Real Money in Seller Financed Notes, But Don’t Forget the Taxes


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Real money in seller financed notes

I received this question at USTaxAid.com. If you’ve got a question and don’t want to spring for a personal consultation, I answer questions for free at USTaxAid.com and through the Facebook group, Diane Kennedy’s US Tax Group.

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Here is the question I received:

Q: I buy and broker seller finance notes and was wondering how my accountant should be accounting for these?

A: There are a couple of tax aspects of seller financed notes to consider.

If you’re the seller and you “take back” a note, there are two possibilities with how you handle the tax.

Let’s assume that it’s a real estate sale. If you are a real estate dealer, you need to pay tax on all of the gain right away. You aren’t eligible for the installment sales method. If you aren’t a real estate dealer, you can take the installment sales method which means that you allocate a portion of the principal you receive to taxable gain.

For example, let’s say you have a property with a basis of $100,000 that you sell for $200,000. That means half of the principal you receive will be taxable. The interest portion is always taxable as interest income.

If you make the same sale as a real estate dealer, you end up having to pay tax on the full $100,000 profit even though you might wait years to get the full payment.

Now let’s say you sell that note at a discount. There is a note for $200,000 but you need cash and don’t want to wait for it. So, you sell it for $160,000. You get all the cash up front and that sets the new gain amount. Instead of $100,000 in gain, you have $60,000 in net gain.

If you’re the buyer of the note, you will be paid $200,000 + interest over a period of time. You bought the note for $160,000, so your basis is set at that.

You have profit of $40,000 that you will receive over time, plus of course, the interest income.

There really isn’t anything fancy about the tax strategies or accounting, you just need to know what you’re doing. The accounting takes a little bit more to set up because the discount is amortized over time with the payments you receive. But once it’s correctly calculated, just follow the schedule.

If you don’t receive the payments and foreclose (or repossess), you next need to figure out your basis in the property you received. That’s another a little more complicated formula.

My guess is that you need a qualified accountant to set up the schedules and then a bookkeeper to follow the schedule. Once that’s done, you’ll be in good shape.

We can help with bookkeeping at a ridiculously affordable price. You’ll pay just $35/hour or a flat rate you agree to before hand. For that you’ll get highly experienced, degreed accountants preparing your financial statements. Give Richard a call at 888-592-4769.


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