<p>My father in law recently passed away. He had very little left after several years in a nursing home. But a few years ago he sold some land and self financed it. The payments are still coming in (will be divided between my husband and his sister) and will be for a few years, part capital and part interest. We are not sure how the tax will work on that. While he was alive the interest part was taxable but not the capital. I would think it would still be the same but my husband is worried it will all be taxable. I don’t even know how to google for this!! Anyone have a clue?</p>
<p>I would definitely ask a tax accountant but I found this discussion on the same topic
[TaxAlmanac</a> - Discussion:Inherited seller-financed mortgage](<a href=“http://www.taxalmanac.org/index.php/Discussion:Inherited_seller-financed_mortgage]TaxAlmanac”>http://www.taxalmanac.org/index.php/Discussion:Inherited_seller-financed_mortgage)</p>
<p>It seems since the property was inherited (no tax on the inherited portion) you would pay tax only on the gain (or interest on the principal). I am not a tax expert - but if I find something more I will post it.</p>
<p>Sorry about the loss of your FIL</p>
<p>Thank you.</p>
<p>The link contained a useful link (the post in tax almanac were contradictory which I have found in the past - makes me wonder about paid tax accountants, to be honest). But I also think it looks, according to the IRS link, like just the interest part will be taxable income.</p>
<p>Swimcatsmom – there are investors and businesses that will purchase the note for a lump sum if that would be helpful. If this mortgage has been in place for a few years it probably has a somewhat higher rate of interest than we’re seeing now.</p>
<p>It depends on when he died. If the death occurred in 2010, the answer may be different than it has been in our lifetimes. This year, while there is no inheritance tax, there was a change in the basis rules for inherited property.
In every other year, when property was inherited, you took a basis of the value of the property as of the date of death. In the OP’s situation, it would have caused only the interest to be taxable. But this is not every other year.
In 2010, the basis of inherited property is whatever the decedent paid for the property originally which would almost certainly cause at least some of the principal payments to be taxable.
You need to see a CPA. </p>
<p>Sorry if that isn’t what you wanted to hear…</p>
<p>The 2010 law allows the heirs to take a step-up basis on up to to $1.3 million of the inheritance. This property is nowhere near $1.3 million (probably not a 10th of that) so we will not be impacted by the new law.</p>
<p>Your husband is confusing two different kinds of taxes.</p>
<p>One is income tax which is the interest generated by the note. This won’t change before or after the estate settles.</p>
<p>The second is inheritence tax which is taxed for large estates. The value of the asset (which is the loan that the buyer is paying on) is part of the estate. The value of the asset is not the value of the property - is the amount the note could be sold for on the market.</p>
<p>You really need to get some expert advice. While I love all my friends on CC, we really don’t know what we’re talking about.</p>
<p>There may also be some state tax issues that are unique to your state, and we don’t even know what state you’re in.</p>
<p>Start with your accountant, and if s/he doesn’t know how to answer this, s/he should refer you to an estate attorney.</p>
<p>When you speak to the expert, don’t forget to explore state tax and inheritance issues as well.</p>
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<p>I disagree. What I said about is exactly correct and I do know what I’m talking about.</p>
<p>Repayment of the principal of the loan is simply transferring the title bit by bit from the seller to the buyer. The principal is not taxable as income because it’s not income. The same principal applies to the sale of a house. </p>
<p>The interest is taxable because it is income that has been generated from an activity.</p>
<p>Well, turns out is more complicated than I though. My FIL put the whole thing in a trust fund in his, my husband, and my sister in laws names some years back (I was not aware of this). Which, if I understand correctly, means it does not go through probate and the base value of the property is the original purchase price, not the value of the property on the date of his death. So the taxes will be even more complicated and will also be much higher. The land was sold for quite a bit more than the original purchase price so a good chunk of the income from the loans will be capital gains and a good chunk will be interest.</p>
<p>I guess he was trying to avoid inheritance taxes, of which there would have been none even before this year as his assets were not that high. Instead we will be paying out more in taxes than we would have otherwise. I guess that is why my husband was worried about the taxes. I did not have all the details.</p>
<p>Oh and the money is all in a different state to the one we live in. 2011 tax returns are going to be so much fun.</p>
<p>Swimcatsmom,</p>
<p>Your story doesn’t make sense.</p>
<p>The property was sold many years ago. The value of the property today is not relevant because it is no longer owned by your family. The property is not passing through the trust fund - the asset is the value of the note, not the value of the property.</p>
<p>Capital gains taxes are not paid upon the FIL death. </p>
<p>Capital gains tax is 15%. Interest income is what the marginal tax rate is for the taxpayer. Both are separate form inheritance tax.</p>
