Question on sale of real estate

[Super Mom]

I have a friend asking me a question, I'm not sure how to answer. She has a piece of real estate she wants to sell. (it's not a residence) She's asking me if lease to own or installment sale is better for her as the seller taxwise. Also, I found the IRS implies around 9% interest on installment sales if not listed as interest in sale, she was asking me if the sale states 3%, that's ok right?

Any advice would be helpful. Thanks!

[ATSMAN]

I have a friend asking me a question, I'm not sure how to answer. She has a piece of real estate she wants to sell. (it's not a residence) She's asking me if lease to own or installment sale is better for her as the seller taxwise. Also, I found the IRS implies around 9% interest on installment sales if not listed as interest in sale, she was asking me if the sale states 3%, that's ok right?

Any advice would be helpful. Thanks!

I am assuming there is a substantial gain and not loss (no installment sale if loss).

What is the terms of the mortgage note that she will hold? Given the interest rate we have now 3% seems reasonable.

In general she may benefit from doing an installment sale unless she waives that provision and takes the gain in the year she sold because her tax bracket is low.

Too many moving parts, you will need to do the projection both ways.

[Burke]

ATSMAN is right. And it is always a risk using an installment sale. While spreading the gain over a number of years, it is also irreversible as far as the tax return is concerned. Once it is done, it cannot be changed, so if in future years, taxpayer income goes up or there is a windfall from another source, it might not be advantageous. Capital gains rates cannot be guaranteed for the future. So if they go up, the tax may go up in that year. Plus the taxpayer runs the risk of loan default from the buyer, and foreclosure and repossession of the property which might not be saleable at the same price, etc, etc. I have had clients where all these have happened. Is the taxpayer drawing Soc Sec which might become taxable? Is there a call provision in the note? What if she has a medical need for the funds? Sometimes, it is better to take the one-time hit and be done with it. There is also the tax-deferred exchange option if she wishes to avoid taxes this year and reinvest in another property.

[ATSMAN]

ATSMAN is right. And it is always a risk since using installment sale, while spreading the gain over a number of years, also is irreversible as far as the tax return is concerned. Once it is done, it cannot be changed, so if in future years, taxpayer income goes up or there is a windfall from another source, it might not be advantageous. Capital gains rates cannot be guaranteed for the future. So if they go up, the tax may go up in that year. Plus the taxpayer runs the risk of loan default from the buyer, and foreclosure and repossession of the property which might not be saleable at the same price, etc, etc. Is the taxpayer drawing Soc Sec which might become taxable? Is there a call provision in the note? What if she has a medical need for the funds? Sometimes, it is better to take the one-time hit and be done with it. There is also the tax-deferred exchange option if she wishes to avoid taxes this year and reinvest in another property.

Just to add to the excellent points made by Burke, if your client engages you to do projections make sure your engagement letter has the necessary caveats.

My wife's uncle owned a strip mall and when he was ready to retire and travel the world he wanted me to run some figures. Being family I actually declined because if the projections did not pan out I was not going to have a "family issue". I referred him to another CPA to get an unbiased opinion!

[Kram BergGold]

Interest

I am pretty sure you use the AFR (Applicable Federal Rate) not 9% to determine the minimum amount of interest that must be charged or imputed.

[Super Mom]

Thanks everyone, I will give her the information on her options, that's her call to make. She did ask about a lease to own---how does that work taxwise?