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Land Contract – Installment Sale
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Agreement For Deed or Contract for Deed

The term “Agreement For Deed” is also known as a “Land Contract”, “Installment Sales Contract”, or a “Contract For Deed”. They are all basically the exact same thing, but for the purposes of this course, we’ll refer to it as an “Agreement For Deed”.

What Is An Agreement For Deed?

An Agreement For Deed is basically seller financing where the seller gives the buyer the deed to the property after the buyer has paid for the property through monthly installments. Some agreements state that the seller will convey the deed and convert to out right seller financing, once the buyer has made a certain number of payments as agreed.

Buying Under an Agreement For Deed

If you’re looking to buy a home or investment property by putting little or no money down and without qualifying, Agreement For Deeds are a great way to do it. It is fairly easy to get a motivated seller to do an Agreement For Deed even if the seller is concerned about their credit or concerned about the due-on-sale clause. The seller can feel more in control with the fact that the deed hasn’t transferred yet. This is important to some sellers who are concerned about you not following through with your side of the agreement.

As a buyer, it is important to know that many banks will allow you to refinance an agreement as if you had a regular seller financed mortgage. This can be very helpful if you need time to build up your credit and want to get into a home now without needing a large down payment. And with a refinance loan you don’t put money down like you would on a normal purchase loan.

This means that you could purchase the property under an Agreement For Deed from the seller using no money down, then later refinance the Agreement For Deed and pay th~ seller off. As part of the refinance, you can also roll the closing costs into the loan and not only close using no money, but it is possible you could actually walk away from closing with money in your pocket.

Learn more below!“Installment Sale Contract” on Bundlr

Out of all U.S. homeowners, 29.3 percent, or 20.6 million, own their home free and clear of a mortgage, according to an analysis from Zillow. Among the 30 largest metro areas, Zillow found Pittsburgh had the highest share of homeowners without mortgage debt–38.6 percent. Zillow chief economist Dr. Stan Humphries explained determining where mortgage-free homeowners are located can also bring insight into potential inventory and demand in certain areas.

Out of all U.S. homeowners, 29.3 percent, or 20.6 million, own their home free and clear of a mortgage, according to an analysis from “”Zillow””:

Among the 30 largest metro areas, Zillow found Pittsburgh had the highest share of homeowners without mortgage debt–38.6 percent.
Tampa had the second highest rate of mortgage-free homeowners at 33.2 percent. The metro was followed by New York (29.7 percent), Cleveland (29.4 percent), and Miami (28.9 percent).

The five metros with the lowest rate of homeowners who own their mortgage were Washington, D.C. (15.5 percent), Atlanta (17.7 percent), Las Vegas (18.3 percent), Denver (18.5 percent), and Charlotte (20 percent).

Zillow also revealed what factors might influence the percentage of homeowners who own their home outright in certain areas.

For one, metro areas with lower home values tended to have a higher rate of mortgage-free homeowners since smaller loan amounts can be paid off more quickly, according to Zillow.

Age and credit rating were also contributing factors. Older homeowners who have had more time to pay off their mortgage were more likely to own their home free and clear. Zillow reported homeowners between 65 to 74 years of age are most likely be without a mortgage, with about 20.5 percent of owners in this age category considered mortgage-free.

The next age group up, 74- to 84-year-olds, were the second most likely to own their home outright. About 17.9 percent of homeowners in this age group are mortgage free.

Zillow also found homeowners with a high VantageScore were more likely to own their home with the mortgage paid off. About 44 percent of mortgage free owners have a credit rating between 800 and 900, but just 15.5 percent of homeowners with the highest credit rating of 900-990 are mortgage free.

“”So far we have used our unique data on how much homeowners owe on their homes primarily to identify underwater and delinquent groups of homeowners,”” said Zillow chief economist Dr. Stan Humphries. “”But looking at those homeowners who are free-and-clear is important, too. Homeowners unencumbered by a mortgage may be more flexible than indebted homeowners, and therefore more apt or willing to list their homes or enter the market for a new property. By determining where these homeowners are located, we can also gain insight into potential inventory and demand in those areas, as well.””

