Subject 2 And Taxes
Hey Gang: I think that I may have already asked this question..if so , sorry, but lately my brain has been going in 73.5 different directions. If I take a house over sub 2, isn't the seller responsible to pay capital gains tax? Let's also for the time being assume that the seller is under 55 so they can't use the one time exempt rule.
Second: If I take the house over sub 2 and use a " Loan Servicing Company" to handle all the payments, and I advertise my investment property as " Owner Financing" find a buyer, he/ she gets all of the beneifits of ownership..which is good for he/she...what about "MY" taxes. Won't I now be in the same position as far as capital gains is concerned? I mean afterall, I did sell it at a price higher then I acquired it for.
Thanks in advance
Kerry
[addsig]
I'm no tax expert, I heard that the one time exemption went away years ago, and is no longer available to anyone. As I understand things, there are no capital gains if they sell sub2 as there is no profit for them. If they were selling for a profit, and had not lived in the house 2 of the last 5 years, they would be responsible for capital gains taxes.
You will not have actually sold the property and booked your profit until your Buyer has fulfilled his obligations.
That is when you transfer the Deed and consider your house sold.
That is when tax implications will come into play.
May be a year or more down the line.
Quote:If I take a house over sub 2, isn't the seller responsible to pay capital gains tax? Let's also for the time being assume that the seller is under 55 so they can't use the one time exempt rule. A sale in a Subject To transaction is a taxable event. If the property is the seller's primary residence and if the seller meets the two year ownership and occupancy tests, then each seller has no tax due on the first $250K of his profit from the sale.
It is not always correct that a seller in a Subject To deal has no equity (profit). The seller's profit is determined by the difference between his cost basis and his sale price. Let's say I bought my primary residence ten years ago for $150K. Last year, I refinanced it for $250K to cash out some of my equity. Today I sell to you in a Subject To deal for the $248K loan balance. My profit in this transaction is $98K. If I qualify for the capital gains exclusion, my profit is tax free, otherwise I have capital gains taxes due on my $98K profit.
The over-55, $125K, once-in-a-lifetime capital gains exemption on the sale of your primary residence was repealed in 1997 and replaced with the two-year rule in Section 121 of the Internal Revenue Code.
Quote:Second: If I take the house over sub 2 ... what about "MY" taxes. Won't I now be in the same position as far as capital gains is concerned? I mean afterall, I did sell it at a price higher then I acquired it for. I disagree with Neill7. You are not too specific about the structure of the sale here, so I will describe two different exit strategies though the tax consequences of each are the same.
First, let's sell with a wrap-around mortgage. You transfer title to the property to your buyer at settlement and you become a secured creditor with a mortgage in second position behind the original mortgage in your Subject To purchase. Your profit in this deal is recognized for tax purposes on the day you go to settlement with your buyer. Even though you may not receive all your profit immediately (you did offer owner financing), you are still liable for the tax due on the entire profit in the year of the sale. Your profit is taxed as ordinary income, and would be reported on Schedule C (1040) of your tax return. Additionally, your net profit is used to calculate your self-employment income taxes on Schedule SE. You may not use the installment sale tax treatment here even though you have entered into an installment sale. Additionally, this property is not eligible to participate in a 1031 tax-deferred exchange.
Because you will have already paid the income taxes due on your profit, the portion of each installment payment you receive from your buyer that is allocated to the loan balance is tax free. The portion of each installment payment allocated to the interest due on your mortgage loan is ordinary income.
In the second exit strategy, you sell on a Contract For Deed. Even though you do not transfer title until the contract is satisfied, the property is considered sold on the day you enter the contract. The IRS treats a Contract For Deed the same as an installment sale.
The tax consequences for this exit strategy are the same as for the first strategy. Your entire profit is recognized on the day you enter the contract. Your entire profit is taxed as ordinary income on Schedule C (1040) and your net income from Schedule C is used to compute your self-employment income taxes on Schedule SE (1040). The installment payments received from your buyer as well as the balloon payment at the end of the contract are divided into a tax free return of principal and interest taxed as ordinary income.
[ Edited by DaveT on Date 05/09/2004 ]
Great info, Dave.
If you don't mind, could you share the consequences if sold on a L/O as well?
Thanks.