House flipping with owner finance sell

[rf78801]

I purchased a house in 2021 and have been fixing it up ever since.  Lots of expenses in 2022 but suspect none are deductible until I sell it.  It should sell in 2023 with me financing the sell.  I expect it will be a 10 year loan.  Because it will be financed over several years would this be considered a sell of a business property?  Am I correct in assuming there are no deductible expenses in 2022 (I took none in 2021 when I purchased it)?

This is the only house I have (or will) do like this, I have other primary employment and am not a "house flipper".

Thanks,

Ron

[Carl]

Sounds to me like it would be treated as an investment and reported as an investment sale. Your fix-up costs for this flip would be added to the cost basis of the property, whereas things like property taxes and insurance would be carrying costs.

One word of advice though.

I have rarely heard of an owner financed sale of real estate working out. From what I know (which is not much) when it comes to seller-financed loans on real estate, there's a 50% change the buyer will default within 2 years and you'll end up taking the property back. That percentage goes up to over 90% before 5 years. Things happen. People lose their jobs, or have other unforeseen circumstances where they can't pay, a wage earner dies, etc.

So with the sale of real estate, make absolutely certain you have your ducks in a row on the legal front with the sale, Expect you'll have to foreclose on the property before the 5 year mark. (you should plan for it, but that doesn't mean it will happen.) Doing so will make the foreclosure process less painful for both parties. (But it's still gonna be painful, no matter what you do.)

[PattiF · Accepted solution]

Yes, you are correct that you cannot use the expenses until you sell the property. If any improvements or repairs were necessary to sell the house, those expenses can be added to the basis. The basis will be deducted from the proceeds of the house when you sell it in 2023. 

To qualify as an increase in the adjusted basis when you sell, the home improvement must:

• Add materially to the value of your home; or
• Prolong your home's useful life significantly; or
• Adapt your home to new uses

Here are some examples of improvements:

• Remodels and room additions (including decks and porches)
• New or upgraded landscaping, irrigation, and sprinkler system
• Hardscapes such as pavement, block or retaining wall, patio
• Fencing
• Storm windows, doors
• New roof
• Upgraded wiring, plumbing, and ductwork
• Central heating, AC, humidifier
• New furnace, water heater
• Filtration, soft-water, or septic system
• Built-in appliances
• New flooring or wall-to-wall carpeting
• Upgraded insulation

And some expenses that are listed on the settlement statement can be added to the basis. These include:

• Title fees
• real estate commissions
• documentary stamps
• credit report costs
• costs of an abstract
• transfer taxes
• home inspection
• flood certificate
• attorney fees, etc.  

Since you are not in the business of flipping houses, this would be considered a one-time investment that is reported on Schedule D as investment income along with other forms needed for a seller-financed mortgage.

[rf78801]

Thanks for the response (and advice) Carl.  It is with some trepidation that I consider the installment sale but it's been a tough market ... two prior sales have fallen through.  This potential buyer is putting down $100K so they've got some skin in the game.  I'd hate to foreclose, but with that level of investment I'm hoping the odds are in my favor.  

Both responders categorized it as an investment sale.  My only confusion is how to handle the loan.

Thanks again!

Ron

[Carl]

If memory serves me, as you work through the investment section and identify the transaction as a real estate sale, you'll be given the option to set it up as an "installment" type of payment.

[Mike9241]

an option available to you is to report the gain on the installment method since this is not inventory. you would complete form 6252 in the year of sale. this way only a % of the gain is reported each year. basically principal collected each year divided by the total principal to be received times the gain. you can not use this if there is a loss.

also, you much either charge interest or treat part of the proceeds as interest.  

[tagteam]

TurboTax has an Installment Sale section where you would enter this transaction (unless you decide to elect out of installment sale treatment).

Note that if you want to use an online version of TurboTax, you will have to use Premier or Self-Employed (however, you can use any desktop version).

[Carl]

It is with some trepidation that I consider the installment sale

Everybody looks at an installment sale differently. There's so much to consider; things I may not even think of. I've never done an installment sale, and probably never will. My viewpoint is that if a lender (such as a bank) isn't willing to take the risk, then why should I? But that's me. I keep in mind also that there's always the possibility that something not yet thought of could affect my viewpoint in the future. That's shy I say, "never say never".

[rf78801]

Concur.  Every situation is different and everyone's risk tolerance is different as well.  This buyer seems to have deep pockets (professional athlete at highest level), has multiple properties and excellent credit.  Not sure why they want private financing, maybe the fees or PMI, just not sure.  But, given the amount of cash down and high monthly payment, I'm accepting the risk of default.  It will cost them $125K to walk away from it (and that will cover a lot of legal fees if necessary). 

Thanks for your thoughts & comments Carl!

Ron