Real Estate Investors Worry About Seller Financing Tax Forms
23 posts across 7 communities in the last 60 days; 39% from r/tax.
“Everyone's focused on the gift tax exclusion, but that part's the easy part. The annoying bit is the IRS gets to net the two sides of the circle — interest that gets "paid" and then gifted right back looks like interest that was never paid, and they know it. The lender still…”
“If you seller finance a commercial property, should you think about the note's future value when setting the terms? Seller financing can solve a problem for both the buyer and seller, but there's an interesting second consideration for the seller: What if you don't actually want…”
“The issue isn't paying the 4.35% AFR; the issue is the pre-arranged, systematic forgiveness of the principal to offset it.You are focusing strictly on individual steps, but the IRS uses the Step-Transaction Doctrine to look at the integrated economic reality. If the seller…”
Real estate investors are concerned about the tax implications of seller financing structures, specifically principal forgiveness and annual gifts. They seek clarification on IRS regulations to avoid recapture issues.
SOURCES (60)
“Not only that but the gains form market stay tax free until you pull out. Not only that but you pay 6-8% just to sell the property at the end. Not worth it in my view. 8 doors. [re: Real estate or stock market? Let’s…”
“Do sellers like seller financing? [re: Gifting Interest on Seller Financing]”
“Smart waiting five years so there was no capital gains tax unless you planned on rolling it all over anyway”
“Single member LLC better - you can write up a contract for distributions but leave ownership structured in a simple, efficient and less costly way.”
“Gift the interest separately by checking instead of netting it out. Recording each payment schedule in Quicken provides the paper trail needed to satisfy IRS scrutiny.”
“Everyone's focused on the gift tax exclusion, but that part's the easy part. The annoying bit is the IRS gets to net the two sides of the circle — interest that gets "paid" and then gifted right back looks like interest that was never paid, and they know it. The lender still owes tax on the phantom income either way, so you're paying a real tax bill for the privilege of being generous. Honestly, if the goal is helping family, just write the note at AFR and gift them cash to”
“So, if the interest actually changes hands once when being paid, then again when it is gifted, that changes the calculus? Or can it just be considered to be collected?”
“The interest aside (there is a soft spot), it is permissible to gift interest under the gift tax exclusion? Of course, I wouldn't jump into it without true professional advice. Just trying to get a feel for the lay of the land.”
“That could be a solution. If I setup an installment to pay my siblings out maybe $20k per year over 10 years, that might work. I think the other thing is, I wonder if there is a way to deal with the taxes because without the stepped up basis she has $300k of capital gains. If I setup a trust and he quitclaimed the deed to the trust, there would be no capital gains taxes, right? And then I could have the rental income go into the trust, and then fund the trust to get each sibling their $20k check”
“Sorry, this one is messier than it looks. If the note says 4.49% and only principal actually changes hands, you're describing a below-market loan, and the forgone interest gets treated as your income and a gift to the buyer at the same time, so you'd be filing a 709 every year to reach a result you could get by just structuring it as a gift loan from the start. Either charge the interest and collect it, or write real gift terms and keep it under the small loan thresholds.”
“Hello all, I'm back with a few more questions on seller financing. This time, I'm looking to explore gifting interest on a seller financing deal. Is it permissible for the lender to gift the interest accrued on the loan to the borrower using their annual gift tax exclusion? The lender would still be required to pay tax on the phantom interest. For example, the AFR (currently 4.49%) would be written into the promissory note. However, only payments to principal would actually change hands.”
“Isn’t the 100h and getting the most hours only relevant in year 1 for the cost seg? Then you’re basically in it for the equity and cash flow?”
“Not to be insulting, but consulting a tax professional before you did this could have given you more options. You can start making payments now on your balance that will be due in 2027. You may be penalized for underwithholding. Make sure the payments go to tax Year 2026. Start making payments now. If you do not have an IRS account, you can open one here and make any payments electronically. Don't mail them. https://www.irs.gov/payments/online-account-for-individuals You can reduce penalties”
“You are also going to get penalized for not immediately making at estimated payment of the potential tax amount They’ll only be penalized if they didn’t meet safe harbor. This kind of one-time event is exactly why the safe harbor thresholds are designed the way they are.”
“I'm not sure if you're questioning/disagreeing, or if you're genuinely asking and would like to know more about how gift taxes work?”
“I recommend speaking with a tax expert about tax issues, not a mortgage broker or lawyer. Mortgage brokers and lawyers are notorious for giving bad advice because they think they know what they don't know. Your dad can give you a gift of equity if it's done properly. There is no taxable gain for the recipient of the gift, but potential tax for the giver. There is a gift limit of around $19,000 per person per year, more than that and a gift tax return must be filed by the giver, and will”
“While that seems sort of logical to divide the basis between the gift and the sale, that is not actually how it works.”
