Installment Sales

[TaoWanderer]

What is the name of your state? CA

This post is was originaly posted in the Tax Forum because it started as more tax related, but has spread into more real estate related topic. Here is the link to the full original thread: https://forum.freeadvice.com/showthread.php?t=371678

1. You can't do a 1031 exchange because the property was personal use, not business use.

If I don't claim it as a primary residence, then it could be considered an investment property, right?

3. If you elect to just pay the tax, your likely income tax each year is very low because you *are* using a structured settlement -- you're just calling it "carrying a note." Here's what's going to happen -- you will file a return for 2007 with an installment sale contract. You'll declare the contract price, the basis, whether the capital gains are exempt from tax, and how much you received in principal payments & interest payments. The principal payments are either ignored (claim exclusion) or go on part 2 of the installment sale form. The interest payments are fully taxable and are reported on Schedule B each year.
You will not attempt to file this return yourself; you will hire a professional who has done taxes for a few installment sales.

I have been using Turbo Tax the past few years. Do you know if Turbo Tax can handle it?

You will also pay a contract servicing escrow company to accept the monthly mortgage payments & make the property tax & insurance payments each year. That way both parties are protected from tax liens & insurance lapsing 2 weeks before the next forest fire. The company will also send both parties a statement of the year's total interest & taxes paid. The fee is usually less than $10/month & worth every penny.

There is only a very old mobile home on the property which has no value and it would probably be a blessing if it burnt down. I have never had insurance on the property.
I wouldn't be liable in any way once the property is sold (e.g. if the new owner falls and breaks a leg), would I?
If she fails to pay the tax, then it goes to the tax auction and I bid it up to the equity that I still have in the property, because the county would have to pay off the note first, right?
I really appreciate your advice, but also I do not make very much money, is why I try to follow the "penny saved is a penny earned" philosophy. Of course, I don't want to do something stupid trying to save a few dollars that will cost me thousands later. I'm only 27, but I try to do my research thoroughly and do things myself.

You will part with some cash to have an attorney look over this contract before signing it. You need to make sure that your rights of repossession are protected. You need the contract to be absolutely clear that the buyer loses all equity if s/he misses 2 payments in a row. What is the late payment penalty? Etc. You also definitely want a prepayment penalty. After all, if the capital gains are taxable, you will have an income spike should the buyer refinance or sell in 4 years, which may give you an unpleasant tax spike. You may not get it in the negotiations, but you want it. Your real estate agent is not an attorney.

We didn't use any real estate agents. We just agreed on the terms and went to an escrow company. The escrow company drew up the note and we all kind of signed everything pretty quickly. The escrow is pending right now waiting for the buyer to come up with the funds. I guess I figured I could trust the escrow company to write the note correctly. Did I do wrong? Does it look like I have rights of repossession and that buyer loses all equity if they default?

Following is the text from the note:

DO NOT DESTROY THIS NOTE: When paid, this note and the Deed of Trust must be surrendered to ORANGE
COAST TITLE COMPANY with request for reconveyance.
INSTALLMENT NOTE
(INTEREST INCLUDED)
$175,000.00 Temecula, California,_July 27, 2007
In installments and at the times hereinafter stated, for value received I/We Promise(s) to pay to
#####################, A SINGLE MAN
or order, at ####################################
The principal sum of ONE HUNDRED SEVENTY-FIVE THOUSAND AND 00/100 Dollars, with interest from
________ on the amounts of principal remaining from time to time unpaid, until said principal sum is paid,
at the rate of 10.00 percent, per annum. Principal and interest due in monthly installments of TWO THOUSAND NINE
HUNDRED FIVE AND 21/100 Dollars, ($2,905.21), or more on the same day of each and every month, beginning on
the day of , and continuing until the __ day of , 2014 , at which
time any remaining principal balance and accrued interest shall be due and payable in full.

Each payment shall be credited first, on the interest then due: and the reminder on the principal sum; and interest shall
thereupon cease upon the amount so credited on the said principal sum. Should default be made in the payment of any
of said installments when due, then the whole sum of principal and interest shall become immediately due and payable at
the option of the holder of this note.

