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Seller Financing



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Tax Benefits of Selling Your House by Installment Plan


Paying for something on an installment plan is familiar to almost everybody. Instead of paying the entire cost of an item upfront, you pay a little over time, over several months or years. Consumers commonly purchase items such as furniture and appliances on an installment plan. This method of payment is not limited to such items. Consumers can purchase almost anything on an installment plan, including real estate. Ins

Installment Sales: Seller Financing

Installment sales of real estate are a form of seller financing. Instead of borrowing money from a bank to pay the seller, the buyer borrows from the seller. The buyer and seller enter into an installment agreement in which the buyer agrees to make a down payment and pay the remainder of the sales price over a term of years. It can be one year or 30 years; it’s up to the buyer and seller to decide. The buyer also agrees to pay interest on the payments. It’s up to the buyer and seller to agree on the interest rate—it can be higher or lower than the rates  lenders charge. The seller ordinarily takes back a purchase money mortgage from the buyer. This way, the buyer’s promise to pay the seller is secured by the property—that is, if the buyer doesn’t pay, the seller can foreclose and get the property back.

Tax Benefits of Installment Sales

Sales in which at least one payment is not due until the following year qualifies as an installment sale for tax purposes. Such sales must be reported to the IRS using the installment method unless the seller opts out of using this method by filing an election with the IRS.

Under the installment method, the payments received by the seller are divided into two classes:

  • gain from the sale, and
  • return of the seller’s basis (cost) in the property.

Taxes need not be paid on the portion of the payments representing the return of basis—the amount the seller originally paid for the property. Tax must be paid on the portion representing the gain from the sale; this is paid at capital gains rates, which are usually lower than ordinary income tax rates. The seller must also pay regular income tax on the interest paid each year. The following example shows how this works.

Example: Bob sells her rental house to John for $200,000. Bob pays John a $20,000 down payment and agrees to pay the remainder in equal $20,000 installments over the next nine years, plus 5% interest. John paid $80,000 for the house and owns it free and clear; so her total gain is $200,000 – $80,000 = $120,000. This means that 60% of each payment represents gain from the sale, and the other 40% is a return of Liz’s basis. When John receives her annual $20,000 payments from Bob he will have to pay capital gains tax on $12,000. He will also have to pay tax at ordinary income rates on the $10,000 in interest he receives each year.

Why would a seller do this? Isn’t it always better to get the entire sale price upfront? Not always. There are many instances when getting paid over several years is better for a seller. If John from the above example had been paid the $200,000 sale price upfront, she would have had to pay tax on her entire $120,000 gain in the year of the sale. With the installment sale, she pays tax on $12,000 each year for 10 years. He pays tax on this amount at the 15% long-term capital gains rate, for a $1,800 annual tax. But she also is receiving interest payments from Bob on $200,000. This means that after he pays her tax, he effectively has $198,200 in earning interest. If John receives the entire $200,000 sales price upfront, she would have had to pay an $18,000 capital gains tax on his $120,000 gain the year of the sale. This leaves him with only $182,000 to earn interest.

Cost Savings of Installment Sales

Installment sales can also save sellers money if the income from the sale would put them in a higher tax bracket if they receive it in one year. This is especially important for higher-income sellers who could be subject to the 3.8% net investment income tax. Single taxpayers with an adjusted gross income (AGI) over $200,000, and marrieds filing jointly who have an AGI over $250,000, are subject to this tax. Depending on their income, such taxpayers end up paying an 18.8% or 23.8% capital gains tax on their gains, instead of 15% or 20%. The key to avoiding this tax is to keep your AGI below these threshold levels. Using an installment sale can help you achieve this.

Get Professional Advice

For more on the subject, see IRS Publication 537, Installment Sales. Also, be sure to consult with your tax professional, lawyer, and real estate broker before doing an installment sale. There are many issues to consider and a lot at stake, so it pays to get advice from the pros in structuring a house installment sale agreement with a buyer.

     Disclaimer: Talk to a Real Estate Attorney or CPA 



   Types of Seller Financing Arrangements

Here’s a quick look at some of the most common types of seller financing.

All-inclusive mortgage. In an all-inclusive mortgage or all-inclusive trust deed (AITD), the seller carries the promissory note and mortgage for the entire balance of the home price, less any down payment.

Junior mortgage. Sometimes lenders are reluctant to finance more than 80% of a home’s value. Sellers can potentially extend credit to buyers to make up the difference: The seller can carry a second or “junior” mortgage for the balance of the purchase price, less any down payment. In this case, the seller immediately gets the proceeds from the first mortgage from the buyer’s first mortgage lender. However, the seller’s risk in carrying a second mortgage is that he or she accepts a lower priority should the borrower default. In a foreclosure or repossession, the seller’s second, or junior, the mortgage is paid only after the first mortgage lender is paid off and only if there are sufficient proceeds from the sale. Also, the bank may not agree to make a loan to someone carrying so much debt.


