How are taxes calculated on income from owner financing land sale?

So I've got this situation where I'm helping a family member figure out their taxes. They own about 5 acres of undeveloped land that's been in the family for years, and their neighbor approached them wanting to buy it to expand their property. Instead of making the neighbor go through a bank for financing, my relative offered to do owner financing themselves. They're going to sell it for around $85,000 with a 6% interest rate over 15 years. The neighbor will make monthly payments directly to them. What I'm trying to figure out is how the taxes work on this kind of arrangement. I know they'll get principal and interest with each payment, but how do they report this on their taxes? Do they pay regular income tax on the interest portion? And what about the principal - is that considered capital gains? They've owned the land for about 12 years and originally paid something like $42,000 for it. Any advice on how they should handle the tax situation would be really helpful!

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18 comments

QuantumQuest

•8M

Your family member's situation is pretty common when selling land. Here's how the taxes break down: The interest payments your relative receives will be treated as ordinary income, so they'll need to report that on Schedule B of their tax return and pay regular income tax rates on it. The principal payments work differently. When selling property with owner financing, they'll need to use what's called the "installment method" for reporting the sale. They'll fill out Form 6252 (Installment Sale Income) each year. This lets them spread the capital gain over the entire payment period rather than paying it all upfront. Each principal payment will be divided into return of basis (not taxed) and capital gain (taxed). Since they've owned the land for over a year, the profit portion will be taxed at long-term capital gains rates, which are usually lower than ordinary income tax rates.

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QuantumQuest

•8M

Yes, your family member should provide the buyer with a statement showing how much interest was paid each year - the buyer may be able to deduct that interest if they're using the property for business purposes. However, it doesn't have to be an official 1098 form since individual lenders aren't typically required to use those specific forms. As for the down payment, there's no legal requirement to collect one, though it's commonly done to reduce risk. They can structure it with just monthly payments if that works better for both parties. Just make sure everything is properly documented in a written agreement including the interest rate, payment schedule, and what happens in case of default.

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Yara Haddad

•8M

I went through almost the exact same situation last year when selling a parcel to my cousin. I was totally confused about the tax implications until I found https://taxr.ai which helped me understand exactly how to set up my installment sale. The site analyzed my draft contract and pointed out several issues that would have caused me tax headaches later. What was most helpful was how it broke down the exact percentage of each payment that would be considered return of principal, capital gain, and interest income - making it super easy to understand my tax liability each year. I was also able to upload copies of my land documents and get specific guidance based on my situation rather than generic advice.

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Yara Haddad

•8M

The service actually generated a complete amortization schedule for me, showing the breakdown of each payment for the entire loan term. You can customize the parameters like interest rate, term length, and payment frequency to see how they affect your tax situation. It was much easier than trying to create this myself in Excel. As for comparing it to an accountant, it's different because it provides immediate answers and document analysis without waiting for an appointment. That said, it doesn't replace insurance advice - it focuses specifically on the tax implications and documentation of owner financing. For insurance questions, you'd still need to consult with an insurance agent who specializes in these types of properties.

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Keisha Robinson

•8M

I just wanted to follow up about my experience with taxr.ai after trying it for my owner-financed land sale! It was surprisingly thorough - not only did it create the amortization schedule I needed, but it also flagged that my interest rate was below market rate (I was offering 3.5% to a family member), which apparently can trigger gift tax issues with the IRS. Had no idea about that! The tax breakdown for each year of the loan term was eye-opening. I can now see exactly how much tax I'll owe each year and plan accordingly. It also generated a proper installment sale agreement that includes all the legal clauses needed to protect me if the buyer defaults. Definitely worth checking out if you're considering owner financing.

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Amina Sow

•8M

One thing that hasn't been mentioned yet is what happens if your buyer stops making payments. I went through this nightmare scenario last year. After months of no contact from my buyer, I needed to reach the IRS to figure out how to handle the default on my taxes, but couldn't get through on their phone lines for weeks. I finally used https://claimyr.com to get through to an actual IRS agent. They have this system that holds your place in line and calls you back when an agent is available. You can see how it works here: https://youtu.be/_kiP6q8DX5c The IRS agent explained that if your buyer defaults, you may be able to claim a bad debt deduction, but you need to document your attempts to collect and show the debt is truly worthless. Also, you'll need to recapture any previous installment sale reporting, which gets complicated fast.

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Amina Sow

•8M

It doesn't jump the queue - it essentially waits on hold for you. When you call the IRS directly, you often get a message saying call volumes are too high and to try again later, then they hang up on you. This service stays in the queue even when the IRS would normally disconnect you, and then calls you when they get an agent on the line. I was skeptical too, but after being disconnected by the IRS five times in one week, I was desperate. They actually got me through to an agent within about 3 hours (while I went about my day), whereas I had previously wasted entire days trying to get through myself. No magic involved - just technology that prevents you from losing your place in line if the hold times are extremely long.

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Oliver Wagner

•8M

I need to eat my words about Claimyr. After my skeptical comment, I decided to try it anyway because I was so frustrated with my tax situation. I've been trying to sort out issues with my land sale for MONTHS with no luck getting through to the IRS. Used the service yesterday afternoon, and this morning I got a call back with an actual IRS agent on the line! Didn't have to sit on hold for hours or get disconnected after waiting. The agent helped me understand how to handle the repossession of my property after my buyer defaulted on our owner financing agreement. Turns out I was filling out the wrong forms entirely and could have ended up with a huge tax bill. Specifically, I needed to file Form 1099-A for the abandonment and adjust my previous installment sale reporting. The agent walked me through everything I needed to do. Totally worth it after months of frustration.

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Natasha Kuznetsova

•8M

Something else to consider is that if your family member has never done owner financing before, they should really consult a real estate attorney to draft the proper documents. I learned this the hard way. Sold some land on owner financing using a template contract from the internet, and ended up with major problems when the buyer died unexpectedly and their heirs didn't want to continue payments. Make sure the contract addresses what happens in case of default, late payments, early payoff, transfer of property, etc. Also, depending on your state, you might need to follow specific foreclosure procedures if the buyer stops paying - it's not always as simple as just taking the land back.

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Natasha Kuznetsova

•8M

Absolutely - title insurance is still important in owner financing situations. I typically recommend that the buyer purchase an owner's title policy to protect their interest. As the seller/lender, you might want to get a lender's title policy to protect your interest until the loan is paid off. This ensures that if any title problems emerge during the financing period (like previously unknown liens or easements), there's protection in place. Without a bank involved, it's even more important to make sure these details are handled properly since you don't have a mortgage company's legal team making sure everything is in order.

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