Tax Issues on a "Subject To" Deal
by Attorney William
Bronchick (legalwiz.com).
For more information go to
legalwiz.com .
You buy a property “subject to” an existing loan. You sell the
property on an installment land contract or lease/option. What are the
tax ramifications?
Part One: Determining Your Basis
Your tax basis is basically what you paid for a property. If you have
a seller $2,000 and took a deed subject an existing loan of $189,000,
your basis is $191,000. Basically, your basis in a subject to is cash
paid to the seller, plus existing loan you are taking over. If you also
paid money for back taxes and mortgage payments, that would also be part
of your basis. So, if in the above example you paid $3,000 to the lender
to cure the back payments, your tax basis is $194,000.
Part Two: Figuring Out Your Gain
If you resell the property for cash, the gain is easy to figure out –
sales prices less your basis, less your sales costs (broker fees,
closing costs, etc). If you resell the property on a lease/option, you
haven’t really sold it at all, since a lease/option is generally not
considered a sale until the tenant exercises the option to purchase.
During the period of the lease, you would be taking depreciation, so
there’s a recapture of that depreciation when you sell at 25%.
If you resell on an installment land contract (aka “contract for
deed”), it IS a sale, even though title does not pass to the buyer.
Thus, your gain is the sales price on the contract, less your tax basis.
This is considered an “installment sale”, so your taxable gain is based
on the cash received, plus any principal received in the year of sale.
When the buyer pays off the balance of the contract, you have a gain in
that tax year for the balance of principal received.
Part Three: The Interest
This part of the equation always gets people confused. In our example
above, you bought a property from Sally Seller subject to the existing
loan. You then sold it on a land contract to Barney Buyer. Who “owns”
the property? For federal income tax purposes, there were two sales –
from Sally to you, then from you to Barney. So Barney would be deducting
the interest he is paying on schedule “A” of his federal income tax
return as the “equitable owner”.
This appears confusing because YOU have the deed and Barney does not.
It is also even more weird because Sally Seller’s lender is sending a
form 1098 for the annual mortgage interest to the IRS in Sally’s name!
Don't let that fool you… the basic rule of the interest deduction is
that the person who has an ownership interest in the property, uses it
as his principal residence, and actually makes the interest payments is
the one who is entitled to the deduction. So, in this case, Sally Seller
neither owns the house nor makes the payments – she does nothing. Barney
Buyer is the “equitable owner”, which gives him an ownership interest.
And, Barney is also actually making the interest payments, which he can
deduct.
One last part of the equation – the interest YOU are paying on the
underlying loan. If you buy subject to and sell on a wraparound, you are
collecting payments from Barney Buyer and continuing to make payments on
Sally’s underlying loan. The interest YOU pay is deductible as an offset
(business interest) against the interest income you are collecting from
Barney Buyer.
by Attorney William
Bronchick (legalwiz.com).
For more information go to
legalwiz.com .
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To" Resources:
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