Installment sales may become more popular as interest rates rise and sellers look for creative ways to move property and Installment Sale Offers Tax Advantages to Sellers. I remember studying about installment sales in 1988 as a young CPA at Arthur Anderson, but in the 23 years I have been practicing real estate I have never experienced one. They just haven't been very popular, I think because most sellers don't want to be creditors.
In an installment sale, the seller becomes the lender and receives payments over time rather than a lump sum at closing. This can benefit both the buyer and seller:
The buyer gets financing even if they can't qualify for a traditional mortgage. The seller provides a "seller carryback" loan.
The seller can incentivize the sale by offering favorable terms like a below-market interest rate.
The seller spreads out capital gains tax liability over the life of the loan rather than taking the full tax hit at once. In an Installment Sale gain is recognized as a percentage of the cash received by the seller in each year.
Here is an example of how an installment sale can work:
A seller sells their primary residence for $2,000,000. They had purchased the home for $400,000 and used it as their personal residence during the entire time. Commissions and expenses of the sale are $100,000.
The seller's taxable gain on the sale is: $1,000,000 ($2,000,000 - $400,000 - $100,000).
The seller enters into an installment sale agreement with the buyer. The buyer pays the seller $25,000 in principal and $5,000 in interest income in the first year.
The seller's gross profit percent is 0.75 ($1,000,000 / $2,000,000).
The seller's taxable gain in the first year is $18,750 ($25,000 x 0.75).
The seller's interest income in the first year is $5,000.
In the second year, the seller would receive $100,000 in principal and $20,000 in interest income. Their taxable gain in the second year would be $75,000 ($100,000 x 0.75).
Installment sales can be a complex topic, but they can be a valuable tool for sellers who are looking to defer and spread out their tax liability. If you are considering an installment sale, it is important to consult with a tax advisor to ensure that you are structuring the sale in a way that is most beneficial to you.
Here are some additional benefits of installment sales:
Earn interest on your money. The seller earns interest on the outstanding balance of the installment sale, starting on the date of the sale.
Secured by a deed of trust. The seller's interest in the property is secured by a deed of trust, which means that they can foreclose on the property if the buyer defaults on the loan.
Flexibility. The terms of the installment sale loan can be negotiated between the buyer and seller. This gives the seller some flexibility in terms of how they want to receive their payments.
Installment Sale Offers Tax Advantages to Sellers
If you are considering selling property, an installment sale may be a good option for you. It is important to consult with a tax advisor to determine if an installment sale is right for you and to structure the sale in a way that is most beneficial to you.
For more information refer to IRS Publication 537, Installment Sales.