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Seller Financing a Home: Selling Your House With Owner Financing

By Hans Goldstein · Updated 2026-09-27

Seller financing a home means you act as the bank. The buyer pays you a down payment, signs a promissory note for the rest, and gives you a deed of trust or mortgage on the house as security; the buyer takes title at closing and pays you monthly. For taxes, the gain above any home sale exclusion is spread over the years you collect principal under IRC §453, and the interest is ordinary income every year.

This guide is written for the seller. It covers how the deal is built, the federal lending rules that apply to homes, how the §121 exclusion and the installment method work together, and a worked example you can adapt.

How seller financing a home works, step by step

1. Agree on price and terms. Price, down payment, interest rate, amortization, any balloon date, late fees and who pays taxes and insurance. Put them in the purchase contract or a seller financing addendum.
2. Check the buyer's credit. You carry the risk, so ask for what a lender would: credit report, income, bank statements.
3. Draft the note and security instrument. The promissory note is the buyer's promise to pay. The deed of trust (or mortgage, depending on the state) lets you foreclose if the buyer defaults. Both are separate from the purchase contract.
4. Close through escrow or a closing attorney. The deed transfers to the buyer, the deed of trust is recorded in your favor, and title insurance should name you as the lender.
5. Service the loan. Collect payments, track principal and interest, confirm property taxes and insurance stay current, and send year-end statements. Many sellers hire a loan servicing company for this.

The paperwork details are in seller financing contract and note terms. The payment math is in how seller financing works.

Free and clear vs a house with a mortgage

Seller financing is simplest when you own the house outright. If you still have a mortgage, three problems show up:

• Due-on-sale clause. Most mortgages let the lender call the loan when you transfer the property. Selling without the lender's consent puts you in breach of your own loan.
• Payoff at closing is a payment. If the buyer's down payment pays off your loan at closing, that cash counts as a payment to you in the year of sale (Temp. Reg. §15a.453-1(b)(3)(i)). Only debt the buyer actually assumes or takes subject to is left out, and only up to your basis.
• Wraparound risk. In a wrap, the buyer pays you and you keep paying your lender. If you stop, the buyer's house is exposed. If the buyer stops, you still owe your lender.

The full rules are in seller financing with an existing mortgage.

Federal lending rules when the property is a home

Homes bring consumer lending rules that land and commercial property do not. Here is what we confirmed in the Truth in Lending rules (Regulation Z). This is a summary, not legal advice.

Loan originator exemptions. Under 12 CFR §1026.36(a)(4) and (a)(5), a seller who finances the sale of its own property is not treated as a "loan originator" if it meets one of two sets of conditions:

Two things stand out. The one-property exemption does not require full amortization, so a balloon can fit. The three-property exemption does not allow a balloon and requires an ability-to-repay review.

Who is a "creditor." Regulation Z treats a person as regularly extending consumer credit if it extended credit secured by a dwelling more than 5 times in the preceding calendar year, or more than once in 12 months for high-cost mortgages (§1026.2(a)(17)(v)). Most one-time home sellers stay below that line.

State rules. States add their own licensing, disclosure and foreclosure rules. California, for example, requires a written seller financing disclosure on sales of 1 to 4 unit dwellings when an "arranger of credit" such as a real estate agent is involved (Cal. Civ. Code §2956). Have a real estate attorney in your state review the documents.

Taxes: the home sale exclusion comes first

If the house was your main home and you owned and lived in it at least 2 of the last 5 years, §121 lets you exclude up to $250,000 of gain, or up to $500,000 for most married couples filing jointly (IRS Publication 523).

Seller financing does not cost you the exclusion. The two rules stack:

• The excluded gain is simply removed from gross profit. Publication 537 says "any gain you exclude isn't included in gross profit when figuring your gross profit percentage."
• Only the remaining gain is spread over the payments under the installment method.

So if your whole gain fits inside the exclusion, the installment method changes nothing for you on the gain. Seller financing then is purely a lending decision: can you earn a good rate on a well-secured loan? The installment method matters only when the gain is larger than the exclusion, or when the house was a rental or second home that gets no exclusion.

Rental or second home. No exclusion (or a reduced one), and gain equal to depreciation taken after May 6, 1997 is never covered by §121. On an installment sale, that unrecaptured §1250 gain comes out of the earliest payments (Reg. §1.453-12), taxed at up to 25%. See installment sales of real estate and the recapture rules at depreciation recapture.

Worked example: selling a home with owner financing

Simple example, all numbers illustrative. A married couple sells the house they have lived in for 20 years.

• Sale price $1,200,000. Adjusted basis $300,000. Selling costs $60,000. No mortgage.
• Total gain: $1,200,000 minus $360,000 = $840,000.
• §121 exclusion: $500,000. Gross profit on the installment method: $340,000.
• Contract price: $1,200,000 (no debt assumed).
• Gross profit percentage: $340,000 / $1,200,000 = 28.33%.

Terms: 20% down ($240,000). Note $960,000 at 6.5%, 30-year amortization, due in full at the end of year 7. Monthly payment: $6,067.85.

What the table shows:

• The exclusion does the heavy lifting. $500,000 of the $840,000 gain is never taxed.
• The balloon brings most of the remaining gain back into one year. About $250,000 of the $340,000 lands in year 7. If spreading the gain is the goal, a longer note or a smaller balloon does more. See seller financing balloon payments.
• Interest is the bigger number. $417,696 of interest over seven years is ordinary income, reported every year.

Check your own numbers in the free calculator.

Reporting the interest on a home sale

When the buyer uses the house as a personal residence, the IRS has a special rule (Publication 537):

• You report the interest on Schedule B and enter the buyer's name, address and Social Security number.
• The buyer deducting the interest enters your name, address and SSN on Schedule A.
• You must give the buyer your SSN. A penalty applies if either side leaves the other's number off.

The interest rate also has a floor. If the note's rate is below the applicable federal rate for its term, part of your principal is recharacterized as interest (§§483, 1274). See seller financing interest rates and the AFR.

Risks specific to houses

• Default and foreclosure. Foreclosing on an owner-occupied home takes time and legal fees, and some states limit deficiency judgments on purchase-money loans. Your tax on a repossession is governed by §1038; see what happens if the buyer defaults.
• Insurance and property tax lapses. Require proof of both, or collect an escrow with each payment.
• Refinance risk at the balloon. If rates are high or the buyer's credit has not improved, the buyer may not be able to refinance, and you face an extension or a default.
• Your cash is tied up. Most of the price arrives over years, not at closing.

The note the buyer signs is a real estate promissory note, secured by a deed of trust or mortgage.

If you are weighing a lease instead of a sale, compare rent to own vs owner financing.

Bottom line

Seller financing a home is a loan secured by the house you used to live in. For most primary residences the §121 exclusion already removes most or all of the gain, so the case for owner financing rests on the buyer's strength and the rate you earn, not on tax deferral. When the gain exceeds the exclusion, or the house was a rental, the installment method can spread what is left, as long as a balloon does not pull it back into one year. Get the documents reviewed by a real estate attorney, and read the seller financing tax guide before you sign.

Questions to ask your CPA

• Do I meet the 2-of-5 year ownership and use tests, and how much of my gain does §121 exclude?
• After the exclusion, is enough gain left for the installment method to matter?
• If I rented the house at any point, how much depreciation comes back, and is any of the exclusion reduced?
• What AFR applies to this note in the month we sign?
• How should I report the buyer's interest on Schedule B, and what records do you need each year?
• If the buyer pays off the note early or I take the house back, what is my tax that year?

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.