Tweet
Layaway for home buyers
An installment sale may get a hard-to-move property to closing. There may be tax advantages too.
By Michael Giusti, Bankrate.com
Having trouble selling your real estate in this soft market?
An installment sale is an often-overlooked sales technique that could make your property more attractive to buyers in this down-trending market and could even save you plenty in taxes.
But it won't work for everyone. In an installment sale, property sellers serve as the lender and the buyer makes payments directly to the seller. It's called such because the price paid for the property comes in installments, not in one lump sum, as is customary in a home sale. The most fundamental requirements are that the sale price is paid over time directly to the seller and at least one payment is received in the tax year after the sale closes.
If it's an investment property, the buyer may take a few well-timed payments spaced out strategically over just a few months -- with at least one in the next tax year -- in order to ease tax consequences. Home sellers, on the other hand, often space payments over 15 years or more as a way of ensuring guaranteed income over a longer term. Either way, an installment sale may be just the trick to get an otherwise stubborn property to closing.
Spreading tax burden
The most common reason people turn to an installment sale is to spread the tax burden from the sale of an investment property over two or more years.
For example, someone sells a $250,000 rental home in December and the buyer makes a 25% down payment at the time of closing. The buyer then pays the balance the following month, splitting the payments into two calendar years. This allows the seller to pay tax only on the down payment in the first year, with the tax on the remainder coming due the following year.
As long as the seller held the home for more than a year, the property would be taxed at the 15% standard capital-gains tax rate. But in the case of an investor who held a property for less than a year, installment sales can become even more attractive for this reason: If the seller expects to be in a lower tax bracket in a subsequent year or years, the installments can be scheduled to correspond, potentially translating to thousands of dollars in tax savings. Even if the seller qualifies for capital-gains treatment, the tax on the sale would be spread over the entire term of the loan, rather than being due upfront like a traditional sale. The seller would have to pay tax in any one year only on the portion of the total selling price that he is collecting that represents his profit on the sale.
Sellers aren't the only ones who benefit from this type of arrangement. From a buyer's perspective, installment sales on investment properties can mean spreading the cost of a sale over a longer term without taking out a bank loan, potentially helping to bring an unattainable sale price into reach.
Bending rules
Because the seller acts as the lender in an installment sale, he or she sets the rules governing who qualifies for financing. If the home is in a slumping real-estate market, the seller may choose to lend a more sympathetic ear to the buyer than a bank loan officer. The seller can even offer more favorable closing costs and waive fees or private mortgage insurance requirements to further save the buyer money and help make his or her home stand out from the crowd. An owner-financed deal might be especially attractive if the buyer has a nontraditional financial situation, such as a small-business owner who may need a no-document loan that a more traditional lender may frown on.
But while bending the rules to accommodate a buyer may help move the house, experts warn that those restrictions are put in place by banks for a reason and that extending credit to an otherwise questionable buyer may lead to trouble down the road.
Sharon Lechter, a certified public accountant and co-author of the book "Rich Dad's Real Estate Advantages: Tax and Legal Secrets of Successful Real Estate Investors," advises anyone considering selling a house through an installment sale to take some basic steps for self-protection.
"Now, you should realize, if you have to foreclose you will get the property back," Lechter says. "That may be a blessing in disguise if home values go up. But if they go down, that is a risk that you need to consider."
Due on sale
In order to sell a home through an installment sale, you generally need to own the property free and clear. That's because most mortgage agreements include the "due-on-sale" clause.
To make an installment sale feasible, you can either own the property outright before the sale or you can use the down payment and any personal savings you may have to pay off the remaining balance.
This due-on-sale aspect means installment sales are typically most attractive to sellers who have owned a property for many years and are likely to have a small mortgage, if any, remaining, or to investment buyers who tend to put substantially larger amounts of cash down. It doesn't make sense if a seller still owes a large mortgage or for someone who is facing cash-flow shortages.
Incidentally, it is a good idea to include a due-on-sale clause in the paperwork when you are drawing up the promissory note for a sale.
Get help
While they can offer many benefits for the buyer and the seller, installment sales include many technicalities and details that can trip up even the most expert real-estate investor. You'll need to consider issues such as who qualifies for tax breaks and what specific protections you need to ensure you aren't stuck on the losing end of a bankruptcy settlement.
For example, the IRS has ruled that "real estate dealers" cannot qualify for the tax advantages of an installment sale. The agency defines a dealer as someone who is in the constant practice of buying and selling houses -- which may include those who flip houses, depending on their specific situation.
Another tax rule to watch out for is that the IRS may determine that you aren't charging a suitable interest rate. In this case it could ignore the rate that you drew up on your papers and assume a higher rate for taxing purposes.
To protect yourself from these pitfalls, Lechter suggests you always employ a tax accountant and a real-estate attorney in any installment transaction.
"You need good advice and good advisers," she says.
5 tips for sellers
Buy a credit report on the buyer. You are becoming a lender, after all, and jumping into a deal with someone who has questionable financing may come back to bite you later.
File a lien on the property. When filing the lien, make sure you secure the first position on the title. This protects you in case the new owner wants to take out a home-equity loan using the home as collateral. The first lien holder gets more preferable standing if things go wrong and the property is foreclosed on.
Include a foreclosure clause. This protects you in case the new owner skips any payments.
Include a due-on-sale clause. Just as institutional lenders do, make sure this is included to ensure you will be paid off if and when the property gets sold.
Record the mortgage. This protects you in case the new owner skips any payments.