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<p>From what you described, there are no inheritence taxes either way. The only taxes being discussed is the capital gains and interest income tax.</p>
<p>Not sure how my “story” does not make sense. it is exactly what has happened, not a “story”. I am just trying to understand the tax implications and this aspect of taxes is very new to me.</p>
<p>My (possibly confused understanding) - If the value of the note was in just his name on his death then wouldn’t that value have become the valuation basis to his heirs? </p>
<p>For instance, putting all interest aside, if he had paid $30,000 for the property then sold it for $120,000 with a self financed mortgage over 10 years then the $1000 coming in to him every month $700 would have been cap gains and the other $300 would not have been income. So at the end of 10 years $90,000 would have been treated as a gain and $30,000 would not, just as if he had sold it outright.</p>
<p>But as he died before the note was paid then, if it was in his name, on his death wouldn’t the value of the note on the date of his death - say $90,000 was outstanding ($67,500 gain and 22,500 of the original cost basis) - become the the valuation basis for the heirs under the step up rules? Meaning they could then use the $90,000 as the basis for tax purposes. So, for the heirs, there would be no capital gains on the income received from the note? That was what I was understanding from reading the IRS rules on it.</p>
<p>But, because of this trust situation, I think the valuation remains as it was when he was alive - that is the original cost basis of the property must be used, meaning there will be capital gains. So using the above numbers (which are not the real numbers) there will end up being cap gains (for the remaining holders of the trust) on $67,500, while if he had kept it all in is name there would have been no cap gains.</p>
<p>Am I completely turned backwards here? This is all new to me. I do our taxes , but nothing this complicated! (I do think we will be consulting a tax accountant, but I like to have some understanding before I talk to an expert so i can ask the right questions)</p>
<p>I hear that the value of the property must be over $2.5 million in order for there to be a tax.</p>
<p>Now you’re talking. That story makes sense. (By story, I don’t mean made up. I mean the style in how you are describing the situation.)</p>
<p>I don’t know how capital gains works when a person sells an asset and at the same time issues a loan to the buyer and the buyer makes payments to the seller.</p>
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<p>Inheritance tax, yes.</p>
<p>Capital gains tax, no.</p>
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Make allowances for my total confusion 
Not sure I know what I’m talking about and if i do I’m not sure how to put it into words!!</p>
<p>I just found this - which I think means that none of this made any difference and the tax would have been the same either way (I think):</p>
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<p>All of the above discussion seems to assume that your father was using what is called the installment sale method, meaning that he would be recognizing the gain (income) from the sale in pieces as the payments came in.</p>
<p>If he didn’t elect installment sale treatment, then he would have recognized the gain at the time of the sale, and paid whatever capital gains taxes were due at that time. The gain would have been the difference between his basis in the property, and the “present value” of the note he received (which would have been much less than the face amount, normally). </p>
<p>If he was using the installment sale method, he would have been filing form 6252 with his tax return. </p>
<p>If he used the accrual method, he would have paid his capital gains taxes in full that year, and his heirs would inherit the outstanding note with a basis equal to its fair market value at the time of this death.</p>
<p>Based on your discussion of the values, I think there will be no inheritance taxes.</p>
<p>That’s interesting. We will have to go through his tax returns and find out what he did. I mentioned this to my husband and he *thinks *that it’s possible his Dad may have done the opposite and taken all the original cost against the earlier payments - is that even possible? We are trying to figure this all out from a distance - my SIL is there and is the one in charge of everything and she is even more confused than we are (if that’s possible) plus we keep getting the info piecemeal. My husband is planning to go visit and try and help figure this stuff out but we wanted to try and have an idea about the issues first. There are several notes and some are quite old as he cut up the land and sold it to different people over a period of several years. </p>
<p>We will have to have to see if we can find his tax returns and figure this all out. It is such a complicated mess! This is all there was left as a few years in the nursing home had wiped out what he had, which was several hundred thousand dollars. Really makes you think about how you want things sorted out so your heirs don’t have a mess to deal with.</p>
<p>Thanks for the input. Still confused but at least I have a little bit of understanding about the different aspects which will help. I love CC. </p>
<p>We have one more year of FAFSA to file for my daughter - just hoping this does not mess that up. There is very little actual money involved but we have filed simple tax returns for the last few years and I think this may end that.</p>