understanding the tax implications and
convincing a seller why they should sell
it to you using seller financing super
important the one con to this I want to
say this and be very clear about this is
when you take depreciation on a property
the depreciation is recaptured when you
sell the property you do not get the
delay you do not get to defer the
depreciation recapture over that period
of those 10 years the depreciation is
recaptured in the year that you sell the
property when you sell a finance there's
going to be a couple elements of taxes
that you pay you're going to be paying
the capital gains tax every single year
and you're going to be paying interest
income on that however long the seller
finance period is but the key is that
you are delaying the payment of tax
which gives you a bunch of years and a
bunch of time to strategize on how you
can offset that
[Music]
tax welcome back everyone to the learn
like a CPA show I'm your host Ryan bakey
and today we are going to talk about the
tax implications of seller financing
this is going to be typically from a
sell perspective now if you checked out
my recent episode about introduction to
seller financing if you want to buy a
property using seller financing like
let's say I'm the buyer you really have
to talk to the seller and convince the
seller why seller financing is actually
their best option and remember the way
that you do this is three different I I
use it three three different pillars the
first pillar is taxes if a person has
owned a property for a while number one
it's probably appreciated in value so
which means they're going to pay capital
gains tax if they sell the property
right normally and but it's also
depreciated in value they've been taking
depreciation or at least they should
have been taking depreciation against
that property the entire time so if they
just sell it out if they sell it in a
normal sale they have to pay capital
gains tax they have to pay depreciation
recapture tax and they have to pay a lot
of taxes in the year that they sell the
property so that's that's wealth pillar
Destroyer number one taxes wealth pillar
Destroyer number two is inflation they
don't want to sell that what if if they
get a big old check it's going to lose
value to inflation so not only are they
going to lose money to Uncle Sam because
they're going to over overpaying taxes
but they're also now that that money is
in that bank account they're losing
value because of inflation so you have
to tell them hey you're going to you
don't even really want to sell this
property normally you should you should
really consider sell seller financing it
to me because of taxes inflation but
also right in current market times it
could be that investor it could be that
seller's best alternative with what they
have to do with the money you know right
now a five or 6% Noe guaranteed income
could be a lot better for somebody
that's trying to go out there and hustle
and try to find a deal that can cash
flow 12 133% you know maybe the person
is better off taking the five or 6%
interest only note on a seller finance
deal because also remember too in seller
financing if the if the buyer defaults
or stops paying you know the seller can
come and take back the property
typically
so understand the tax
implications and real quick guys if you
could think about how you find this
podcast maybe it was on Facebook
Instagram maybe somebody shared it with
you I don't run ads for the show or have
sponsorships so the only way this grows
is through a word of mouth if this was
valuable for you in any way the only ask
that I can make is that you share it
with somebody else pass it on to the
next person whose investing Journey or
business can be changed by listening to
the show much love guys and let's get
into the episode understanding the tax
implications and convincing a seller why
they should sell it to you using seller
financing super important we're going to
kind of break down the little details
here as as far as the calculations go so
I'm going to set some uh parameters up
so let's say let's say I'm going to buy
a house and I think it's I think it's
worth about 500k I'm going to buy this
house from Nancy okay now Nancy back in
2000 Nancy Nancy bought the house
for
$250,000 that's what she paid for it now
the house today in
2023 is worth 500K
okay now so if Nancy Wass to sell a
house or a rental property she's going
to pay capital gains tax on the
difference between
250,000 and 500,000 so she's going to
pay Capital
Gains uh let's just assume
20% on
$250,000 so she's going to pay 50,000
bucks in capital gains tax if she was to
sell that property in the first year
now what she also has is because she's
pretty much fully depreciated the
property by now for over for 23 years
let's say her cost basis in the property
her her depreciable basis is probably
close to zero I mean not completely zero
but let's just assume zero for our
numbers so not only does she owe $50,000
in capital gains tax but she probably
also owes close to
250,000 in recapture tax
that's at her that's at a 25 that's up
to a 25%
bracket so she could be paying that
alone's going to be um you know 55,000
plus so she could be getting paid 500k
for the property and after closing costs
Etc like that but she's got a $100,000
tax bill right between the depreciation
recapture and the capital gain and
remember she gets the cash she it gets
tax she she loses value to inflation
okay but what they can do instead is
they seller finance it to you so the way
that seller financing works is let's say
somebody has a $250,000 capital gain and
they're going to sell or Finance it over
over a 10-year note well now that
capital gain gets deferred over the 10
years uh typically in the first year of
a seller finance deal there's going to
be more capital gain tax than the rest
of the years because when you do get
that 20 or 30% down you're going to pay
