I am looking at potentially seller financing a primary residence and I am trying to figure out if the principal part of the payment would be excluded from capital gains even if the term is say, 30 years?
I understand that the interest portion is taxed as income, but I am confused as to if the principal payments would be considered excluded capital gains under the "2 out of 5 year rule" if the principal payments were made over a much longer period like a 30 year mortgage.
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IRS tax topic 701
If you sold your home under a contract that provides for all or part of the selling price to be paid in a later year, you made an installment sale. If you have an installment sale, report the sale under the installment method unless you elect out. Even if you use the installment method to defer some of the gain, the exclusion of gain under Section 121 remains available. Refer to Publication 537, Installment Sales, Form 6252, Installment Sale Income, and Topic No. 705, Installment Sales, for more information on installment sales.
in Turbotax you would use the installment sale form (which would require you to manually calculate your allowable home sale exclusion) not the home sale form
I would say that unless the gain exceeds the exclusion there is no purpose to using the installment sale method. $0 taxable is $0 taxable. the interest would be taxable each year. what you risk is changes in the tax laws over the next 30 years, buyer default, inflation and other risks too. if the gain exceeds the exclusion the IS method may be advisable, but should you die before the 30 years are up, under present law this would be income in respect of a decedent and your heirs would then be required to pick up the gain as it is received. The way the IS works is any gain over the exclusion is picked up every year you collect principal starting with the year of sale. simple formula each year - taxable gain times gross profit percentage (gross profit divided by contract price) calculated in the year of sale.
IRS tax topic 701
If you sold your home under a contract that provides for all or part of the selling price to be paid in a later year, you made an installment sale. If you have an installment sale, report the sale under the installment method unless you elect out. Even if you use the installment method to defer some of the gain, the exclusion of gain under Section 121 remains available. Refer to Publication 537, Installment Sales, Form 6252, Installment Sale Income, and Topic No. 705, Installment Sales, for more information on installment sales.
in Turbotax you would use the installment sale form (which would require you to manually calculate your allowable home sale exclusion) not the home sale form
I would say that unless the gain exceeds the exclusion there is no purpose to using the installment sale method. $0 taxable is $0 taxable. the interest would be taxable each year. what you risk is changes in the tax laws over the next 30 years, buyer default, inflation and other risks too. if the gain exceeds the exclusion the IS method may be advisable, but should you die before the 30 years are up, under present law this would be income in respect of a decedent and your heirs would then be required to pick up the gain as it is received. The way the IS works is any gain over the exclusion is picked up every year you collect principal starting with the year of sale. simple formula each year - taxable gain times gross profit percentage (gross profit divided by contract price) calculated in the year of sale.
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