“As you take it to your lawyer highlight the clause to your lawyer and see how things develop. Congrats on getting that far in your journey.”
“Original basis is 40K. There would be adjustments for partnership income and distributions - hopefully there are basis worksheets. Did repurchase happen in 2025 or 2026.”
“If you seller finance a commercial property, should you think about the note's future value when setting the terms? Seller financing can solve a problem for both the buyer and seller, but there's an interesting second consideration for the seller: What if you don't actually want to collect those payments for the next 5, 7, or 10 years? The seller may eventually want to sell the note and turn the future payments into cash. If that's a possibility, the original note terms become im”
“When you need a lump sum, you either sell something and pay the tax or borrow the money and pay the interest. Usually interest is the cheaper option, and this is one of the strategies that the very wealthy use, but you'd have to do the math and see what works best in your situation.”
“Rent your current house out to get cash flow. Take a mortgage out on the house to pay for your French apartment. Tax burden delayed.”
“You’d need to find one who works with France expats. Probably 95% of US based CPAs do not have any knowledge about international taxes”
“I’d probably have a CPA document a reasonable FMV allocation using comps appraisal rather than trying to reverse engineer it from insurance.”
“0% for 10 years is pretty damn hard to beat lol. I'd be curious how everyone here would handle the balloon though. That's the part I'd be thinking about the most. Ten years is a long runway, but I'd still want a pretty clear idea of how I'm getting out of it when that day comes. Anyone here actually done a 0% seller carry like this?”
“Good points. I'm trying to stay within the 15% bracket, but could easily go into the 20% if selling too much as our lifestyle has inflated with increased income and paper wealth. It's not an asset that has to be sold at once, it can be spaced over however long I choose. However the asset is potentially high risk, so would like to diversify at least a substantial part asap. Edit: Also, of course I have to be in CA for that additional satisfaction of paying one of the highest state taxes.”
“is any of that 6M in an IRA or other retirement account or is is strictly taxable brokerage?”
“Yes but- the shape of the curve is different than for earned income- you'll saturate at 20% plus 3.8% NIIT plus state tax at 600k. It's not terrible. If you're spending a FAT amount, you may be nearly into the 20% bracket already? Anyhow, it's worth doing the numbers on selling now vs later. I'm assuming from the question that this is a single lumpy asset that would need to be sold in a single transaction? If not, the obvious alternative is to sell it gradually over 3-6 years”
“You aren't taxed on your equity, you're taxed on your GAIN. (The difference between your purchase price and your sales price, with adjustments.) Mortgages and equity don't enter into the equation.”
“if u report an interest income from the installment sale and have a matching interest expense from the note which is usally what occurs…you will get flagged for sure…irs will recognize the installment sale, interest income, and interest expense and put two and two together”
“Please remember to keep conversation where it can be seen and reviewed by everyone. Offering or requesting DMs is not allowed here due to the no soliciting rule and the amount of scams that go on DMs.”
“The issue isn't paying the 4.35% AFR; the issue is the pre-arranged, systematic forgiveness of the principal to offset it.You are focusing strictly on individual steps, but the IRS uses the Step-Transaction Doctrine to look at the integrated economic reality. If the seller forgives principal every single year to match your interest obligations, the IRS will argue there was never a true intent to establish a bona fide debt.To a tax court, this looks like a pre-engineered scheme to artificiall”
“The CPA is needed by both the seller and the buyers. The seller will need to file a Gift Tax Return since he will be giving a gift over $19k. The buyers need a CPA to figure out what their cost basis in the house will be.”
“AMT impacts very few taxpayers. It’s been less than a percent of taxpayers since 2018 but will probably go up again to 3ish percent as some tax law changes from 2018 phase out after 2025. So, unlikely to matter for you.”
“Sounds good. Big 4 laughed at me when i suggested it years ago (also the spouse as real estate professional). I personally would probably not recommend any CPA who uses the word "loophole" to describe the tax code. There is simply code.”
“Yes, you basically have it right. For the IRS, you won't pay Net Investment Income Tax unless your total income is over the threshold ($200K Single, HoH / $250K MFJ / $125K MFS) and then it's only on the portion of investment income that falls above the threshold. For CA, if any of your mutual funds have income that is more than 50% from CA muni bonds, the CA portion of that income is tax free on your state return. Income from Federal Treasuries is also exempt from CA tax.”