Zillow’s analysis was based on data analyzed through the third quarter. Mortgage data from TransUnion was also used, and the data covered 800 metro areas, 2,100 counties, and 21,900 ZIP codes nationwide.

Avoiding A Big Tax Bill On Real Estate Gains

Selling your home for a huge profit is nearly every homeowner’s dream come true. Who wouldn’t want to make a pretty penny off his or her home? But in order to really profit on your home’s sale, you may want to defer taking your profit in lump sum. Read on to find out why, and to learn about another option: an installment sale.

Big Payout = Big Tax Bill
Let’s take a look at a common homeowner situation:

Example – When a Gain on a Property Increases Tax Liability
Hal Bookman looked at the buyer\’s offer for his rental home and couldn\’t believe the number that was printed there. His property had doubled in value in only five years, and he hadn\’t considered it cheap even when he bought it. However, when Hal gleefully told his tax advisor about the sale, his advisor was less excited; taking the income in one lump sum would not be in Hal\’s best interest from a tax perspective.
If Hal declares the entire proceeds of the sale in the same year he sells the property, he will be ineligible for virtually all of the tax credits to which he would normally be entitled. His itemized deductions would also be reduced as a result of the additional income from the sale. Hal asks his tax advisor if there is anything he can do to reduce his taxable income for the year. The advisor knows just the tool to use: an installment sale agreement.

The Purpose of Installment Sales
According to Publication 537, the IRS allows taxpayers to defer gains on major sales of property or other investments with an installment sale agreement. This arrangement permits sellers to declare a prorated portion of their capital gains over several years, as long as the proper paperwork is completed during the year of the sale.How the Installment Sale Method Works
Declaring gains under an installment sale is theoretically simple. The taxation of installment sales mirrors that of annuities, where a prorated portion of each payment is considered a return of principal. The only stipulations are that the property being sold cannot be a publicly traded security of any kind, and the taxpayer cannot be a dealer of the sold property in any sense.

Let’s take a look at an example of this method, and see how Hal could structure his installment sale if he wanted to defer his income taxes to a future year.

Example – Deferring Taxes With an Installment Sale
Hal receives $400,000 for his rental home. He bought the property for $188,000 and paid $12,000 in selling expenses, which are added to the home\’s basis, making it $200,000. Therefore, Hal has $200,000 ($400,000 – $200,000) of reportable gain to declare. Hal\’s advisor recommends he break down his sale proceeds into eight annual installments of $50,000 each, instead of declaring $400,000 in one year. As long as the installments are constructively received each year, this method will allow Hal to remain eligible for tax credits and deductions that the lump-sum payment would prevent him from receiving.

Reporting Installment Sale Income
Installment sale income can be broken down into three separate categories: gain, principal and interest. Each of these categories is treated differently on Form 1040.Capital Gain
In the above example, Hal must declare the gain each year as being either long or short term depending upon whether the gain was long or short term in the year of the sale. Long-term gains are taxed at a lower rate, while short-term gains are taxed as ordinary income. Because Hal held the house for five years, the gain in this case will be long-term. If the gain had been short-term, Hal still would be taxed on the installment income at a lower rate than he would if he had to declare the lump sum gain. This is because short-term gains are taxed as ordinary income at the taxpayer’s top marginal tax rate. The gain from an installment sale is reported on IRS Form 6252 and then carried to the Schedule D on Form 1040.

Taxpayers with installment sale income must also charge interest to the buyer at a rate that is the lower of the applicable federal rate (or 9% compounded semiannually). The buyer will pay interest on the unpaid installments until the balance has been remanded. Therefore, if Hal charges the 9% rate on his sale to the buyer, he will also receive and report approximately an additional $4,500 of interest income for each $50,000 installment that has yet to be paid. The interest is reported separately as ordinary interest income on Schedule B. (Note: If the interest is not reported separately, then the IRS will consider part of the sale proceeds to be interest.)

