Tax questions on carrying a mortgage on a house.

We are thinking of selling our house in a year and we anticipate a $60K profit and yes it would be tax free for us. One possibility is to sell it to Mrs Cad’s son. He would get a mortgage for the balance of our loan and we would carry the profit as a second mortgage.

  1. What would be the tax liability on his mortgage payments? Taxed on everything? Only the interest? All tax free?

  2. What would be the tax liability if we sell the note for instant money?

I’m assuming that your gain qualifies for exclusion as from the sale of a personal residence. You can exclude the gross profit in the installment sale calculation, so none of the principal you receive is taxed. You will owe tax on the interest provided by the note, and there are some rules about imputed interest if the rate isn’t high enough. If you sell the note immediately, you did not earn any interest while holding it and pay no tax unless you somehow sold the note for a gain. That might occur if interest rates changed a ton in the small period of time you held the note, but seems unlikely.

This is not a phrase I’ve encountered. Say the house is $160k. It sounds like he’s borrowing $100k from the bank, which he pays to you immediately? And then what is happening with this $60k?

ETA I see that’s not right at all. Please show us the numbers.

So, you don’t need the profit from he house moving forward? Like to buy the next place you’ll live? Instead of a 60$K payout/profit you’ll be getting monthly payments?

Sounds a great deal for the kid. Not seeing how it’s a great deal for you though. Can you explain that part a little more?

Also, what will you face if, he cannot pay the second mortgage due to illness, unemployment etc? Will you be okay? Will it put you in a hard spot financially? If he refuses to willingly leave, if he can’t pay, will you be comfortable evicting him? Taking legal action?

These seem like issues you should consider to me, whether the son, ‘seems the type’, or not! Have you thought of these things?

I’m anticipating his asking to buy the house in a year and I want to have all of my information handy specifically because I want to make sure his mom doesn’t give away our money to help out her son. Specifically the tax benefit. If she does it wrong (like renting it to him with us as a landlord) it could cost us up to $18,000.
@Ruken. He takes a loan for $195K to pay off the note*. We hold a second mortgage for $60K @ 5% per annum.**

*IMO that’s a non-starter right there.
** Second non-starter. He can’t afford the $1600/mo the two mortgages will cost him.

Saint Cad, I still don’t understand. You put more numbers in, but I don’t know who’s borrowing from whom.

It seems like Saint Cad currently owes $195K to Bank 1 on a house worth $255K. Mrs. Saint Cad’s son borrows $195K from another bank to pay off the money Saint Cad owes, and Saint Cad holds a second mortgage on the house for $60K. That puts Bank #1 whole, Saint Cad has a $60K note from his son-in-law, who has $255K worth of debt, and the second bank has a $195K note on the house.

A possible issue is that the debt to equity ratio may be too high, essentially the son is putting zero money down. Could he get the mortgage from the bank for the $195K under these conditions? It sounds like the kind of deal where Saint Cad would be expected to keep this “under the table” and the son expects to tell the bank that he’s putting $60K down when he’s actually borrowing the money from Saint Cad.

The fact pattern is unclear.

I think you are talking about seller financing? In the case of seller financing, the mortgage interest paid would by the son in law could be treated as typical bank loan and he would be able to deduct the interest on the mortgage interest (if he meets the standard other requirements). For you the person making the loan, it gets a bit more complicated depending on your situation. The interest you receive from the son in law would be considered interest income (schedule B). The principal repayment from the son in law could be considered capital gain if it is over the exclusion amount (but you said it wasn’t).

I don’t know what this means:

Do you have two outstanding notes, one for $195K and one for $60K? There may be challenges with him taking a note on the property if it doesn’t have a clear title - and a second note would carry a lien against the property. There may be a way to add him to the title rather than through a sale, but that gets more complicated when it comes to the financing. I think the current state needs to be clarified.

Could a tax person weigh in? (I’m sure we have them on the boards).

Seems like there are two completely separate transactions:

  1. Sale of the house for $255 k - no cap gains because it is under the tax credit limit
  2. A $60 k loan to the son - annual interest received from son is taxable on a schedule D (and at 5% there are no imputed interest issues, current long term AFR rates are about 2.15%)

I don’t the think the “principle payments” of the loan from the son impact the tax calcs for the home sale at all, since they are essentially completely separate transactions. (E.g., the seller basically received $255k, paid off the bank, computes their tax burden for the sale, and loaned $60 k to the son at 5%. The $60 k loan is after the fact.)

Recommend seeing a tax CPA for 1 hour, they will tell it to you straight.

So…you’re volunteering to hold a second mortgage on a house where you don’t think the son can actually meet the payments?

Why would you do that? And again, what’s the plan if he defaults?

If you are selling it to a third party, I would just have sell it at the current monthly principle outstanding, which would not be a gain/loss situation. Otherwise you would have a tax impact for the delta.

If for your son, just include a prepayment without penalty clause in the note, so he can clearly pay off the remaining principle and close out the note. No tax impact to anybody except the interest that has been paid up to that point.

You will probably need a monthly principle/interest schedule, showing payments and reduction of principle.

As a tax person, I can say that you really have the only answer.

We’re talking about an installment sale to a related party.

One thing I’ll say: in order for mortgage interest to be deductible, it must be a loan secured by a residence. The process of securing a mortgage varies by state/county, but it would mean that the bank providing the primary mortgage would have to be aware of the second mortgage.

Then there are legal issues that also varies by state/county. My personal experience with that is a really long story, but the short version is that refinancing the first mortgage required consent by the company holding the second mortgage. They refused to agree, so we had to refinance both at once. (Which is kind of what we wanted to do all along, we were just exploring options.) This isn’t even a tax issue, but once you start properly securing a mortgage, you lost a lot of flexibility.