Land Contract: How It Works for Sellers, Risks and Taxes
A land contract is a way to sell real estate where you, the seller, act as the lender and keep legal title until the buyer pays you in full. The buyer moves in (or takes over the land) at signing, pays you in installments, and gets the deed with the final payment. For federal taxes a land contract is usually an installment sale: you report gain as you collect principal, not all in the year you sign.
This guide covers what a land contract is, how one works from signing to deed, the pros and cons from the seller's side, and the tax math with a worked example. If you are deciding between a land contract and a note secured by a deed of trust, start with our side-by-side on land contract vs seller financing.
What is a land contract?
A land contract (also called an installment land contract, land sale contract, or in many states a contract for deed) is a single agreement in which:
- The seller agrees to sell and to deliver the deed once the buyer finishes paying.
- The buyer agrees to pay a down payment and then installments of principal and interest.
- The buyer receives possession and equitable title now; the seller keeps legal title as security.
That last point is the whole difference from ordinary seller financing. In a standard seller-financed sale the buyer gets the deed at closing and signs a promissory note secured by a mortgage or deed of trust. In a land contract, the deed stays with you.
The name "land contract" does not mean it is only for vacant land. Houses, farms, small commercial buildings and lots are all sold this way.
How does a land contract work? Step by step
- Agree on terms. Price, down payment, interest rate, amortization, any balloon date, late fees, and who pays taxes, insurance and repairs. Our guide to seller financing note terms covers each item.
- Check your own mortgage. If you still owe a lender, a land contract can trigger the loan's due-on-sale clause. Federal rules specifically allow lenders to call a loan when a subordinate lien is created under a contract for deed.
- Sign the contract and record it (or a memorandum of it) where your state requires or allows. Some states put a recording deadline on one party or the other.
- Buyer takes possession. From this day the buyer usually pays the property taxes, carries insurance and handles maintenance.
- Buyer pays you monthly. Keep an amortization schedule and an annual statement of interest and principal. Many sellers use a third-party servicer.
- Final payment and deed. When the buyer pays off the balance (often by refinancing with a bank at a balloon date), you sign and deliver the deed.
- If the buyer defaults, your remedy depends on state law: forfeiture (cancel the contract and retake the property) in some states and situations, foreclosure in others.
Land contract pros and cons for the seller
| Pros | Cons |
|---|---|
| Larger pool of buyers, including those a bank will not finance | Buyer may have little cash at stake |
| Often a higher price or faster sale | Default risk sits with you, not a bank |
| Interest income, usually above bank CD or Treasury yields | State laws can require foreclosure after a threshold of payments |
| Gain spread over the years you collect principal | Your money is tied up until payoff or refinance |
| You keep legal title until paid in full | Title held by you can still be clouded by liens against the buyer's interest, judgments or bankruptcy |
| Can sell land or unusual property banks dislike | Existing mortgage on the property creates due-on-sale risk |
The biggest misconception is that keeping title makes you safe. In many states courts and statutes treat a land contract buyer who has built real equity much like a mortgage borrower. See the state examples in our contract for deed article.
Land contract taxes for the seller
When is the sale for tax purposes?
For federal income tax, a sale generally happens when the benefits and burdens of ownership pass to the buyer, not when the deed is delivered. Under a typical land contract the buyer gets possession, pays the taxes and insurance, keeps any income and bears the risk of loss from day one. That is a sale in the year you sign, even though you hold title for years.
This matters in both directions. You stop depreciating a rental on the sale date, and the installment clock starts that year.
The installment method applies
IRS Publication 537 says the buyer's obligation to make future payments "can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you." So a land contract qualifies for the installment method under §453 unless you elect out.
The mechanics:
- Gross profit percentage = gross profit (price minus adjusted basis and selling costs) divided by contract price. See gross profit percentage.
- Each year's taxable gain = principal you collect that year (including the down payment in year one) times that percentage.
- Interest is ordinary income in the year received. The contract must carry at least the applicable federal rate or part of the principal is recharacterized as interest (§§483, 1274). See applicable federal rate (AFR).
- Depreciation recapture on business or rental property (§1245 ordinary recapture) is taxed in the year of sale regardless of payments (§453(i)). Real estate held for rent usually has little §1245 recapture, but any unrecaptured §1250 gain is recognized first as payments come in (Reg. §1.453-12).
