Seller Financing Tax Benefits to the seller?

6 Replies

I'm currently in talks with a Senior Owner to buy his 10 Unit Rental Property through Seller Financing. i have couple of questions Regards to tax benefits to him. so I can speak more Confidently about this deal.

Numbers are not accurate Let's take some assumptions

he bought the property in 1970 for $100k. I'm giving him Purchase price of $1M. zero down Pay. 30 years term @5% Interest Rate.


1. his Capital gains will be $900k(Sale Price - adjusted basis) which will be charged at 20% Long term capital gain. which triggers $180K in Federal Tax and not Including NJ state Tax, if he sells at one shot. but if we do Seller Financing I guess his Principal and Interest Payments will be taxed at ordinary tax rate based on his Tax Brackets over 30 years of our Loan term. in this seller Financing is he Paying same amount back to the Gov. in taxes as he would pay in One time sale or is he benefiting from seller financing by offsetting Taxes?

2. when does the Depreciation Recapture triggers in this seller financing? at the end of 30 Year Term? i think he only paid $100k back in 1970 he might only depreciated the same amount over 39.5 years and any Improvements he made. will this Depreciation Recapture can be a Disaster for my seller doing seller financing? or it's still a Good deal for him?

I appreciate any thoughts on this. Thank you!!

Originally posted by @Mallikarjun Reddy Pateel :

I'm currently in talks with a Senior Owner to buy his 10 Unit Rental Property through Seller Financing. i have couple of questions Regards to tax benefits to him. so I can speak more Confidently about this deal.

Numbers are not accurate Let's take some assumptions

he bought the property in 1970 for $100k. I'm giving him Purchase price of $1M. zero down Pay. 30 years term @5% Interest Rate.


1. his Capital gains will be $900k(Sale Price - adjusted basis) which will be charged at 20% Long term capital gain. which triggers $180K in Federal Tax and not Including NJ state Tax, if he sells at one shot. but if we do Seller Financing I guess his Principal and Interest Payments will be taxed at ordinary tax rate based on his Tax Brackets over 30 years of our Loan term. in this seller Financing is he Paying same amount back to the Gov. in taxes as he would pay in One time sale or is he benefiting from seller financing by offsetting Taxes?

2. when does the Depreciation Recapture triggers in this seller financing? at the end of 30 Year Term? i think he only paid $100k back in 1970 he might only depreciated the same amount over 39.5 years and any Improvements he made. will this Depreciation Recapture can be a Disaster for my seller doing seller financing? or it's still a Good deal for him?

I appreciate any thoughts on this. Thank you!!

With that kind of gain, he is going to save thousands of dollar. However, I would be careful with the proposed tax hike.

He will pay capital gain, not ordinary gain 

The gain that he will recognize with each year’s payments would be the recapture first. After entire recapture is recognized, he will start the cap gain recognition. 

With installment sale, he is going to avoid the extra 3.8% NIItax vs. without installment sale. That can be significant for him as well. 

We can’t say how much he will end up paying because each year might be different. If there are years when he is in the lower cap gain bracket, he would pay less compared to at once total and vice-versa. The 30 years is a long time and the rate is destined to change as early as next year with the Biden’s proposal. 

It might be a bad deal for him if he is expected to receive his social security benefits in the next 30 years, if he hasn’t already received it. 

 

Thanks!

based on the numbers he will be receiving $64,418 every year(adjusted Interest + Principal Payments every year). is this entire income charged as Capital gains by subtracting his adjusted basis? plus Recaptured amount? 

or he will pay Ordinary Tax rate on this every year Principal and Interest payments he receive? 

@Ashish Acharya , Am I understanding you correctly that the 'early payments in the first few years would look something like this (Lets assume 90K of depreciation recapture) ;

Year 1,2,AND 3 = 50K interest and 3Ok of "Principal" in the payment. Interest is taxed at sellers ordinary income tax rate, and the 30K would ALL be counted as depreciation recapture at the sellers ordinary income tax rate UP TO 25% (meaning even if they are in a higher bracket, 25% is the max for that).

Then in the remain years the interest would remain at ordinary income tax rates, and the "principal portion" for the rest of the term would be counted as capital gains tax rate, which would likely be in the 15% group instead of the 20% if sold traditionally.

Is that close to correct? :-)

Could you also clarify the Social Security comment please?

Thanks, Dan Dietz

@Mallikarjun Reddy Pateel my understanding is that each year you need to separate the interest portion from the principal portion as they will remain taxed differently-throughout the life of the contract. Similar to how for taxes you can 'write off' your interest, but not your principal.

Dan Dietz

Originally posted by @Daniel Dietz :

@Ashish Acharya, Am I understanding you correctly that the 'early payments in the first few years would look something like this (Lets assume 90K of depreciation recapture) ;

Year 1,2,AND 3 = 50K interest and 3Ok of "Principal" in the payment. Interest is taxed at sellers ordinary income tax rate, and the 30K would ALL be counted as depreciation recapture at the sellers ordinary income tax rate UP TO 25% (meaning even if they are in a higher bracket, 25% is the max for that).

Then in the remain years the interest would remain at ordinary income tax rates, and the "principal portion" for the rest of the term would be counted as capital gains tax rate, which would likely be in the 15% group instead of the 20% if sold traditionally.

Is that close to correct? :-)

Could you also clarify the Social Security comment please?

Thanks, Dan Dietz

You are correct. 

Seller financing might make the benefits taxable when you can opt-out or not do seller financing and not get extra income during your retirement years to reduce your AGI

 


@Daniel Dietz right, there is 3 Components IRS will be taxing my seller, if I do Installment sale(Seller Financing)

  • Interest income.
  • Return on his adjusted basis in the property.
  • Gain on the sale.

my question is, will it benefit my seller compared to paying Huge chunk of money on capital gains almost a seven figure vs doing a Installment sale and paying Taxes on yearly basis for the adjusted basis sale price + Interest payments he receives.