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My wife and I are selling a house to friends and holding the…

My wife and I...

My wife and I are selling a house to friends and holding the note for 5 years with a balloon due at that time. We are offering 2% interest with nothing down so they can better qualify for a conventional mortgage in 5 yrs. Will we still qualify for capital gains exemption as that is imperative to do the deal. Is there a minimum interest that we must charge so as not to be some sort of gift?

Accountant's Assistant: The Accountant will know how to help. Is there anything else the Accountant should be aware of?

Not that I can think of at this time. Oh yea. the property is in Hawaii.

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3/8/2018
Barbara
Barbara, Enrolled Agent
Category: Tax
Satisfied Customers: 5,781
Experience: 20+ years of experience in tax preparation; 30+ years of experience as a real estate/corporate paralegal.
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Welcome to Just Answer. My name is ***** ***** I will be happy to assist you.

Are you selling your primary residence?

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Under IRC 121, you can qualify for the sale of home exemption from capital gains tax even if the sale is an installment sale, which is the transaction you describe.

The only issue is if the buyers default on the note and you re-acquire the property, you will have to recognize any gain you previously excluded if you do not re-sell the property within one year.

See the following: https://www.caltaxadviser.com/blog/2014/06/irs-may-not-let-you-exclude-gains-from-selling-a-home/

https://www.irs.gov/taxtopics/tc701

Please let me know if I can assist you further.

Thank you and best regards,

Barb

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Customer reply replied 1 month ago
there is no requirement for a minimum interest rate to avoid the transaction appearing to be a gift and then a different tax category?

An installment sale contract generally provides for adequate stated interest if the contract's stated principal amount is less than or equal to the sum of the present values of all principal and interest payments called for under the contract. The present value of a payment is determined based on the test rate of interest, defined next. (If section 483 applies to the contract, payments due within 6 months after the sale are taken into account at face value.) In general, an installment sale contract provides for adequate stated interest if the stated interest rate (based on an appropriate compounding period) is at least equal to the test rate of interest.

See the AFR requirements in Publication 537:

https://www.irs.gov/pub/irs-pdf/p537.pdf

https://www.irs.gov/pub/irs-drop/rr-18-06.pdf

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Barbara, Enrolled Agent
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Have a great day!

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