve Driscoll]

I am interested in purchasing the home of an elderly couple who wants to sell.  They have owned the home for a long time and have seen 10x appreciation.  This is their personal home.  

In the event they owner finance, will they have to pay taxes on the interest portion of the note, the down payment or a balloon payment?

Thanks

[Ashish Acharya]

Steve, 

If they owner finance, each payment will have three components: 

1) tax-free return of their basis

2) capital gain (up to 500k gain is tax-free if they lived in the house for 2 out of 5 years ,and it was not rental) 

3) interest portion - Taxable to seller as interest income.