It’s been discussed on this forum previously that when selling a property on an installment loan / seller financing, one could either have a principal amount (probably somewhat close to what one would accept for a cash sale) with an interest rate applied to that principal balance for the life of the loan, or write up the closing docs reflecting the sale price as the total cash amount you would receive over the whole seller financing term (down payment plus all monthly payments combined) with a 0% interest rate.
The latter approach (higher sale price, 0% interest) seemed easier for me to manage administratively, and had the added benefit of ensuring I’d still receive the total amount, even in the (probably unlikely) event that my buyer decides to pay me off early.
However, talking with my accountant yesterday in preparation for what will be my first tax return after doing my first seller financed deal last year, he told me that, “You will want to charge interest to comply with federal tax laws. It can be fairly low. You can use the Applicable Federal Rate to determine the rate to use. I would use the mid term rate for the month you sell the property.” He also sent me this link of Applicable Federal Rates by month and year: https://apps.irs.gov/app/picklist/list/federalRates.html
I’m not sure what I’m supposed to do at this point, now that I’m already 9 months into an installment loan that was clearly written up at 0% interest. Possibly I’ll just need to pay taxes on “interest payments” that I haven’t actually received (and am not actually contractually entitled to)? If so, fortunately the federal rates for the month in question are pretty low (0.43%), but I’m still not crazy about having to pay short-term capital gains and taxes on imaginary interest on top of that.
Have others encountered this? Any info that might help clear this up?
Edited to add: Also wondering if I’m supposed to issue a year-end mortgage statement to my buyer, reflecting interest that he’s not actually paying? I plan to talk with my accountant further about all this, but am hoping to get some additional perspectives before I do so.
@dl7573 I think what you’re referring to here is imputed interest.Here’s an article that explains it fairly well. It applies whenever there’s a loan with no interest charged or a minuscule amount charged.
What was the total price of the property you sold? Was it under $10,000? According to the article linked about, that seems to be a significant detail that can potentially get you out of it.
I think charging 0% interest can still be a useful marketing tool, but even if you go there, it’s still a good idea to assume you’ll have to pay taxes based on the imputed interest amount.
2nd paragraph: “A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate (AFR).”
Third column of same page: "Exceptions for loans without significant tax effect. The following loans are specifically exempted from the (imputed interest) rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender.
Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender’s customary business practices…"
In other words, there is no imputed interest owed because the business is structured specifically around non-interest bearing financing. An example of this would be car dealers offering zero percent auto loans, banks mailing out zero percent credit card offers, or land dealers offering zero percent land loans, all customary business practices. Imagine the car dealers charging zero interest then getting hit with imputed interest they didn’t collect, or the credit card companies getting charged interest while collecting zero percent. Not going to happen.
Two questions I have:
How is “customary business practices” defined? If one starts out like I did not charging interest to keep things simple, and then one sells a few with interest, does that remove you from the customary category, or are you still in the customary bracket selling 0% interest 50% of the time, or is it customary to offer it on occasion?
Define “same terms and conditions”
** Verify this with your lawyer. I’m not a lawyer. I only play one on the internet.
@donyost@Geoffrey, thanks for the very helpful replies! I haven’t verified this with my accountant yet, but am thinking this should be a non-issue with my one seller-financed deal, so far, due to the factors that you both raised, in that the amount that I financed on this property fell under $10k, and this was an arms length deal (to the general public) under terms consistent with what I intend to be customary my customary business practices (when seller-financing).