Land contract. Land contracts don’t pass title to the buyer, but give the buyer “equitable title,” a temporarily shared ownership. The buyer makes payments to the seller and, after the final payment, the buyer gets the deed.

Lease option. The seller leases the property to the buyer for a contracted term, like an ordinary rental—except that the seller also agrees, in return for an upfront fee, to sell the property to the buyer within some specified time in the future, at agreed-upon terms (possibly including price). Some or all of the rental payments can be credited against the purchase price. Numerous variations exist on lease options.

Assumable mortgage. Assumable mortgages allow the buyer to take the seller’s place on the existing mortgage. Some FHA and VA loans, as well as conventional adjustable mortgage rate (ARM) loans, are assumable, with the bank’s approval.


        Dodd Frank and CFPB Vettings question and DOCUMENTED about Income and Occupancy to accurately determine the buyers’ Ability to repay the proposed loan and if you dont certify the buyer has it in event of default you risk having your lien invalidated should you try to foreclose and buyer hires a smart attorney


Both the buyer and seller will likely need an MLO and Real Estate Agent—perhaps both—to write up the contract for the sale of the property, the promissory note, and any other necessary paperwork.


  Selling your Mortgage Note For The Highest Price

  • The ideal seller-financed note has an interest rate at least 4% higher than what banks offer, at least 10% equity, and no more than 10 years of payments remaining.(unless inflation hits)
  • Underwrite your borrowers. A loan is only as good as the borrower’s ability to pay. Verify earnings history and their credit report. Check for prior bankruptcies, foreclosures, or evictions. Finally, if they currently rent, verify they’ve been making rent payments on time.
  • Keep PERFECT records. Verifiable payment histories are critical. Use a licensed 3rd party loan servicer or title/escrow company to collect and track payments and MLO to determine DTI LTV so as not to be a predatory lender
  • Safe Deposit Box the original contract. Think of your real estate seller-financed contract as a check someone wrote you. Keep it in a secure place. At closing, it will be given to the closing agent who will then forward it to your Note Buyer.
  • Train your borrower early on. The contract says you’ll charge a late fee for late payments, charge it. Poor habits repeat if you allow them to.
  • Keep track of insurance and taxes. Your loan servicer should confirm every six months that property taxes are being paid, and at each insurance renewal interval that the policy is current.

Check on the property. While it’s technically in the borrower’s hands (you may not enter inside), they still have a responsibility to maintain what serves as collateral for your loan. Look for a roof, broken windows, shingles, or other serious issues which could reduce the home’s value.

Tips to Reduce the Seller’s Risk

Many sellers are reluctant to underwrite a mortgage because they fear that the buyer will default (that is, not make the loan payments).  Take steps to reduce the risk of default. A good professional can help the seller do the following:

Require a loan application.  Insist that the buyer complete a detailed loan application form, and thoroughly verify all information the buyer provides there. That includes running a credit check and vetting employment, assets, financial claims, references, and other background information and documentation.

Approval of the buyer’s finances. The written sales contract—which specifies the terms of the deal along with the loan amount, interest rate, and term—should be made contingent upon the seller’s approval of the buyer’s financial situation.

Loan secured by the home. The loan should be secured by the property so the seller (lender) can foreclose if the buyer defaults. The home should be properly appraised at to confirm that its value is equal to or higher than the purchase price.

Down payment. Institutional lenders ask for down payments to give themselves a cushion against the risk of losing the investment. It also gives

the buyer a stake in the property and makes them less likely to walk away at the first sign of financial trouble. Sellers should do likewise and collect at least 10% of the purchase price. Otherwise, in a soft and falling market, foreclosure could leave the seller with a home that can’t be sold to cover all the costs.


Seller financing is negotiable. To come up with an interest rate, compare current rates that are not specific to individual lenders. Use services like BankRate check for daily and weekly rates in the area of the property. Be prepared to offer a competitive interest rate, low initial payments, and other concessions to lure buyers.

Sellers typically don’t charge buyers points (each point is 1% of the loan amount), commissions, yield spread premiums, or other mortgage costs, they often can afford to give a buyer a better financing deal than the bank. They can also offer less stringent qualifying criteria and down payment allowances.

The seller must or should not bow to a buyer’s every whim. The seller  has a right to decent return. A favorable mortgage that comes with few costs and lower monthly payments should translate into a fair market value for the home.

     Arizona Notes Funding will buy all interest rate notes                         



Seller Finance

Federal Law requires that all home loans attached to a dwelling meet The Dodd-Frank Act’s Ability-to-Repay requirements. This is achieved through proper origination, disclosing and underwriting practices. If you are selling a home (including mobile homes) and extending credit to an owner-occupying buyer, then you are required to comply with the Dodd-Frank Act.


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