Congratulations you got an offer but the buyer wants to finance the transaction with a Land Contract….Personally, I’m not a big fan of being a land contract holder due to the additional work to get my money out of a transaction and move on. My initial response to a Land Contract offer is, “No” or “Pass”, but recently banks have been looking to purchase land contracts from private holders so now this opens up the potential to make the land contract liquid.
So….let’s say you decide to go forward and accept the Land Contract offer and sell the Land Contract to a bank, then the next question is, “How am I going to get taxed on the sale of the land contract?”
And like a good accountant my answer is, “Depends on several qualifications….”
Initially, we look at the property and determine if it was your primary residence? and for how long? Have you ever rented it out to someone else? Then we look at you as the seller and determine do you qualify as a Homeowner, Passive Investor or Real Estate Professional. Also, we need to know your filing status in the year of the sale of the property and the date of sale of the Land Contract.
1. Homeowner selling Land Contract
Qualifiers: Primary residence for 2 years, less than 2 years can be prorated.
Pros: $250,000 for Single or $500,000 for Married Filing Joint in tax exempt gain.
Cons: Cannot write off loss if there is one.
2. Passive Investor
Qualifiers: Not your primary home and land contracts are not your primary source of revenue.
Pros: Can write off loss up to capital loss limit, remainder is carried forward.
Cons: Subject to Capital or ordinary gains depending on how long you held the note.
3. Real Estate Professional
Qualifiers: Subjective somewhat but must spend approximately 2,000 hours a year in the Real Estate industry – talk to a tax professional before claiming this because there are more qualifiers and may vary depending on individual circumstances.
Pros: Can take an ordinary deduction for any loss.
Cons: Typically, all transactions are ordinary even if held for more than 12 months and you must qualify each year.
Example 1 – Straight forward
If the house was your primary residence and you sold it for $600,000 and purchased it originally 10 years ago for $100,000 and you are married. Buyer brings $600,000 cash to the closing.
In this case you qualify for the $500,000 exemption because you are married and filing a joint return and you have lived in the home for more than 2 years.
Example 2- Little more complicated
Same as Example 1 but it’s not your primary residence and seller presents a Land Contract instead of cash, with 10% down ($60,000).
Seller won’t qualify for homeowner exemption since you haven’t owned the home for two years, but the good news is you only pay tax on a prorated portion of the cash you received in each taxable year. So in this case, $60,000 was received, 83% is gain [(Sale Price – Cost + Improvements) Divided by Cost + Improvements] then multiply this gain percentage against what you received in cash in the current year and that will be your total taxable amount for the current year.
In future years you will claim interest income and gain based on same gain percentage in the initial year and cash collected in each preceding year.
EXAMPLE 3 – Little more complicated
Using all of the fact patterns From Example 1 and modified by Example 2, let’s say you sell the land contract to a bank five years into the land contract and the seller of the land contract seller has passive losses of $500,000 from other real estate ventures.
-In the 5-year period the land contract holder has collect a total of $80,000
-Land Contract note at date of sale was $520,000
-Bank Paid $450,000 for the Land Contract
The remainder of the gain, $433,330, will be recognized in the current year as well as a $70,000 long term capital loss from the discounted sale of the Land Contract. The gain and loss can be offset against each other.
There are several variations to this transaction and prepping for the correct transaction can go long way in the beginning as well as defining who the seller is could lead to some very attractive tax strategies. I prepped these examples at a high level to understand the taxable consequences of selling a land contract, this is not all of the finite details which are needed but paint the general overall picture.
I’m happy to discuss your specific situation and feel free to call or email your facts and I can see how to best aide you in the process.