Tax implications of selling a non-owner-occupied house and receiving installments

Question

My mother is in the process of selling her rental unit to a buyer. They have a contract laid out where the buyer is making 10-year amortized payments for 5 years, with a balloon payment at the end. When the final payment is made, the sale of the house will be completed.

• What portion of the monthly payment is reported as taxable income?
• Possibly relevant: Does the signing of the contract constitute a house sale, Or does the title have to change hands for a sale to be completed?

The IRS defines installment sales as sales in which you receive at least one payment after the tax year in which the sale took place. Since the "sale" wouldn't take place until the last payment were made, I'm not sure how this would be reported.

Answer 1

Noah, I hear member @littleadv whispering "this is one where you should be contacting a pro, at least to file the first year's return."

That said, IRS documentation has come a long way, at least for those willing to stare at it, re-read, and cross check in case of confusion.

Your friend here is Publication 537, Installment Sales. From there:

Each payment on an installment sale usually consists of the following three parts.

• Interest income
• Return of your adjusted basis in the property
• Gain on the sale

In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. You do not include in income the part that is the return of your basis in the property. Basis is the amount of your investment in the property for installment sale purposes.

The implication of the above is that if she has a large gain (I hope so), the IRS doesn't expect her to claim the gain and be subject to tax on it if she hasn't gotten the money yet. Part of the beauty of the installment sale is its use for an older person wishing to annuitize the value of a rental while getting out of property. Spreading that gain over 10-15 years can really reduce the tax.

Of course, the above doesn't quite show you the math. See Pub 537, and its accompanying form 6252 for the details. (And talk to a pro)

Answer 2

IANAL, but...

This transaction as described could be viewed as follows: your mother sold the unit to the buyer and completed the sale. In payment, she took back a mortgage for the full purchase price. This mortgage had a particular principal amount and interest rate, a 10-year amortization and a five year term. Title has changed hands, with the mortgage registered against the title in the event of default. The buyer takes possession and proceeds to pay off the mortgage.

With this interpretation, any mortgage amortization program can calculate the changing interest portion of each payment the buyer makes.

Another complication: Your interest income declared to the IRS should match the buyer's mortgage interest deduction claimed from the IRS...