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Installment Sale

DEFINITION

Creative financing method whereby the seller extends credit to the buyer in return for monthly mortgage payments. Installment sales contract: In the context of realestate, an installment sales contract is a payment method used to purchase real property by paying for the property installments, such as over the course of months or years. It is a form of selling financing, whereby the buyer borrows the required funds from the seller by paying a down payment and the remainder at a later date over a period of time.

EXPLANATION

An installment sale is a method used by sellers of real estate which allows a deferral of capital gains in future years of taxation. This means a taxpayer may elect to sale a property and receive payments after the present tax year in which the transaction is occurring. The seller has the option to report the profit of the sale upon the closing of the transaction or when installment payments are collected.

In an installment sale, the buyer must make regular payments or agreed upon installment payments. Installment sales involve a minimum of one of the payments to be collected following a year of the property’s sale.

Tax Rules for Installment Sales

The standard IRS rules for installment sales do not apply if the property is sold at a monetary loss. Installment sales only apply to sales with a profit. Therefore, if the profit sale does not retain a profit for the seller, it cannot be an installment sale.

By spreading the income of the sale to another tax year, the seller or taxpayer may be able to avoid paying higher taxes by being in a smaller tax bracket for the year, in turn reducing his or her overall tax liability.

Installment Sales and Land Contracts

In an installment sale of a land contract, the seller of the property provides buyer financing for the purchase of the property. Also, known as an installment sales contract, a land contract is a real estate contract that turns over the property to the buyer without the deed until the buyer makes payments for an agreed upon duration.

Purpose of Installment Sale

The sales contract will provide details of the real estate transaction including but not limited to sale price, date of payment, and amount financed. A land contract is common for buyers who cannot qualify for a standard loan. Under this form of agreement, the buyer agrees to pay the seller the loan in installments. The loan typically includes a balloon payment to reduce the length of the loan term and subsequently terminate the seller’s interest. By paying down the principal amount, the buyer is increasing their equity and diminishing the seller’s interest in the property.

The main purpose of a land contract is to provide short term seller financing. Typically, when the loan is close to being paid off or the buyer has improved their ability to qualify from a standard lender, the buyer will refinance with a conventional loan, thereby terminating the land contract. Oftentimes, land contracts are utilized when the buyer cannot qualify for traditional financing or when there is not enough time to attain financing prior to the close date of the purchase contract.

Because land contracts are written by buyers and sellers, individual terms of the agreement can be modified according to the wishes of both parties. Loan programs under a land contract may include interest only loans, PITI payments, negative amortization, balloons, and others.

In a land contract, as mentioned above, the seller retains title to the property, while the buyer has access to the property. Because of the complex nature of land contracts, buyers and sellers should consult their attorneys before signing any paperwork.

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