DUE ON SALE: If the trustor shall sell, conveyor alienate said property, or any part hereof, or any interest therein, or
shall be divested of his title or any interest therein in any manner or way, whether voluntarily or involuntarily, without
the written consent of the beneficiary being first had and obtained, beneficiary shall have the right, at its option, except
as prohibited by law, to declare any indebtedness or obligations secured hereby, irrespective of the maturity date
specified in any note evidencing the same, immediately due and payable.

LATE CHARGE: A late charge of 20% of the monthly payment shall be due in the event payment is received later than
10 days from which it is due.

Should suit be commenced to collect this note or any portion thereof, such sum as the Court may deem reasonable shall
be added hereto as attorney's fees. Principal and interest in lawful money of the United States of America. This note is
secured by a certain DEED OF TRUST to ORANGE COAST TITLE COMPANY, a California corporation, as
trustee.

 

[TaoWanderer]

Is a prepayment penalty the norm in seller carry backs and what would be normal terms for a prepayment penalty in seller carry notes?

 

[TaoWanderer]

Here is the original post:

I bought a 4 acre real estate in Riverside County, California on 3/29/05 with an old mobile home on it for $77,000. I lived there and in Reno, NV over the past 28 months, but spent most of my time at the property in California. I am now selling the property for $195,000 with $20,000 down and I’m carrying the a note for $175,000. At 10% for 7 years. I am about to close on escrow in the next couple of days and am frantically researching my options regarding tax deferment i.e. declaring it as principal residence via IRS code §§ 121, 1031 exchange, structured settlement, income averaging, other.

Declaring it as a principal residence would be the easiest because it would defer all of the capital gains tax (gain of $118,000). I have been living there most of time for the past 28 months and as soon as I bought the property I turned on the electricity in my name on 3/30/05. I turned off the electricity on 10/18/06 and switched to using a generator. The property has a well and septic and a use a cell phone only, so there is no other utility bills as proof of residence. The factors that are working against me are:
• NV drivers license
• Did not file CA state tax return
• Address on Federal 2005 and 2006 Tax return was in Reno, NV at my parents house where I was getting my mail.
• Not registered to vote in CA
• Did not mark as primary residence on letter sent to me by Riverside County.
• I have been a NV resident my whole life, I am 27
• My 2 vehicles half owned by me are registered in Oregon where the other owner pays the insurance.

Would it be safe / wise to declare as a principal residence or am I asking for trouble i.e. automatic red flags, audit?

Does the IRS stick my return in a computer that looks for red flags?

If I declare as a principal residence would it bring up an automatic red flag by the IRS’s computer check system?

If I was audited what would happen?

Would I be able to prove that I lived there for 2 years?

If I want to do a 1031 exchange would that work if I am carrying a note?

Not sure what a structured settlement is but read that it was an alternative to 1031 exchange, is this a good option?

My income in the past 3 years has been below the standard deduction so would income averaging be a possibility?

Are the any other options that I haven’t thought of yet?

Do I have to pay CA state tax when I sell the property if I’m a NV resident?

Is the address on the Federal Tax return meant to be a mailing address or a residence address?

 

[lcannister]

What on earth makes you think this is still not a tax question?

I suspect you were given answers in the other post, no I am not going to read it, that you did not like so you are trying again here.

You do not seem to have any proof of this being a principal residences as define by the IRS and I suspect this "principal residence" thing just came about when you determined that a second home is considered a capital gains asset.

 

[TaoWanderer]

What on earth makes you think this is still not a tax question?

I suspect you were given answers in the other post, no I am not going to read it, that you did not like so you are trying again here.

You do not seem to have any proof of this being a principal residences as define by the IRS and I suspect this "principal residence" thing just came about when you determined that a second home is considered a capital gains asset.

Yes, I know the capital gains question is a tax question and that is why I asked in the tax forum first. It is my other questions that are not very tax related and they told me to ask in here.

I pretty much decided against declaring it a principle residence, even though there was a debate happening in the tax forum as to whether or not I should.

The most important thing I'm trying to figure right now is whether I should have included a prepayment penalty in the note and whether I should add one now as the escrow has not closed yet, but could close any day now as soon as the money arrives. The escrow agent says I can add one it will just have to be resigned by the buyer.

I'm not sure what the terms should be though, what is normal / fair?