Mortgage Interest Paid AFTER Installment Sale Executed

[JoshinNC]

My client owned a primary residence with a mortgage. They executed an installment sale and began receiving payments in 2013. They also continued to make mortgage payments on the residence throughout 2013 (and 2014). I am thinking that all interest paid after the installment sale was executed is investment interest, not deductible mortgage interest. I'm unable to find a clear answer in any Pub.

Any help?

[Roland Slugg]

He must have sold the real estate on a contract of sale or on a wrap mortgage. Don't see those very often these days.

Yes, the interest he pays is classified as investment interest. It's not mortgage interest any more (at least not for him), it's not personal interest, it's not rental or business interest, so all that's left is investment interest.

[Snaggletooth]

Furthermore

I agree with all that has been said, but would like to add that the perception of "netting out" in the mind of the seller doesn't necessarily work.

The interest paid by the buyer is fully taxable at ordinary income rates. The deductibility of "investment interest" may be elusive. To begin with, the taxpayer must be able to itemize in order to claim it, and even if so, is only able to benefit by the amount exceeding the std deduction.

For high income taxpayers, the interest received becomes subject to the new "medicare" tax as it is investment income. The taxpayer may also have the itemized deductions eroded away by the phase-out. Investment interest is exempt from the phaseout, but the rest of the itemized deductions may be eroded away.

And true "wraparound" mortgages become reportable as principle received in the very first year. By definition, I believe a "wraparound" mortgage for this purpose is when the buy takes responsibility for the sellers mortgage. This is becoming increasingly rare because banks are no longer willing to simply transfer debtors on a single mortgage. They can make more money by requiring a buyer to create a new loan.

[Roland Slugg]

By definition, I believe a "wraparound" mortgage for this purpose is when the buy (sic: buyer) takes responsibility for the sellers mortgage.

No, that's not what a wraparound mortgage is at all. A wrap is a type of seller financing in which the existing mortgage is not paid off or assumed by the buyer, but instead the seller remains liable for and continues to make its payments.

For high income taxpayers, the interest received becomes subject to the new "medicare" tax as it is investment income.

Yes, the interest income is subject to the new NIIT, but the interest paid is deductible/offset against that, leaving only the excess of the income over the expense subject to the NIIT.

And true "wraparound" mortgages become reportable as principle received in the very first year.

I'm not buyin' that either. Income reportable on the installment method should be the same, or nearly so, whether the seller finances the sale with a wrap or if the buyer gets a new loan and the seller takes back a second on the property sold.

[Snaggletooth]

Apologize to Original Post

No, that's not what a wraparound mortgage is at all. A wrap is a type of seller financing in which the existing mortgage is not paid off or assumed by the buyer, but instead the seller remains liable for and continues to make its payments.

[Snag] Don't know, Sluggo. The arrangement you describe is known as a "land contract" in these parts. I did look up the definition of a wrap but got three versions of what you describe, so I'll withdraw my definition.

Yes, the interest income is subject to the new NIIT, but the interest paid is deductible/offset against that, leaving only the excess of the income over the expense subject to the NIIT.

[Snag] I'm wrong again. On the form 8960 which calculates the new "medicare" tax, there is indeed a provision on line 9a which allows the offset of investment interest.

I'm not buyin' that either. Income reportable on the installment method should be the same, or nearly so, whether the seller finances the sale with a wrap or if the buyer gets a new loan and the seller takes back a second on the property sold.

No you're not going to buy that if you don't buy my definition. If, however, the seller is relieved of a mortgage liability, the amount of the relief is added to the principle received in the first year of the installment.

My apologies to the original post for the misleading information. Thanks to Roland Slugg for bringing this out.

[JoshinNC]

Thanks for the responses

and for confirming my original thought that the interest paid by my client (the seller) is investment interest. Not sure about wraparound mortgages, but this doesn't appear to be that type.

Thanks again!