more taxes in the first year when you do
seller financing then years 2 through 10
let's say but let's just keep the math
simple let's say now instead of this
$250,000 gain in having to pay taxes on
$250,000 capital gain you're able to
stretch that out over 10 years so now if
I'm looking at year one to year
10 you only have to pay capital gains
tax on 25k every single year
for 10
years right and so again let's assume
that the capital gain rate is
20% the same amount of taxes are still
being paid arguably because it would
have been a $250,000 gain at 20% but now
it's a $250,000 gain at 20% but it's
spread out over 10
years guess what happens inflation eats
away at that dollar so that person is
much better off instead of instead of
collecting $250,000 gain and paying 20%
tax on an year one they're better off
recognizing $25,000 of gain over a
10-year period because now as they're
paying this tax back that money is
losing value because of inflation so
they're in a better position if I owe
you $250,000 you want it right away you
don't want me to pay it back over 10
years right like why who would who would
do that uh people would do that if they
get paid interest so
when you do seller financing there's
typically going to be an interest rate
there so let's just for for example sake
let's say the person seller finance is
it 500k at uh or let's say they seller
finance um $400,000 at a $400,000 at a
5% note
now times five now interest income in
seller finance deal is taxable too so if
I seller finance $400,000 at a 5% note
I'm collecting $20,000 a year in
interest that's going to be taxable at
whatever my tax bracket is so when you
sell our finance there's going to be a
couple elements of taxes that you pay
you're going to be paying the capital
gains tax every single year for however
long the seller finance term is five
seven 10 years and you're going to be
paying interest income on that however
long the seller finance period is but
the key is that hey guys just wanted to
interrupt the podcast today let you know
about my Facebook group Tax Strategies
for Real Estate Investors we have over
6,300 Real Estate Investors in the
community actively engaging every single
day you're going to learn all my top
tips you're going to get to network with
other professionals and you're going to
get to see all the past recordings and
all the past posts in that Facebook
group so make sure you join today it's
going to be linked in the podcast below
and now back to the show the key is that
you are delaying the payment of tax
which gives you a bunch of years and a
bunch of time toize on how you can
offset that tax and then odds are when
we see seller financing the most kind of
kind of take play is you have a mom and
pop that have started a business they're
business owners they have high business
income and instead of selling the
property or their business and paying
all those taxes in the first year if
they sell or Finance it they're able to
stretch out that gain over a period of
time and so instead of paying a bunch of
taxes in year one they're spreading out
the amount of taxes they pay over 10
years and ultimately not number one
they're paying less in taxes overall but
number two they're delaying the tax
payment which is the most important part
because again inflation is going to eat
away at that money so if I owe you
$250,000 it's better that I pay I want
to pay that I want to pay that off over
as many years as possible and and let
inflation eat away at that dollar but if
you're the person that is being owed
$250,000 you obviously want to get that
money sooner so that's how kind of
running through these numbers is going
to be able to convince a seller uh to
seller finance it to you when you could
explain to them that like hey you really
don't want to sell this property in the
first year uh and collect all the cash
because you're going to be hit with a
huge tax bill your best bet is to sell
or Finance it to me uh and I will pay
you interest in an exchange for the
property and remember the seller can
always come and take the property if the
buyer does not make the
payments the one con to this I want to
say this and be very clear about this is
when you take depreciation on a property
so in this example where they bought a
property for 250 let's say it's fully
depreciated down to zero the
depreciation is is recaptured when you
sell the property you do not get to
delay you do not get to defer the
depreciation recapture over that period
of those 10 years the depreciation is
recaptured in the year that you sell the
property so that that can create uh
what's called the wherewith all to pay
problem if you haven't heard about that
before go check out one of the podcasts
I did a couple months ago about uh
wherewithal to pay problem uh decoding
the seller's problem the tax problem
when you go to sell a property go check
that out but this is this is the only
con for a seller to sell Finance is the
fact that they have depreciation
recapture in the year that they sell the
property so just make sure that when you
when you're trying to convince people to
sell our finance to you it takes a lot
of education and you want to make sure
that you're you're looking out for their
best interest and you explain it to them
because if you just come off as Sharky
and you're just trying to get a deal
done they're not going to listen to you
but if you if you put it in their best
interest and and show to the seller that
you're looking out for them and that
here's why they should do X Y and Z
because it's going to save them money
that's going to be how you're going to
get the deal done so these are the tax
implications of seller financing if you
want to learn more check out my Facebook
group Tax Strategies for Real Estate
Investors we've had a ton of questions
related to seller finance coming through
the group lately and I'm sure we can
help you answer your next question on
seller financing
