One of the first questions sellers ask me about owner financing is not about the buyer. It is about taxes. "If I carry the note, do I pay tax on the whole gain this year?" Usually not. But it depends on who you are and what you do with the note.
I am not a CPA, and this is not tax advice. It is a plain English map of the IRS rules so you know what to ask yours.
What is an installment sale?
A sale where you get at least one payment after the year of the sale.
That is the IRS definition in Publication 537. Selling land on owner financing is the classic example. Under the installment method, you pay tax on your gain as you collect it, not all in the year you sell. You report it each year on Form 6252.
How is seller financed land taxed?
Each principal payment is part return of your cost and part taxable gain. Interest is ordinary income.
The IRS uses a gross profit percentage: your gain divided by the contract price. That percent of every principal payment, including the down payment, is taxable gain in the year you get it. The interest your buyer pays is taxed separately as interest income.
| Example | Amount |
|---|---|
| Sale price | $100,000 |
| Your cost (basis) | $30,000 |
| Gain | $70,000 |
| Gross profit percentage | 70% |
| Down payment | $20,000, so $14,000 is gain this year |
| Note | $80,000, 70% of each principal payment is gain as it comes in |
This example ignores selling costs and assumes no mortgage on the land. Your CPA will adjust for both.
Want cash now instead of payments?
We buy land notes at closing for 80% to 90% of the balance. Ask your CPA how the sale is taxed, then send us the deal.
Get a Free QuoteSell Your NoteWhat happens to my taxes if I sell the note?
Selling the note generally makes the rest of your deferred gain taxable that year.
When you sell an installment note, the IRS compares what you get for it to your basis in the note (Pub 537). Your basis is the unpaid balance minus the untaxed gain in it. In the example, the $80,000 note has a $24,000 basis. Sell it for $68,000 and about $44,000 more is gain that year.
Notice what the discount does. Cash sale at $100,000: $70,000 gain. Owner financing and selling the note for $68,000: $14,000 plus $44,000, or $58,000. You collected less and reported less. Whether that beats holding the note depends on your tax bracket and what you do with the cash.
Can a land flipper use the installment method?
Usually not. Dealers who sell land as inventory generally cannot defer the gain.
Pub 537 says dealer sales, including "real property held for sale to customers in the ordinary course of a trade or business," are not installment sales. If you buy and flip land as a business, the IRS may see you as a dealer, and your gain is taxed in the year of the sale either way. There is a narrow exception for dealers of residential lots who elect to pay an interest charge.
Here is why it matters. If you are a dealer, holding the note does not defer your tax, so it rarely makes sense to hold a note just for tax reasons. Selling it at closing gets you the cash to pay the tax and buy the next deal.
Rule of thumb: investors may defer, dealers usually cannot. Ask your CPA which you are.
What else should I ask my CPA?
Minimum interest, borrowing against the note, and how the gain is taxed.
- Minimum interest. If your note charges little or no interest, the IRS can treat part of the principal as interest, using the applicable federal rate.
- Borrowing against the note. If the sale price is over $150,000, pledging the note as security for a loan can count as a payment under the pledge rule. Ask before you use note hypothecation.
- Capital gain or ordinary income. It depends on whether the land was an investment or inventory, and how long you held it.
- State tax. Your state may tax the gain differently.
Plan the tax before you close, not after. Once the deal records, most choices are made.
Frequently Asked Questions
How is owner financed land taxed?
Under the installment method, you pay tax on your gain as you collect principal payments, reported on IRS Form 6252. Interest is taxed as ordinary income.
Do I pay tax if I sell my land note?
Generally yes. Selling the note makes the rest of your deferred gain taxable that year, based on what you get for the note minus your basis in it.
Can land flippers use the installment method?
Usually not. IRS Publication 537 says real property held for sale to customers in a trade or business is not an installment sale, with a narrow exception for residential lot dealers who elect an interest charge.
What form reports an installment sale?
IRS Form 6252, filed with your return each year you receive a payment.