Having cut my real estate investment broker teeth during the Nixon through Reagan administrations I can tell you without reservation — creative financing doesn’t include the owner carrying back a note secured by a trust deed on the property. Period, no debate. In fact, I’ll go as far to say whenever I hear that I know it’s an amateur talking, or a newbie real estate agent. It’s akin to calling ‘See Jane run’ classic prose.
Though carrying back some (all?) of the financing when selling/exchanging an investment property isn’t usually on the the A-list for sellers, in these times it can be a tax saving/planning tool. It can also make the difference in getting a deal done. It’s Friday, so I’ll be brief. No, really, stop laughin’.
When you receive interest from a note you carried back on your sale/exchange you only pay taxes on it in the year you receive it. If it’s structured correctly, and the payments are interest only, you will have delayed the portion of capital gains taxes that have been triggered at close of escrow. Those taxes will only become due and payable when either the note is paid in full, or you received payments over and above the interest due. If that occurs, not all the principal you receive would be taxed. That’s ‘cuz the IRC (Internal Revenue Code) says some of each dollar returned to you is called return of capital, while some is return on capital. You’re of course never taxed on the return of our original capital. The IRC very helpfully provides a formula which gives the taxpayer/investor the proper percentages which apply to his particular situation. One investor might pay taxes on 74¢ of every dollar received. Another only 27¢ — depending on what the formula concludes for each particular investments set of facts.
Specifically, on the tax planning front, here’s what’s possible.
If you think your ordinary (job) income will be less in future years for whatever reason, it makes sense to delay receipt until then. Duh. It’s more likely than not your marginal tax rate will be lower. Another stipulation your note might contain, is the periodic annual principal pay down of the loan balance. This will allow you to receive your capital gain in smaller chunks, conveniently spread over several tax years. When we’ve had clients to this in the past it’s been a real tax saver.
Also, I’ve included dozens of notes/trust deeds in tax deferred exchanges. Think about it. If your local market made it necessary for you to carry some of the financing, it’s entirely plausible the owner of the property(s) into which you’re trading might in turn be persuaded to take the very note you now have. In that case, there’s no need for you to pay taxes at all. You were never in what’s known as ‘constructive receipt’ of either the note or the cash payoff it represented.
For the record? Once I had my exchanger/client take a Mercedes as part of the consideration for his property — and got the seller on the other end (upleg) of the exchange to take it as part of their consideration. Sad part was, my guy never even got to drive it once. 
Sometimes your menu has more options than you thought. Who knew?
Enjoy the three day weekend — if ya don’t hafta work Monday. Me? I’ll be takin’ it easy, but since my laptop and cell never get a day off….Anywho, if the thought hits ya, Contact me, and we’ll see what’s up. Have a good one.
Related posts:
- The Best Of All Worlds — Sell & Pay No Taxes — No 1031 Exchange
- Real Estate Investing — Capital Gains Taxes — The Economy
- Realizing Big Time Capital Gain — Payin’ Little Or No Taxes — How He Do Dat?
- How To Pay Taxes By Screwin’ Up Tax Deferred (1031) Exchange
- What Clause Might Save Grief For The Real Estate Investor?
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