Owner Financing & Taxes
I have a great relationship with my bank...they're willing to let me owner finance raw acreage that they have a mortgage against (I do have to personally gaurantee each note). My rate with them is 6.5%, I would finance it at 9.95% and pocket the difference (they have no interest in buying the paper back). Here's my problem...Example: I buy 20 acres for $15,000 and sell it owner financed at $29,900--won't I have to come up with the $$$ to pay Uncle Sam on the difference (profit) come tax time? Unless there's something "Creative" someone can suggest this won't work for me because I won't have enough up-front cash to cover the taxes. I've done the above scenario before but with property that was paid for. Technically I realize there's no difference if it was paid for by me or by the bank...just wondering if there's another way to approach this. If so, I can build up a pretty good receivables base, if there's not another approach I guess I'll have to start saving my money.
Thanks.
Let's say you approach this as a property flipping business. You are engaged in an activity which is a dealer to real estate. As such, all of your profit is taxable in the year of sale. Let's say you do this as a sole proprietorship. Let's say you are in the 25% tax bracket.
Your profit on the deal in your example is $14900. The income tax liability on this profit is $3725 assuming you had no business expenses (Schedule C) to offset your net taxable income. Additionally, your self-employment taxes from this deal will be about $2280. You now have a total tax liability from this deal of $6005.
If you owner finance with 20% down, then your downpayment is $5980. In the worst case scenario, you only need to come up with $25 out of pocket to pay your tax bill.
Meanwhile, interest income received on your wraparound mortgage is reported as income on your Schedule C while the interest you are still paying on the underlying first mortgage is deducted as a business interest expense on Schedule C.
So DaveT,
You're saying, in the second instance, that if this person is able to characterize it as an investment (as opposed to a flip/dealer prop) they can then qualify for installment sales treatment, right? This way they can pay taxes on the gain as they receive it over the period of the contract?
Erick,
Second instance???? There is no second instance in my post.
If the property is investment property (in accordance with the IRS definition of investment use), then installment sale tax treatment would apply.
In the scenario outlined by knees, the property is not investment property, but rather stock-in-trade. As such, installment sale tax treatment can not be used even if the property is sold with seller financing.
If you havent been tagged "a Dealer" I dont see why you should voluntarily use that tax treatment.
Installment sales is the way to go.
Pay tax as you receive your profits.
how this is done exactly is best answered by a PROFESSIONALLY LICENSED CPA.
N.
Quote:If you havent been tagged "a Dealer" I dont see why you should voluntarily use that tax treatment.Neill7,
If you do not properly report your dealer activity (Schedule C, Schedule SE, etc.), then, at some future date when you are audited, you get "tagged" as a dealer.
At that point, the IRS does not say: "OK from this point forward you are a dealer and you have to report your future transactions as dealer dispositions."
Instead the IRS will say: "We have determined that all year real estate transactions for the past six years are dealer dispositions which you have improperly reported as installment sales. We are going to recompute your tax returns for the past six years to take the correct tax treatment for each dealer disposition. Additionally, back taxes, interest, and penalties will be assessed. How will you be paying your bill?"