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Tax.appeal.168
Tax.appeal.168, Tax Accountant
Category: Tax
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Experience:  3+ decades of varied tax industry exp. Tax Biz owner
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I want to sell a house to my daughter FMV of 175000 (what I paid 18 months)

Customer Question

I want to sell a house to my daughter for the FMV of 175000 (what I paid for it 18 months) for $10,000 down and I hold the mortgage for the rest. Do I have to pay income tax on the monthly payment if I charge no interest?
Submitted: 1 year ago.
Category: Tax
Expert:  Tax.appeal.168 replied 1 year ago.
Welcome. Thank you for choosing us to assist you. My name is ***** ***** my goal is to help make your life, a little... less taxing.
Q: Do I have to pay income tax on the monthly payment if I charge no interest?
A: Yes. Even if you do not charge interest, the monthly payment is income to you and is required to be reported.
As for not charging interest, this can raise a red flag with the IRS. I know that you are not loaning the money to your daughter, but I think the same rule applies as it relates to charging interest. SEE BELOW:
Interest-free loans
If you loan a significant amount of money to your kids, say, enough to buy a house, it’s important to charge interest.
If you don’t, the IRS can determine that interest you should have charged was a gift. (In addition, the borrower may be more motivated to actually pay you back if there’s interest involved!)
The rate of interest on the loan must be at least as high as the minimum interest rates set by the IRS.
REFERENCE SOURCE:
http://blog.taxact.com/family-loans-does-the-irs-care-if-i-lend-my-kids-money/
Let me know if I can be of further assistance to you regarding this matter.
Expert:  Lane replied 1 year ago.
Hi,
I have a DIFFERENT answer.
Above, the following is stated:
"Q: Do I have to pay income tax on the monthly payment if I charge no interest?
A: Yes. Even if you do not charge interest, the monthly payment is income to you and is required to be reported.
That is NOT correct. The repayment of loan principal is NOT income.
You did not take a deduction when you lent it and the person to whom you lent did not recognize income (because they have to pay it back).
However, on the following I do agree, in part (that interest must be charged) but from there forward, I again disagree.
IRS calls interest free loans (regardless of whether it's family or not) below market loans:
You can read more about that here, in IRS Publication 550:
http://www.irs.gov/publications/p550/ch01.html#en_US_2014_publink10009882
For a TERM loan such as this, the lender is treated as transferring an additional lump-sum cash payment to the borrower (as a dividend, contribution to capital, etc.) on the date the loan is made.
The amount of this payment is the amount of the loan minus the present value, at the applicable federal rate, of all payments due under the loan. An equal amount is treated as original issue discount (OID)
The lender must report the annual part of the OID as interest income. The borrower may be able to deduct the OID as interest expense.
The way to pre-empt this, is to charge an interest rate that is in line with current market rates and report ONLY THE INTEREST as income.
IRS' applicable Federal Rate (AFR) is one way to do this, (you can see that here: http://apps.irs.gov/app/picklist/list/federalRates.html ) but this is what IRS calls a facts and circumstances test. It is only necessary that you can show that the interest rate you charged is in line with current market rates at the time the loan was made.
And finally, your daughter, if this is her primary residence, or second home, can deduct the interest.
But, again, ONLY the interest rate you charge is income to you ... NOT the entire loan repayment.
let me know if you have questions...
lane
Expert:  Tax.appeal.168 replied 1 year ago.
I stand by my original response. The monthly payments made to you by your daughter as mortgage payments is taxable income to you.
Expert:  Lane replied 1 year ago.
So sorry, but this is not correct.
The repayment of the principal that you are financing if there is no gain, is not income.
You invested for X. You are selling for x ... no gain.
Only the interest would be income ... and yes, there must be interest.
Expert:  Tax.appeal.168 replied 1 year ago.
Hello again,
Pardon the back and forth interaction here between me and the other person. Wanting to sell the house this way, is considered an an installment sale. As the other person was quite insistent that he was correct regarding whether the monthly payment was taxable, I did further research on installment sales. I AGREE that the other person is correct in regards ***** ***** interest being taxable and if there is not a gain, there is no tax on the monthly income. To get a better understanding about installment sales, SEE BELOW:
An installment sale is a sale of property where you will receive at least one payment after the tax year in which the sale occurs. You are required to report gain on an installment sale under the installment method unless you "elect out" on or before the due date for filing your tax return (including extensions) for the year of the sale. You may elect out by reporting all the gain as income in the year of the sale on Form 4797 (PDF), Sales of Business Property, or on Form 1040, Schedule D (PDF), Capital Gains and Losses, and Form 8949 (PDF), Sales and Other Dispositions of Capital Assets. Installment method rules do not apply to sales that result in a loss. You cannot use the installment method to report gain from the sale of inventory or stocks and securities traded on an established securities market. You must report any portion of the gain from the sale of depreciable assets that is ordinary income under the depreciation recapture rules in the year of the sale.
Your total gain on an installment method sale is generally the amount by which the selling price of the property you sold exceeds your adjusted basis in that property. The selling price includes the money and the fair market value of property you received for the sale of the property, any selling expenses paid by the buyer, and existing debt encumbering the property that the buyer pays, assumes or takes subject to.
Under the installment method, you include in income each year only part of the gain you receive, or are considered to have received. Use Form 6252 (PDF), Installment Sale Income, to report an installment sale in the year the sale occurs and for each year you receive an installment payment. You will need to file Form 1040 (PDF), U.S. Individual Income Tax Return, and may need to attach Form 4797 (PDF) and Form 1040, Schedule D (PDF).
You report interest on an installment sale as ordinary income in the same manner as any other interest income. If the installment sales contract does not provide for adequate stated interest, part of the stated principal may be recharacterized as "imputed" interest or as interest under the original issue discount rules, even if you have a loss. You must use the applicable federal rate (AFR) to figure the unstated interest on the sale. The rates are published monthly in the Index of Applicable Federal Rates (AFR) Rulings on IRS.gov.
You can also refer to IRS Pub 537:
http://www.irs.gov/publications/p537/ar02.html
I apologize for the misinformation regarding the monthly payments being taxable in my initial response.