Key Takeaways
- Subject-to buyer's basis is purchase price paid, not mortgage balance.
- Seller financing creates installment sale spreading gains over time.
- Installment sales reduce annual tax burden by keeping seller in lower brackets.
- CPA experienced in creative financing is essential.
Creative financing creates unique tax situations for both parties.
Buyer Tax Implications
Subject-to: basis is purchase price paid (not mortgage balance). Depreciation on building portion. Seller financing: basis is full purchase price, interest deductible on Schedule E. Lease option: no depreciable interest until option exercised.
Seller Tax Implications
Seller financing creates installment sale: gain recognized proportionally as payments received. Spreads income over years, potentially keeping seller in lower brackets.
Tax Planning
Installment sales spread liability. Cost segregation accelerates depreciation. 1031 exchanges available for later sales. CPA experienced in creative financing essential.
Compliance Matrix
Sources
Common Mistakes to Avoid
Using the existing mortgage balance as the depreciation basis in subject-to acquisitions
Consequence: Incorrect tax deductions that may trigger IRS scrutiny and penalties
Correction: The depreciable basis is the purchase price paid — consult a CPA experienced in creative financing for proper basis calculation.
Sellers not understanding installment sale tax treatment before agreeing to seller financing
Consequence: Unexpected tax liability on interest income, leading to seller regret and potential disputes
Correction: Ensure sellers consult their CPA about installment sale tax implications before closing the transaction.
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Test Your Knowledge
1.What is the buyer's depreciation basis in a subject-to acquisition?
2.How does installment sale treatment benefit the seller in a seller-financed transaction?
3.What percentage of each principal payment represents capital gain in a $200K sale with $120K basis?