Tax, Tax, Tax Considerations When Planning a Land Contract - Real Estate - Selling

Tax can have a major impact on your rental property's bottom line. Do not overlook tax implications when planning for owner financing deals, like a land contract (a.k.a real estate contract, or contract for deed).

The legal title is not recorded or transferred until the buyer fulfills the contract's obligations usually a few years from the Closing. However, your property is considered sold, in IRS rules, when a real estate contract is signed.

From the seller perspective, the capital gains (if any) would be recognized as an installment sale and would be recognized proportionally as the principal payments are received. As a seller, you cannot depreciate the property, and cannot engage in a 1031 exchange at the final sale. You would report interest income on the mortgage payments received, and the mortgage payments you make would be deductible as investment interest on Schedule A.

It's a great tax advantage to pay capital gain tax over the years through installment sale if you have a sizable gain and are not considering 1031 exchange. However, you will lose the ability to take depreciation and mortgage interest deduction. Evaluate carefully your tax situation before deciding on your best strategy - Long Term Lease To Own or Real Estate Contract. Always consult a tax professional for your individual situation.

The buyer in a land contract can deduct the interest and tax portion of his payments from his income if he itemizes, and in the case of an investor who uses the property for business, can deduct any expenses related to the property, and can depreciate the property and any improvements he adds.

A recent hot topic is that if the buyer of a real estate contract qualifies for the $8000 tax credit. IRS does not yet have a formal explanation, but a lot of buyers, who do not qualify for a conventional loan, will jump into real estate contracts to claim the tax credits set to expire in April 2010. Based on IRS, If the taxpayer obtains the "benefits and burdens" of ownership of a residence in a seller financing arrangement, then the taxpayer can claim the credit even though the seller retains legal title. Factors that indicate that a taxpayer has the benefits and burdens of ownership include:

1. the right of possession,

2. the right to obtain legal title upon full payment of the purchase price,

3. the right to construct improvements,

4. the obligation to pay property taxes,

5. the risk of loss,

6. the responsibility to insure the property, and

7. the duty to maintain the property.

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