inherited a seller financed mortgage for a house

[id503]

I live in CA and inherited a seller financed mortgage for a house that is located in OR. I receive $600 a month from the buyer which includes principle and interest. Am I taxed on the full amount or only the interest? Also, where do I enter the information in TurboTax Home & Business? Do I need to file state taxes in CA and OR? I have not received a 1099-INT or any other forms.

[JoannaB2 · Accepted solution]

It depends.  If your live and work in California, you have to file Form CA540 as resident,  You may have to file a non-resident Oregon return on your interest income, if your income was over the Orgeon Department of Revenue filing requirement.  The interest paid and/or received on a seller-financed loan on an Installment Sale must be included on your income tax return.  If you're the seller, report the interest on Schedule B, and the buyer reports the interest as mortgage interest on Schedule A, if enough to claimed itemized deductions.

Here's how to enter seller-financed loan interest income on Schedule B:. 

1. Log In to Turbo Tax,
2. Under Income and Expenses tab, scroll all the way down until your get to "Interest From Seller-Financed Loan", then click edit.
3. The next screen is a question "Any seller-financed loan?".
4. If your answer is yes on the question above, it will take you to Seller-Financed screen.
5. Under Seller-Financed screen, enter the buyer's name, address, SSN of the buyer, and the amount  of interest buyer paid to you.
6. The amount of interest will be transferred over to Schedule B of 1040 form.

[id503]

I want to make sure I understand correctly.

1. Am I now considered the seller because I inherited the note?

2. Are there any other forms (Fed or State) I need to fill out, i.e. indicating the inheritance?

3. Sounds like I only need to pay tax on the interest portion of the monthly payments? Can you confirm I don't need to pay tax on the principal?

[ColeenD3]

1) Yes, you are the seller.

2) Not per se. You may be asked how you came to own the property, at which time you can indicate it.

3) You only pay tax on the interest. You should have an amortization schedule that indicates how much is interest and how much is principal.

Amortization Schedule

[id503]

I just learned the situation may be a bit more complicated. The original contract was singed in 2004 by the girlfriend of the man that wanted to buy the property. Since her name is on the contract, I guess she is technically considered the buyer. He has been living there since 2004 but his girlfriend moved out years later when they broke up. He has always made direct payments to the seller (originally my Mom and now me since she passed). The girlfriend never made payments but her name is still on the contract.

My question is regarding the use of 1040 Schedule B. The instructions state, "You received interest from a seller-financed mortgage and the buyer used the property as a personal residence." Since the girlfriend is technically the buyer and does not live there as her primary residence, can we still use Schedule B? If not, how and where do we report the interest? Or do we now have to pay tax on interest and principal?

[PattiF]

You will need to sign a new contract with the person who has been paying the payments and include his information on the Schedule B along with the interest payment.

Here is some information about your situation concerning the transfer of an installment obligation as a result of the death. You are taxed on the installment payments the same as the seller would have been had they lived to receive the payments, This is from Publication 537 from the IRS. 

With an installment sale, one can report all of the gain in the year of the sale. Or, you may be able to report part of your gain when you receive each payment. You should see which method was used on your mothers taxes; if it was interest only, or if some income was reported each year along with the interest.

[id503]

We won't be able to get a new contract with the person sending the payments. Because of that, I assume we cannot use schedule B. Where do I than report interest and/or interest and income?

[PattiF]

If the parties involved don't want to change the paperwork, you can continue to report the interest as in the past.

I am going to repost the IRS paragraph since it seems blurry.

[njstewart1234]

What if I inherited a property (land, no house) and we decide to sell it via seller financing.  What of the proceeds are taxable and at what rate (is it capital gains tax or income tax)?

So for example, would the trustees of the estate be taxed on the down payment, the interest of the monthly payment?  Also, if we had a 5 year term that required the buyer to pay off the remaining balance after 5 years, would we be taxed on that lump sum payment after 5 years?  Thanks!

[Mike9241]

using old threads is a bad idea. It can make things confusing and lead to a wrong answer.  but if I understand correctly, your situation is different than the older threads.  you inherited the land that had not yet been sold. Thus, its tax basis for sale starts out with its fair market value (FMV) on the date the owner died.  Your gain would be sales price less FMV less selling costs such as title charges.  if there is a gain you can use the installment sale method to spread the gain out over the period you collect the proceeds or you can waive the installment sale provisions and recognize the entire gain in year of sale. regardless of which you do the interest would be taxable in the year received.   assuming this is a term loan IRS code sec 7872 specifies the minimum interest rate that must be charged or imputed. 

IRC 7872

(2)Applicable Federal rate

(A)Term loans

In the case of any term loan, the applicable Federal rate shall be the applicable Federal rate in effect under section 1274(d) (as of the day on which the loan was made), compounded semiannually.