An installment sale may get a hard-to-move property to closing. There may be tax advantages too.
By Michael Giusti, Bankrate.com
Having trouble selling your real estate in this soft market?
An installment sale is an often-overlooked sales technique that could make your property more attractive to buyers in this down-trending market and could even save you plenty in taxes.
But it won't work for everyone. In an installment sale, property sellers serve as the lender and the buyer makes payments directly to the seller. It's called such because the price paid for the property comes in installments, not in one lump sum, as is customary in a home sale. The most fundamental requirements are that the sale price is paid over time directly to the seller and at least one payment is received in the tax year after the sale closes.
If it's an investment property, the buyer may take a few well-timed payments spaced out strategically over just a few months -- with at least one in the next tax year -- in order to ease tax consequences. Home sellers, on the other hand, often space payments over 15 years or more as a way of ensuring guaranteed income over a longer term. Either way, an installment sale may be just the trick to get an otherwise stubborn property to closing.
Spreading tax burden
The most common reason people turn to an installment sale is to spread the tax burden from the sale of an investment property over two or more years.
For example, someone sells a $250,000 rental home in December and the buyer makes a 25% down payment at the time of closing. The buyer then pays the balance the following month, splitting the payments into two calendar years. This allows the seller to pay tax only on the down payment in the first year, with the tax on the remainder coming due the following year.
As long as the seller held the home for more than a year, the property would be taxed at the 15% standard capital-gains tax rate. But in the case of an investor who held a property for less than a year, installment sales can become even more attractive for this reason: If the seller expects to be in a lower tax bracket in a subsequent year or years, the installments can be scheduled to correspond, potentially translating to thousands of dollars in tax savings. Even if the seller qualifies for capital-gains treatment, the tax on the sale would be spread over the entire term of the loan, rather than being due upfront like a traditional sale. The seller would have to pay tax in any one year only on the portion of the total selling price that he is collecting that represents his profit on the sale.
Sellers aren't the only ones who benefit from this type of arrangement. From a buyer's perspective, installment sales on investment properties can mean spreading the cost of a sale over a longer term without taking out a bank loan, potentially helping to bring an unattainable sale price into reach.
Bending rules
Because the seller acts as the lender in an installment sale, he or she sets the rules governing who qualifies for financing. If the home is in a slumping real-estate market, the seller may choose to lend a more sympathetic ear to the buyer than a bank loan officer. The seller can even offer more favorable closing costs and waive fees or private mortgage insurance requirements to further save the buyer money and help make his or her home stand out from the crowd. An owner-financed deal might be especially attractive if the buyer has a nontraditional financial situation, such as a small-business owner who may need a no-document loan that a more traditional lender may frown on.
But while bending the rules to accommodate a buyer may help move the house, experts warn that those restrictions are put in place by banks for a reason and that extending credit to an otherwise questionable buyer may lead to trouble down the road.
Sharon Lechter, a certified public accountant and co-author of the book "Rich Dad's Real Estate Advantages: Tax and Legal Secrets of Successful Real Estate Investors," advises anyone considering selling a house through an installment sale to take some basic steps for self-protection.
"Now, you should realize, if you have to foreclose you will get the property back," Lechter says. "That may be a blessing in disguise if home values go up. But if they go down, that is a risk that you need to consider."
Due on sale
In order to sell a home through an installment sale, you generally need to own the property free and clear. That's because most mortgage agreements include the "due-on-sale" clause.
To make an installment sale feasible, you can either own the property outright before the sale or you can use the down payment and any personal savings you may have to pay off the remaining balance.
This due-on-sale aspect means installment sales are typically most attractive to sellers who have owned a property for many years and are likely to have a small mortgage, if any, remaining, or to investment buyers who tend to put substantially larger amounts of cash down. It doesn't make sense if a seller still owes a large mortgage or for someone who is facing cash-flow shortages.
Incidentally, it is a good idea to include a due-on-sale clause in the paperwork when you are drawing up the promissory note for a sale.
Get help
While they can offer many benefits for the buyer and the seller, installment sales include many technicalities and details that can trip up even the most expert real-estate investor. You'll need to consider issues such as who qualifies for tax breaks and what specific protections you need to ensure you aren't stuck on the losing end of a bankruptcy settlement.
For example, the IRS has ruled that "real estate dealers" cannot qualify for the tax advantages of an installment sale. The agency defines a dealer as someone who is in the constant practice of buying and selling houses -- which may include those who flip houses, depending on their specific situation.
Another tax rule to watch out for is that the IRS may determine that you aren't charging a suitable interest rate. In this case it could ignore the rate that you drew up on your papers and assume a higher rate for taxing purposes.
To protect yourself from these pitfalls, Lechter suggests you always employ a tax accountant and a real-estate attorney in any installment transaction.
"You need good advice and good advisers," she says.
5 tips for sellers
Buy a credit report on the buyer. You are becoming a lender, after all, and jumping into a deal with someone who has questionable financing may come back to bite you later.
File a lien on the property. When filing the lien, make sure you secure the first position on the title. This protects you in case the new owner wants to take out a home-equity loan using the home as collateral. The first lien holder gets more preferable standing if things go wrong and the property is foreclosed on.
Include a foreclosure clause. This protects you in case the new owner skips any payments.
Include a due-on-sale clause. Just as institutional lenders do, make sure this is included to ensure you will be paid off if and when the property gets sold.
Record the mortgage. This protects you in case the new owner skips any payments.
Comment