Seller Financing: The Seller's Hub
Seller financing (owner financing) means you lend the buyer part of the price and are paid over time with interest, secured by the property. For taxes it is usually an installment sale under IRC Section 453: gain is taxed as principal arrives and interest is ordinary income. This hub organizes every guide and calculator on the site by the decision you are making.
By Hans Goldstein · Last updated · Questions: hans@goldsteinco.net, 213-340-2018
How does seller financing work, step by step?
- Agree on terms: price, down payment (often 10% to 30%), interest rate, amortization and any balloon. See how to structure seller financing.
- Document it: a promissory note and a deed of trust or mortgage recorded against the property, or a land contract where you keep title until payoff.
- Close: the buyer takes title (or possession, under a land contract) and pays the down payment. Your existing mortgage usually has to be paid off first because of its due-on-sale clause.
- Collect: monthly principal and interest, yourself or through a loan servicer. Many notes balloon after 5 to 10 years, when the buyer refinances.
- Report: Form 6252 every year for the gain, Schedule B for the interest, and a Form 1098 from you if the buyer is an individual paying mortgage interest in your trade or business.
How is seller financing taxed?
As an installment sale under IRC 453, unless you elect out and report the whole gain in the year of sale (IRC 453(d)). Every principal payment is split by the gross profit percentage; interest is separate.
| Part of what you receive | How it is taxed | Authority |
|---|---|---|
| Principal x gross profit percentage | Capital gain (Section 1231 gain for a rental), in the year received | IRC 453(c); Form 6252 |
| Principal x (1 - gross profit percentage) | Tax-free return of basis | IRC 453(c) |
| Interest | Ordinary income each year; 3.8% NIIT at high income | IRC 61, 1411 |
| Section 1245 recapture | Ordinary income, all in the year of sale | IRC 453(i) |
| Unrecaptured Section 1250 gain | Up to 25%, out of each payment's gain first | IRC 1(h)(6); Treas. Reg. 1.453-12 |
| Assumed debt over your basis | A payment in the year of sale | Treas. Reg. 15a.453-1(b)(3) |
| Interest below the AFR | Part of principal recharacterized as interest | IRC 483, 1274 |
| Notes over $5 million at year-end | Interest charge on the deferred tax; a pledge is a payment | IRC 453A |
| Selling or pledging the note | Remaining deferred gain taxed now | IRC 453B, 453A(d) |
Worked example: $800,000 of land, 20% down, 7% note, 7-year balloon
- Basis $300,000, selling costs $48,000. Gross profit: $800,000 - $300,000 - $48,000 = $452,000. Contract price $800,000. Gross profit percentage 56.5%.
- Note: $640,000 at 7%, amortized over 30 years, so the payment is about $4,258 a month.
- Year one: $160,000 down + $6,501 of amortized principal = $166,501 of principal, of which $94,073 is taxable gain. The $44,594 of interest is ordinary income.
- Years two to six: $6,971 to $9,216 of principal a year, so only $3,900 to $5,200 of gain a year.
- Year seven: the balloon. $593,226 of principal arrives at once, and $335,173 of gain lands in one tax year.
That last line is the part most sellers miss: a balloon, a refinance or an early payoff puts most of the deferred gain back into a single year. Model your own terms with the seller financing calculator or the owner financing calculator.
What are the risks, and how do sellers manage them?
- Default. Get a real down payment, check credit, record the deed of trust, and require insurance and tax escrow. Repossessing real property has its own tax rules (IRC 1038). See what happens if the buyer defaults.
- Early payoff. You cannot stop a buyer from refinancing unless the note has a prepayment restriction, and the remaining gain is taxed that year.
- Rate. Charge at least the AFR (seller financing interest rate).
- Your own mortgage. A due-on-sale clause usually rules out leaving your loan in place; a wrap carries real lender risk.
- Lending rules. Financing an owner-occupied home can trigger Dodd-Frank ability-to-repay and loan originator rules and the SAFE Act (seller financing rules).
What if you want the tax deferral without carrying the note?
A structured installment sale uses the same IRC 453 installment method. The buyer pays the full price at closing, usually with a bank loan. Before closing, you agree to take part of the price as payments from an assignment company, funded by an annuity from an A-rated insurer; the payments are contractually guaranteed by the insurer's claims-paying ability. No buyer default and no early payoff. The trade-offs: the rate is usually lower than a seller-financed note, the schedule is locked (no speeding it up, borrowing against it or cashing it out, which is what protects the deferral), it has to be set up before closing, there is no published IRS ruling on this specific structure so your CPA should review it, and a commission is built into the pricing (disclosures). Compare both on the calculator or read seller financing vs a structured sale.
Which calculator should I use?
- Installment sale calculator
Cash vs seller financing vs structured sale, after tax.
- Seller financing calculator
Your note's payments and the seller's tax each year.
- Owner financing calculator
Amortization schedule and balloon.