“Comment 3 is right to flag the recharacterization risk, but it's worth being more specific about why. If the forgiveness schedule is baked into the promissory note or any side agreement at closing, the IRS has a strong argument that the "forgiven" principal was never really a loan at all, it was just deferred purchase price dressed up to look like debt. That collapses the whole structure because you lose the interest deduction (no real debt, no real interest) and the sellers lose t”
“A good appraiser can. A mediocre one (which is probably the majority) can’t. I work with these discounts all the time in the Estate Tax realm.”
“Please forgive me (and I will edit above0, I left out a critical sentence in the OP. We, as buyers, would pay their income tax burden for the interest using OUR annual gift tax exclusion. So we would be on the hook annually for Interest + Income Taxes on that interest I guess I don't see how this is trying to circumvent tax laws...We will write the note and pay the sellers the AFR (4.35%) and they will be charged income tax on that interest. We would pay those taxes for them using our annual”
“The IRS will see right through this. This setup is a textbook violation of the Step Transaction Doctrine”
“This is a textbook example of a disguised transaction that the IRS will easily tear apart.Forgiving the exact amount of principal every single year to match the AFR interest obligations shows clear intent to circumvent tax laws. The IRS applies the Step-Transaction Doctrine here—they look at the ultimate economic result, which is an illegal workaround of the mandatory 4.35% interest rule.If audited, the sellers face back taxes on imputed interest, and you will lose your projected cost basis. If”
“Could someone explain how larger seller credit helps the math to people like me who are less familiar with it?”
“You are dealing with several separate tax tests. Most of your assumptions are close, but two important corrections are needed: the seven-day rule does not automatically make the losses deductible, and the placed-in-service date does not make the entire building eligible for bonus depreciation. Passive-loss treatment: An average guest stay of seven days or less means the activity generally is not treated as a rental activity under the passive-activity rules. You must also materially participate f”
“I know you want to keep the seller's taxes low, but trying to satisfy both their price and their tax desires is making this deal needlessly complicated. Complications now only make things more complicated later if circumstances change. First - Would the property actually sell for $1,000,000 on the market? Don't overpay just to be nice. If they want more money than the property actually deserves, then they need to make the compromise of getting some of that value as taxable income. If pro”
“The interest rate has to be at least the published AFR (4.35% for August) in order to avoid imputed interest. The sellers are our friends and we're working together to get creative but above-board to make it as affordable as possible”
“I guess you are glad getting such good advice from this forum. Origin of the claim ought to be what controls and since the whole or partial forfeiture of the escrow was home sale related it might fly as far as taxes go. I suggest you go get some advice from someone who will back up their opinion with the tax filing when and if it happens.”
“The IRS will consider any settlement to be a combination of capital gain on the house and unstated interest on the capital gain portion from the time of the loss. See 26USC483 for how to calculate (or ask your CPA).”
“Thanks for the well-articulated example there. That was the problem I couldn't get me head all the way around. Would you please explain how you came up with the Adjusted Purchase price, mathematically? We are looking to do a 9-year term at 4.35% with a $100,000 down payment and amortized over 30 years.”
“The biggest tax-saving lever is usually matching the strategy to your exit plan: depreciation can be great for near-term taxable income, but it’s not a permanent deduction and can come back as recapture when you sell. For buy-and-hold, focus on accurate cost segregation and expense tracking; for flips, be careful about ordinary income treatment and whether the project really benefits from those upfront deductions.”
“Yes, we would not be taxed on the cancellation but we would have to adjust our cost basis on the property. When we sell, the IRS will get their cut on capital gains by having a lower cost basis. Topic no. 431, Canceled debt – Is it taxable or not? https://www.irs.gov/taxtopics/tc431”
“I dont think it's that complicated. I had chatGPT run the numbers for me and then I just double checked its math. Seemed like it penciled out fine”
“That was our first consideration but then the balloon payment at the end of the seller-financing period becomes complicated.”
“That was our first consideration but then the balloon payment at the end of the seller-financing period becomes complicated.”
“I don’t want to hijack this thread, so I plan on making a post about the deal as soon as I have enough karma to post in this sub Reddit. I really want to get some opinions..”
“Fair point. I’m looking at a seller-financed deal myself where the eventual refinance/balloon risk is one of the things I’m trying to think through, so that’s probably why my brain went there.”
“Why not just lower the purchase price so that the amount paid with interest will be 1 mil? Seems like the most straight forward solution”
“I think you're overcomplicating the calculation. Just adjust the final purchase price to account for interest rate, then adjust it again to account for the seller's contribution toward the tax burden. Taxes on the interest will account for about 1% of the purchase price.”