When you sell a home quickly, you lose many of the special protections and lowered tax liabilities that the IRS grants you. This is especially true if you are selling an investment property instead of a personal residence. However, offering owner financing can help you spread out any profits over time, letting you delay paying at least some of your taxes.
Investment Home or Personal Residence
If the home you are selling is an investment property, the IRS requires you to pay capital gains tax on your profits. While providing owner financing lets you spread out the capital gains tax, you will still need to pay it eventually. If the house that you are selling is your personal residence, you might be eligible to avoid paying capital gains tax on your profits if you owned and lived in the house for at least two years.
Calculating Your Taxable Profit
Whether the home you sell is a personal residence or an investment property, the process of calculating your profit is the same. You subtract your cost basis from your net selling price. Your net selling price is the property's selling price after you subtract out the costs of selling it, like the commissions. Your cost basis is what you paid for the property plus your closing costs plus anything you spent to improve the property. After adjusting the purchase price up and the selling price down, if you do not have a profit, you will not owe any tax on the sale.
Capital Gains Exclusion
If you are selling your personal residence and you lived in it for at least two years, you can exclude a large portion of your gain from capital gains taxes. As of the 2013 tax year, married couples get to exclude up to $500,000 in gain from taxes and single people get $250,000 in tax-free gain. If you lived in your house for less than two years and sold under special conditions, such as due to a change in employment or unforeseen circumstances, you could be eligible to claim a pro-rata share of the exclusion. For instance, if you lived in the house for 12 of the 24 months, you'd still be able to take advantage of half of the exclusion.
Capital Gains Rate
As of 2013, there are two capital gains tax rates that will apply to any taxable profits from the sale of your home. If you held your home for at least one year, it will be treated as a long-term capital gain and you will pay 0 percent federal capital gains tax if you fall in the 10 or 15 percent bracket, 20 percent if you fall in the 39.6 percent bracket or 15 percent if you fall in any other bracket. Homes held for less than one year are treated as short-term capital gains, which get taxed as regular income.
Tax on Owner Financing Payments
The IRS levies tax on the payments that you get from the buyer of the property that you financed. First, you will pay capital gains taxes on any principal that they pay you that is considered taxable profit. You will also have to pay tax on any interest that they pay you. Interest is taxed as regular income
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.