Part of each installment sale is considered by the IRS to be a tax-free return of principal. This amount can be determined by calculating the exclusion ratio. Divide the amount of actual gain by the sale price, which in this case is $200,000/$400,000, providing an exclusion ratio of 50%. Simply multiply this ratio by the amount of the installment: This is the amount that is to be excluded from tax because it is designated as principal. Therefore, $25,000 ($50,000 x 50%) of principal is returned each year.

Mortgages and Contract Price
If the buyer of the property assumes a mortgage or some other promissory note with the purchase, the cost basis of the property must be reduced by the amount of the mortgage/note. For example, if the rental property that Hal sold for $400,000 has a mortgage of $100,000, then the contract price is reduced to $300,000 ($400,000-$100,000). This means that Hal will only have $100,000 of total gain to report in installments.

If the amount of the mortgage exceeds the total adjusted basis of the property, then the difference must be reported as a payment in the first year, and the contract price is increased by that amount. For example, if Hal’s property has a mortgage of $250,000, the basis of the house will be $200,000 ($188,000 + $12,000). In this case, Hal will have to report an excess payment of $50,000 during the first year in addition to the installment payment. The contract price will also then be $250,000, leaving $150,000 for a taxable gain.

There are many rules and regulations pertaining to installment sales that must be followed carefully. However, those who understand the rules can retain their eligibility for many deductions and credits that must otherwise be forfeited. For more information on subtopics like changes in selling price, the different forms that payments received can take, and when it might be better to forgo an installment agreement and take a lump-sum payment instead visit the IRS website or consult your tax advisor.

If you’re selling a prime piece of real estate, you can probably get top dollar in today’s market. But it may be worthwhile to structure the deal so you receive payments over several years.

Strategy: Sell the property on the “installment sale” basis. As long as you receive payments from the buyer in two or more tax years, you don’t owe current tax on all of your gain in the year of sale.

Not only does this defer the tax, it may also reduce your overall tax bill on the gain.

Recent tax-law changes further encourage real estate sellers to use the installment-sale method.

Here’s the whole story: Under the installment sale rules, only a portion of the gain is taxable in the year in which you receive a payment. Also, the taxable portion on the sale qualifies for favorable capital gain treatment.

The current maximum federal income tax rate on long-term capital gains is 20% for taxpayers in the highest ordinary income tax bracket. How­­ever, most taxpayers will owe no more than 15% to the feds on long-term capital gains. For sales of depreciable real estate, a maximum federal rate of 25% applies to the portion of gain attributable to your depreciation deductions. In addition, a 3.8% Medicare surtax now applies to the lesser of “net investment income,”(NII) which includes most sales of rental real estate properties, or the amount by which your modified adjusted gross income (MAGI) exceeds a threshold of $250,000 for joint filers (or a MAGI of $200,000 for single filers). These figures are not indexed for inflation.

Thus, you could pay an effective tax rate of 23.8% (20% + 3.8%) or 28.8% (25% + 3.8%) on the sale of highly appreciated long-term capital gain property in 2015.

What is the taxable portion of the payment? It’s based on the “gross profit ratio.” Gross profit ratio is determined by dividing the gross profit from the real estate sale by the contract price.

Example: You acquired a parcel of commercially zoned land several years ago. It has an adjusted tax basis of $600,000. In 2015, you agree to sell the property for $1.5 million in five annual installments of $300,000 each with the first installment received in 2015. Because your gross profit is $900,000 ($1.5 million – $600,000), the taxable percentage of each installment payment is 60% ($900,000 divided by $1.5 million).

When you report the sale on your 2015 tax return, you’re only taxed on $180,000 of gain (60% of $300,000), reducing your exposure to the 20% capital gains rate and the 3.8% net investment income tax.

