CPA | Accepting new clients | 50 States · Member since 2022 · 1k+ posts · 871 votes
2mo
Yeah, I did a seller financed deal here in the Bay Area earlier this year, so I can speak to this a bit.
One thing that doesn't get talked about enough with these deals: if you're the seller carrying the note, don't assume you get to spread out ALL your gain evenly as you collect payments. Depreciation recapture doesn't qualify for installment sale treatment under IRC 453. It gets taxed in full in the year of sale, even though you might not see most of the actual cash until years down the road.
So picture this: you sell a rental you've owned for 15 years, structure it as seller financing with payments trickling in over 10 years, but the IRS wants tax on all that recaptured depreciation (taxed at a max 25% rate) right now, in year one. That can be a nasty surprise if you didn't plan your cash reserves around it, especially with Bay Area property values where the depreciation recapture chunk alone can be six figures.
The capital gain above and beyond recapture is what actually gets to spread out proportionally as you receive principal payments, which is the real benefit of doing this.
Worth running the numbers with your tax preparer before you lock in the structure, since the interest rate you charge, down payment size, and term length all affect how painful that first year tax bill ends up being.
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