Owner Financing - Is interest a good idea?

[John T.]

Hello BP Community!

I'm considering offering owner financing on one of my properties.  Property is worth 135K and is free and clear.  I want to offer a 5 year note on it to a potential buyer.  I've already spoken with a title company on putting it together, so I know it is possible.  My Question is...

From a tax perspective, should I charge interest?  My end target is to make AT LEAST 140K back.  Knowing that 140K is my end number once the note has matured, is it better to factor in interest and manipulate sale price to end with 140K or have no interest on the note and just get 140K in five years?  Does it matter from a tax perspective?

[Don Konipol]

If you do "manipulate" i.e. lower the price and charge interest to make up the difference you will have to find another investment that pays the same interest as you were charging if the note you hold pays off early.

Essentially, you are placing no "time value" on your money, saying that one dollar five years from now is the same as one dollar today.

The IRS will "impute" an interest rate when a rate of 0 or below a certain threshold is contracted.  In today's low interest environment it's probably not much.  The goal of the IRS is not to allow interest income to be converted to capital gains

You, of course, can make any decision you want with your assets.  But if your goal ( or at least one of your goals) is to built wealth, then maximizing the value and return on your investments should be a primary concern.  If you can sell a property for $135,000 with owner financing and interest at 8%, why would you sell it for $135,000 with interest at 0%.?  If you offer 30 year amortization with a 5 year balloon you would be costing yourself over $50,000 in interest.

The only two rationals I see are if (1) the property will only sell for $135,000 if owner financing at 0 interest is offered ( in which case it is not worth $135,000), or (2) you are thing about offering a loan which fully amortizes in 5 years (so foregoing interest brings down the high monthly payments significantly and equity build fast).

Both the above scenarios are "marketing ploys", which are used much more extensively in high interest environment, rather than our current low interest environment.  However, it is possible that you can attract a niche buyer who has high income but for some reason does not qualify for a conventional loan.