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Wraparound Mortgage: How a Wrap Works, Risks and Seller Taxes

By Hans Goldstein · Updated 2026-09-27

A wrap around mortgage is seller financing that "wraps" your existing loan: the buyer signs a note to you for most of the price, including the balance you still owe your lender, and you keep paying that lender out of the buyer's bigger payment. You pocket the difference. Your old loan stays in place and in your name, which is both the attraction (a low old rate) and the danger (you remain liable, and the lender can usually call the loan).

This article explains how the money flows, what an AITD is, a full example with the interest spread, the risks, and a short summary of the tax treatment. The detailed tax mechanics of existing mortgages are in our guide to seller financing with an existing mortgage.

What is a wrap around mortgage (or wrap around loan)?

Three parties, two loans:

The wrap note's balance is larger than the underlying loan, and its rate is usually higher. Each month the buyer pays you; you pay the bank; you keep the spread.

AITD: all-inclusive trust deed

In deed-of-trust states such as California, a wrap is usually documented as an all-inclusive trust deed (AITD) with an all-inclusive promissory note. "All-inclusive" means the note's face amount includes the senior loan. Legally the AITD is a junior deed of trust; the buyer gets the deed at closing and you hold a lien behind your bank. In other states the same economics are done with a wraparound mortgage or with a land contract where you keep title.

How does a wrap around mortgage work? Step by step

1. Price and down payment. Buyer pays cash down.
2. Wrap note. Buyer signs a note to you for the rest of the price, including the underlying loan balance, at a rate and term you negotiate. See seller financing note terms.
3. Deed and security. Buyer usually gets the deed; you record a junior lien (or keep title under a land contract).
4. Servicing. Buyer pays you or, better, a neutral servicer. The servicer pays the underlying lender first, then remits the rest to you. This protects the buyer (the bank gets paid) and you (a clean payment record).
5. Taxes and insurance. Escrowed, so neither lien is put at risk by a tax sale or an uninsured loss.
6. Payoff. When the buyer refinances or sells, the payoff first retires your underlying loan, and you keep the rest of the wrap balance.

Wrap around mortgage example

Simple example. Assumptions: sale price $400,000; seller's adjusted basis $200,000; seller's existing loan $150,000 at 3.5% with 20 years left; buyer pays $40,000 down; wrap note $360,000 at 7% over 30 years. The property is held as an investment with no depreciation; federal tax only, 2026 joint brackets.

Why sellers like it: you earn 7% on $360,000 while paying 3.5% on $150,000 of it. That is roughly $18,300 a year of net cash flow in this example, plus the down payment, and the spread comes almost entirely from the old low-rate loan.

Why buyers accept it: no bank qualification, a lower down payment, and a rate below what they could get on their own.

The risks, in order of size

1. The due-on-sale clause. Most mortgages let the lender demand full payment if the property is sold or transferred without consent. Federal law (the Garn-St Germain Act, 12 U.S.C. §1701j-3) expressly lets lenders enforce these clauses, with a short list of exceptions that do not cover a sale to an unrelated buyer. A wrap does not remove the clause; it only means the lender has not acted yet. If the lender calls the loan, the buyer must refinance or you must pay off the loan. Read due-on-sale clause before you wrap anything.

2. You stay liable. The underlying loan remains yours. If the buyer stops paying, you must keep paying the bank while you foreclose or cancel, or your credit and the property are at risk.

3. Buyer default and property condition. You may take back a property that has been neglected, with your old loan still on it.

4. Payment timing and servicing errors. If you collect from the buyer and forget to pay the bank, the buyer can be foreclosed through no fault of their own. Use a licensed servicer.

5. Insurance and taxes. Both lenders need to be named on the insurance, and taxes must be escrowed.

6. Consumer lending rules on homes. If the buyer will live in the home, federal rules on seller financing and loan originators can apply to how you set the rate and terms. See seller financing a home.

How a wraparound changes the seller's taxes (summary)

You report the sale on the installment method (§453) and report all the interest the buyer pays you as ordinary income. The interest you pay on the underlying loan is a separate question; ask your CPA how and whether it is deductible after the sale.

The open question is whether the wrapped loan counts as debt the buyer "took subject to." It matters because debt taken subject to reduces your contract price, which raises your gross profit percentage and can push gain into year one.

• The regulation. Temp. Reg. §15a.453-1(b)(3)(ii) says the wrapped debt "shall be deemed to have been taken subject to even though title to the property has not passed in the year of sale and even though the seller remains liable for payments on the wrapped indebtedness."
• The Tax Court. In Professional Equities, Inc. v. Commissioner, 89 T.C. 165 (1987), the court decided a wraparound case for the taxpayer, rejecting the regulation's approach.

Using the example above (no debt in excess of basis, so no extra year-one payment under either view):

Total gain over the life of the deal is the same $200,000 either way; the approach changes timing. If the underlying loan were larger than your basis, the regulation would also treat the excess as a year-one payment. The full worked comparison, including the assumed-loan and payoff-at-closing cases, is in seller financing with an existing mortgage. Pick an approach with your CPA and document it.

Model the down payment and note terms with the calculator.

If the loan gets called, gain speeds up

If the lender enforces the due-on-sale clause in year 3 and the buyer refinances, the whole wrap balance (about $348,000 in the example) is paid to you at once. Under the court approach that pulls about $174,000 of gain into year 3. Assuming $80,000 of other taxable income plus that year's interest, federal tax on that year's gain jumps from a few hundred dollars to about $27,600 including net investment income tax (2026 joint brackets, statute-ordered calculation, federal only). The installment benefit you planned on ends early.

Wrap vs seller carry back vs assumption

A seller carry back is the cleaner option when the buyer can get a bank first loan for most of the price.

Bottom line

A wrap around mortgage lets you sell with financing while keeping a cheap old loan in place and earning the interest spread. The price of that spread is risk you keep: the lender can usually call the loan, you stay liable if the buyer stops paying, and the tax treatment of the wrapped debt is unsettled. Use a neutral servicer, escrow taxes and insurance, get attorney-drafted documents, and agree with your CPA on the tax approach before closing.

Questions to ask your CPA

• Will you treat the wrapped loan as taken subject to (the regulation) or not (Professional Equities), and why?
• Is any of my underlying debt above my basis, creating a year-one payment?
• How do I report the wrap interest I receive and the underlying interest I pay?
• If the lender calls the loan and the buyer refinances, how much gain accelerates into that year?
• Does my note rate meet the applicable federal rate test?
• Should I set aside cash from the down payment for the year-one tax?

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.