For simplicity, let’s say you save the 5% capital gains differential on $100,000 of income each year. That’s a tax savings of $25,000 (5% of $500,000)—well worth the wait.

Finally, watch out for a little-known tax trap. If the sales price of your property (other than farm property or personal property) exceeds $150,000, interest must be paid to the government on the deferred tax to the extent that your outstanding installment receivables exceed $5 million.

If your buyers are being ignored by the bank, consider a loan from the seller.

In today’s stymied real estate market, lenders are more cautious about making loans and sellers are more inclined to agree to carry financing to sell their properties more quickly. Here’s a look at how installment sales could work for your clients.

Installment sales are structured so that the seller receives payments for parts of the purchase price over a period of time following the closing.

If a buyer makes a substantial down payment and is sufficiently creditworthy, and if the seller either owns a property outright or has the resources to pay off any remaining mortgage, installment sales can be beneficial to both parties.

An installment sale also enables a seller to defer income taxes when at least one installment payment is received after the tax year in which the transaction closed. The seller recognizes the gain over the taxable years in which the payments are actually received.

Deferring taxes can be a real benefit to home owners whose capital gain exceeds the $250,000 individual exemption on the sale of a principal residence or who haven’t held the home for the two-year period required. Installment sales also benefit investment sellers who don’t want to use a Section 1031 exchange to defer taxes.

Each installment payment consists of three elements:

  • A partial return of the seller’s adjusted basis in the property sold, which isn’t taxable to the seller.
  • A portion of the taxpayer’s realized gain on the sale, which is taxable as a capital gain.
  • Accrued interest, which is taxable as ordinary interest income. An installment note must include an adequate stated rate of interest to be paid by the buyer. An adequate rate of interest is equal to or greater than the rate published by the IRS.

Each year, a seller receiving payments from an installment sale must determine how much of the year’s payments are taxable as capital gains and how much are a nontaxable recovery of the seller’s cost basis.

The taxpayer’s adjusted basis starts with the original purchase price, including initial closing costs. It then increases by any capital improvements and the selling expenses incurred in the sale. It’s reduced by any depreciation taken during the time of the seller’s ownership. The taxpayer multiplies the non-interest portion of the total payments received in that year by the gross profit ratio for the sale.\

The gross profit ratio is the taxpayer’s total anticipated gross profit divided by the total contract price. The anticipated gross profit is the contract price less the taxpayer’s adjusted basis. The contract price is equal to the selling price, reduced by the amount of any qualifying indebtedness that is assumed by the buyer.

Qualifying indebtedness is limited to the seller’s adjusted basis in the property. If the seller has refinanced the property and taken cash in an amount that creates indebtedness greater than the seller’s adjusted basis, the qualified indebtedness for purposes of calculating the contract price is limited to the adjusted basis.

Consider the example of a sale of raw land (below). In Year 1, Seller sold Black Acres to Buyer for $1.2 million. Buyer paid $200,000 in cash at closing and agreed to assume the current $200,000 mortgage. Seller agreed to finance $800,000 of the purchase price over a five-year installment note, with the first installment being due in Year 2.

The gross profit of $400,000 is divided by the seller-financing contract price of $1 million to determine a gross profit ratio of 40 percent. In applying this gross profit percentage to the $200,000 received in Year 1, the seller will recognize $80,000 of gain in the year of the sale. If the principal portion of the payments received by seller in Year 2 is equal to $160,000, the seller will recognize gain equal to 40 percent of $160,000, or $64,000 in Year 2. (Note that gain on real property that depreciates, such as an office building, would be calculated differently because gain from depreciation is taxed at 25 percent.)

Installment sellers should consult an attorney to better understand the risks of default by the buyer and inquire about ways to reduce the risk.

Calculating Gain

Selling price: $1,200,000

Less assumed mortgage: ($200,000)

Contract price: $1,000,000

Adjusted basis: ($720,000)

Selling expenses: ($80,000)

Gross profit (selling price minus adjusted basis minus selling expenses): $400,000