- Note value calculator
What a note buyer would pay you today.
- Real estate capital gains calculator
Tax in one year vs spread out.
- Gross profit percentage calculator
The taxable part of each payment.
- Form 6252 calculator
Every line, year of sale and later.
- 1031 boot calculator
Take a note for the boot in a partial exchange.
Every seller financing guide on this site
Start here
- Seller Financing (Owner Financing): A Complete Guide for Sellers
- Seller Financing Example: Payments, Interest and the Seller's Tax
- Is Seller Financing a Good Idea? Pros, Cons and Risks for Sellers
- Seller Financing vs Bank Financing: What Changes for the Seller
- Seller Carry Back: How It Works, the Risks, and the Taxes
Setting the terms
- How to Structure Seller Financing: Terms, Down Payment, Balloon
- Seller Financing Contract Terms: What to Put in the Note
- Real Estate Promissory Note: What Sellers Need in the Note
- Seller Financing Addendum: What It Covers and What to Add
- Seller Financing Balloon Payment: How It Works and How It's Taxed
- Seller Financing Interest Rate: AFR Minimum and Imputed Interest
- Applicable Federal Rate (AFR): Rates, Tables and How to Use Them
- Due on Sale Clause: What It Means for Seller Financing
- Seller Financing With an Existing Mortgage: Payoff, Assume, Wrap
- Wraparound Mortgage: How a Wrap Works, Risks and Seller Taxes
Taxes
- Seller Financing Taxes: How an Owner-Financed Sale Is Taxed
- Seller Financing Interest Income: How to Report It
- Imputed Interest: Sections 483 and 1274 Explained for Sellers
- Gross Profit Percentage on an Installment Sale (Worked Examples)
- Form 6252 Instructions: How to Report an Installment Sale
- Installment Sale Depreciation Recapture: Why Year One Gets Taxed
- Section 453A: Interest Charge and Pledge Rule on Large Notes
By property type
- Seller Financing a Home: Selling Your House With Owner Financing
- Seller Financing Rental Property: Tax Rules and a Worked Example
- Seller Financing Commercial Real Estate: Terms, Taxes and Risks
- Seller Financing for Land: How Owner-Financed Land Is Taxed
- Seller Financing a Business Sale: Taxes, Allocation and the Note
- SBA Seller Note Rules: Standby, Equity Injection and Taxes
- Selling a House to a Family Member: Gift of Equity, Taxes, Notes
Contracts and alternatives to a note
- Land Contract: How It Works for Sellers, Risks and Taxes
- Contract for Deed: How It Works, Who Pays Taxes, Seller Risks
- Land Contract vs Seller Financing: Title, Default and Taxes
- Rent to Own vs Owner Financing: Which Is Better for the Seller?
Rules, risks and after closing
- Seller Financing Rules: Dodd-Frank, the SAFE Act and State Law
- Seller Financing Loan Servicing: What a Servicer Does and Costs
- What Happens If the Buyer Defaults on Seller Financing?
- Buyer Defaulted or Paid Early? Your Installment Sale Tax
- Selling a Promissory Note: Discounts, Note Buyers and Taxes
- What Happens to an Installment Note When the Seller Dies
Getting the deferral without the note
- Seller Financing vs Structured Sale vs Cash: Side by Side
- Structured Installment Sale: How It Works, Costs and Trade-offs
Selling land specifically? See how the seller is taxed on owner-financed land.
Seller financing FAQ
How does seller financing work for the seller?
You accept a down payment and a promissory note for the rest of the price, secured by a deed of trust or mortgage on the property. The buyer pays you principal and interest, often with a balloon after 5 to 10 years. If the buyer stops paying, your remedy is foreclosure or, under a land contract, forfeiture.
How is seller financing taxed?
Usually as an installment sale under IRC 453: each principal payment is part taxable gain (at the gross profit percentage) and part tax-free basis, reported on Form 6252. Interest is ordinary income each year. Section 1245 depreciation recapture is taxed in full in the year of sale.
What interest rate do I have to charge?
At least the applicable federal rate for the note's term. For a sale you can use the lowest AFR of the three months ending with the month of the binding contract (IRC 1274(d)(2)). Below it, part of the principal is recharacterized as interest under IRC 483 or 1274.
What are the biggest risks of seller financing?
Buyer default (foreclosure time and cost, and a property that may come back in worse shape), early payoff or refinance that pulls the remaining gain into one year, a due-on-sale clause on your own mortgage, and lending rules on owner-occupied homes. You also service the note or pay someone to.
Is there a way to spread the tax without carrying a note?
Yes. In a structured installment sale the buyer pays the full price at closing and an assignment company pays you on a schedule you set before closing, funded by an annuity from an A-rated insurer. The payments are contractually guaranteed by the insurer's claims-paying ability. The trade-offs are a lower rate than most notes, payments that cannot be sped up or cashed out, and a commission built into the pricing.