- You report on Form 6252 in the year of sale and every year you receive a payment. See Form 6252 instructions.
Reporting the interest
If the buyer uses the property as a personal residence, the Schedule B instructions tell you to list the interest the buyer paid you first, with "the buyer's name, address, and SSN," and to let the buyer know your SSN; failing to do so can cost a $50 penalty. The buyer needs your information to deduct mortgage interest.
Worked example: land contract on a $300,000 property
Simple example. Assumptions: married couple filing jointly, 2026 federal brackets, $80,000 of other taxable income each year, property held long term, no depreciation, no state tax, no selling costs.
- Price $300,000, adjusted basis $120,000, gain $180,000
- Down payment $30,000; contract balance $270,000 at 7% over 15 years
- Monthly payment: $2,426.84
- Gross profit percentage: $180,000 / $300,000 = 60%
| Year | Principal received | Taxable gain (60%) | Interest (ordinary) | Federal tax on the gain |
|---|---|---|---|---|
| 1 | $40,556 (incl. $30,000 down) | $24,334 | $18,566 | $3,600 |
| 2 | $11,320 | $6,792 | $17,802 | $854 |
| 3 | $12,138 | $7,283 | $16,984 | $805 |
| 15 | $28,047 | $16,828 | $1,075 | $0 |
Over all 15 years, federal tax on the $180,000 gain (including the 3.8% net investment income tax where it applies) totals about $9,685. Selling for $300,000 cash in one year with the same other income produces about $24,545 of federal tax on the same gain ($24,165 income tax plus $380 NIIT), because most of it lands in the 15% bracket at once instead of spreading some of it through the 0% bracket each year.
Two cautions. The interest is taxed separately at ordinary rates every year. And the comparison assumes the buyer pays as agreed; a default changes everything. Figures computed with a statute-ordered §1(h)(1) model; run your own with the calculator.
If the buyer defaults
Your remedy is set by state law and your contract. In some states, and for buyers who have paid little, the seller can declare a forfeiture, cancel the contract and keep payments already made. In other states, or once a buyer has paid past a set threshold, the seller must foreclose like a mortgage lender. See contract for deed for Texas, Minnesota and Ohio examples.
For taxes, taking back real property sold on a secured installment obligation is generally governed by §1038, which limits the gain you recognize on the repossession. The details, including basis in the repossessed property, are in our guide to installment note default and repossession.
Land contract vs other ways to sell with financing
| Land contract | Note and deed of trust | Lease with option to buy | |
|---|---|---|---|
| Who holds legal title | Seller until paid | Buyer at closing | Seller until option exercised |
| Tax treatment | Installment sale from signing (usually) | Installment sale from closing | Rental income until exercised |
| Seller's remedy | Forfeiture or foreclosure, by state | Foreclosure | Eviction, option ends |
| Typical buyer | Buyer who cannot get a bank loan | Same | Tenant building credit |
If you are weighing a lease option instead, see rent to own vs owner financing.
Bottom line
A land contract is seller financing where you keep the deed until you are paid. It widens your buyer pool and, for federal tax, usually lets you report gain as you collect principal under §453, which can keep more of the gain in lower brackets. Keeping title does not remove default risk; your state's law decides whether you can simply cancel the contract or must foreclose. Price the deal, set a real down payment and interest rate at or above the AFR, and have a local real estate attorney draft the contract.
Questions to ask your CPA
- Do the benefits and burdens of ownership pass at signing, so the sale is reported this year?
- What is my gross profit percentage after selling costs, and how much gain is in year one?
- Is my interest rate at or above the applicable federal rate for this term?
- Is there any depreciation recapture that must be reported in the year of sale?
- How should I report the buyer's interest (Schedule B) and what do I send the buyer each January?
- If the buyer defaults, how does §1038 apply and what will my basis be in the property I take back?
Run your own numbers. Compare a cash sale, seller financing and a structured installment sale side by side, free.
Educational only, not tax, legal or investment advice. Examples are illustrative. Have your CPA or tax attorney review your facts before you act. Hans Goldstein is a licensed insurance agent (CA Insurance License #4273294) and is not a CPA or attorney. He is paid a commission only if a structured installment sale is funded; seller financing pays him nothing. Disclosures.