Capital gains and owner financing?

I'm selling an investment property I bought for $250,000 in 2004 in Utah for $450,000. Since we bought it we did a cash out refinance and now owe $320,000. The buyer will pay off the $320,000 and will owe me the remainder. Am I liable for the taxes owed on the $70,000 ($320k - $250k) gain immediately? (I understand I will be taxed on the remainder as I receive it).

No, you will not be paying capital gains on only $70,000 of your $200,000 gain in the year of the sale. You will figure your income from the installment sale using Form 6252.

I will ignore selling commissions and depreciation (which do have an impact and figure into the computations in Form 6252):

You have a gross profit of $200,000 from the $450,000 sale, so your gross profit percentage is 20/45 or 4/9. For each payment of principal you receive from the buyer, 4/9 of that amount is considered capital gain and 5/9 is a return of your original investment in the property. So the initial payment of $320,000 is considered to be about $142,000 of capital gain and $178,000 return of your original investment in the property. Form 6252 will transfer the $142,000 to Schedule D.

Then for each succeeding payment, interest must be charged or imputed. The interest is ordinary income, and the principal payment is divided into 4/9 of capital gain and 5/9 return of investment.

Over the life of the installment contract, you will be paying capital gains tax on $200,000. In fact, your gains will be divided into capital gains and ordinary income due to depreciation on the investment property.

You should owe around $20,000 extra on the $200,000 gain (10% maximum per current law, I think) - the financing has nothing to do with taxes. The old law, before 1986, did allow tax deferments on contract sales but I think that's no longer the case.

I've not kept up with the tax law over the past couple decades, so check with a good (I repeat good) tax preparer (attorney or accountant) and get them to show you the actual law governing anything different from what I've said.

Best check with your tax person but depending on how you declare this Owner financing or a Installment sale could possibly make a difference. Spend a few buck at your tax person office on this as it could save you Thousands. Or you could do a 1031 and possibly avoid all tax liability.

Your income on it would be $200k (450k - 250k). Taxes will be owed on that amount. As it is a substantial sum, it is best to seek the advice of your tax accountant. If you receive the income on this in installments, then your income ($200k) as well as the resulting tax liability will be streched out over the period of life of the installment sale.

- Good Luck!