Owner financing tax implications

[Anonymous]

Which are better overall tax implications.  Understanding that the tax % is based on the individual's tax bracket at the time:

If I sell a house, that has been a rental for over 5 years, at owner financing, terms being:

- 20% down payment

- 5 years owner financing

- at 5% interest

- 30 year amortization

- balloon payment after 5 years

Question: when selling an investment house, one pays long term capital gains on the net profit. 

What are the tax implications when it’s owner financing?  Are the taxes deferred until the balloon payment date or due at the initial sale date?

[Mike9241]

not quite. as a rental property, you should have taken depreciation on it. when you sell on the installment basis (form 6252) the first income that is taxed is section 1250 recapture depreciation the larger of allowed or allowable. after you have reported all 1250 recapture as income, then the balance gets taxed as long-term capital gain as collected.  if you have not taken depreciation, you need the help of a tax pro.

with owner financing, you report as taxable income each year the interest income received and the portion of the principal collected that is income  - 1250 recapture first then capital gain. there is no requirement to use the installment sales method but then the entire gain is taxable in the year of sale - still 1250 recapture and capital gain. each year you receive interest that's reported as income.

[Rick19744 · Accepted solution]

As a follow-up to @Mike9241 post.

As noted, ALL depreciation is recaptured and taxed in the first year of the installment sale.  This catches some individuals off guard, so you need to plan accordingly.  In planning, you need to make sure that the down payment will cover the tax due as a result of the depreciation recapture in that initial year.

[Anonymous]

Thank you!

Is selling a property with owner financing better tax wise that selling outright, assuming my tax bracket remains the same?

[Rick19744]

Many factors, but in general "no".

• seller financed will provide you with some additional interest income over the installment period
• seller financed you run the risk of the buyer defaulting on the payments
  • at this point you will need to spend $$ on legal fees to have the property returned to you
  • you may spend $$ just to get the buyer to continue making partial payments
  • all of this can be stressful and time consuming
• No seller financing - the transaction is done, you have all the proceeds and can move on
• No seller financing - you have a known tax rate (once and done) that is not subject to congressional tax rate changes down the road