There are several benefits to a landowner financing the sale of their own land. But there are also disadvantages. Here are some thoughts to consider:
- Seller-financing is a way to defer the taxes paid on capital gains. A seller pays tax as payments are made. So, by spreading payments out over time, the taxes are spread out over time.
- Seller-financing can lower the overall tax rate. Since capital gains rates are progressive (depending on total income), payments can be taxed at a lower capital gains rate (assuming steady income from other sources) over many years, as opposed to a seller taking the sale proceeds all in cash and showing a huge income all in one year.
- Seller-financing may enable the seller to obtain an above-market interest rate for the portion of the sale proceeds that are financed.
- Seller-financing creates a mechanism for steady, recurring cash flow over time. For folks on fixed incomes, this can be attractive.
- In a “soft” real estate market, seller-financing offers a way to attract buyers that might not be discovered otherwise. And sometimes it enables sellers to obtain a higher sale price because of the financing accommodation.
But, there are also disadvantages to seller-financing:
- A buyer can default on the debt. This can happen for many reasons including bankruptcy, death of the borrower, or financial hardship. If a buyer stops making payments, the seller may have to go through legal channels to repossess the property (which can be a long and expensive process). Plus, they didn’t get all their money and they have to start over with finding a new buyer. One way to avoid having to go through the repossession process is to sell using a “contract for deed” or “bond for title”. These devices let the seller keep title to the property until certain payment thresholds are met.
- A buyer can damage or decrease the value of the property while it’s in their possession (cut timber, sell land out of the middle that damages the balance, etc.) and then default on the debt. Now don’t you wish you’d just paid the taxes and moved on! It’s important that loan documents (mortgage, note, etc.) stipulate collateral safeguards until the debt is repaid (written pre-approvals, partial release payments, etc.).
- Seller-financing of land with a high cost-basis may offer little or no tax savings. “High basis” means that the sale price is very close to the price paid for the property (or its value at the date of inheritance). Consequently, very little capital gain is realized.
The lending criteria used by most commercial banks today are much stricter than they used to be. It is our experience that sometimes when a buyer requests “seller-financing”, it is code for “I may not qualify for a commercial loan”. If true, this should be a red-flag to a landowner. It’s important to verify that a buyer is credit worthy before entering into a seller-financing arrangement. In fact, at Cyprus Partners we request that buyers making an offer contingent on seller-financing provide us with a current “pre-qualification letter” from a commercial bank to accompany their offer. Just the same as when a buyer makes an offer contingent on bank financing. A pre-qualification letter states that the bank has reviewed the credit worthiness and financial condition of a prospective borrower and is willing to make a loan, depending on the property and terms of purchase.
Items to negotiate when considering seller-financing include the amount of cash at closing, length of loan, interest rate and payment schedule (monthly, annual, payment date & penalties for late payment, etc.).
While seller-financing can be advantageous to a landowner seeking to sell their land, there are painful disadvantages too, sometimes more painful than just paying all the tax in the year of the sale. And, there are more issues and safeguards to consider than can be covered in this article. So, a wise landowner will seek advice from their land broker, their accountant and an experienced real estate attorney before entering into a seller-financing arrangement with a buyer.
This article is an excerpt from Tom Brickman’s e-book, “Buying Rural Land: Tips and How-to’s”, a collection of well-written, quick reads to help you find a rural property you’ll love and simplify getting it done. Download the e-book and learn from a seasoned pro with 40 years of experience.
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