Land sales contract and capital gains.

Assuming that the overall gain is within the limits for excludable income from the sale of a principal residence, yes.

Again, yes.

Yes

See my first answer above - IF you meet all the conditions, then yes.

See Below.

Great question!

I've answered the first three parts above, inserted into your op. The last issue is a bit more drawn out so I'm addressing it here.

You should read up on the differences between a foreclosure and a repossession. Many people get these confused, these are NOT interchangeable terms.

In your situation you would have a repossession - where the party who sold the item AND carried the note takes the property back. In this situation you now have BOTH the property and the money. Hence, any money that you've collected would instantly convert into taxable income and tax would be due with the return for the year in question.

This is one of the most often missed and misunderstood transactions and not understanding can be extremely detrimental to your wallet. Consider this fact pattern:

Mom and Dad build a very nice house, 30 years ago. Its paid for, no mortgage. Mom and dad pass on and the 3 children inherit the house and get to step up the basis to full FMV - let's say that is $500,000.

Now the kids sell the house, under the installment plan, to someone and they carry the note. In theory there is no gain on the sale because of the step up in basis. They distribute the money collected each month and they each report and pay tax on their share of the interest.

Let's say that after 25 years of collecting payments they've collected $350K so far, all of which was tax free because there was no gain. Now, 25 years into a 30 note the buyer defaults and the kids repossess the house. Now they have BOTH the house AND the money they've collected. WHAM! The $350K that they collected is now taxable income!

BUT WAIT, there's more -

The kids have spent that money. Remember, the house payment was only about $2700 a month, or about $900 per kid. That money has been spent, not saved. So the kids have NO CASH available to pay the tax due on this windfall.

You may also have an issue with repossessing an asset that has substantially appreciated in value. Off the top of my head I'm not quite sure how that factors into the equation, but I'd bet it does.

Your situation is a bit different since you're talking shorter term. BUT the issue remains that if you get to keep the house AND the money SOMETHING will be taxable. If you do this you need to make sure to set aside enough cash to cover any tax that might be due in the event you repossess and you need to set aside enough cash to cover any collection costs you might incur if you need to repossess.

BTW - foreclosure is when a third party lender takes collateral when a loan goes into default. I believe that there are different rules for this than there are for a repossession.

Good luck, Gene E. Utterback, EA, RFC, ABA

Wouldn't Tax Code Section 1038(b)(2) limit gain recognition to zero in this case, with an adjustment to the basis of the reacquired house, reducing it to $150K? That Code provision says: "The amount of gain determined under paragraph (1) resulting from a reacquisition during any taxable year beginning after the date of the enactment of this section shall not exceed the amount by which the price at which the real property was sold exceeded its adjusted basis, reduced by the sum of--

(A) the amount of the gain on the sale of such property returned as income for periods prior to the reacquisition of such property, and

(B) the amount of money and the fair market value of other property (other than obligations of the purchaser received with respect to the sale of such property) paid or transferred by the seller in connection with the reacquisition of such property."

You raise a very good point, one which would need to be thoroughly researched - which I freely admit I have NOT done. It very well may be that you are correct, but the case I was involved with - many years back - turned out differently and quite frankly I don't recall that code section coming up.

This is a GREAT illustration of why anyone coming here for help cannot rely on ONLY what's posted here. I took one position, that I truly believe to be valid, while Mr. Daniels has taken another, and which I might add he has backed up with a citation (which I did not do). The real answer will depend on the particulars of the actual situation and the rules that apply at the time. At best, you should take what you get here as a starting point AND VERIFY it with your own research.

Good luck, Gene E. Utterback, EA, RFC, ABA

The IRS doesn't always get it right, either. I've seen cases where the IRS failed to argue (or even find) the right legal theory behind their case, and ended up losing a case they should have won.

Stu

How does that differ from the case where the buyer backs out and forfeits some earnest money? Isn't that considered a reduction in basis?

Suppose I buy a house for $100K, live in it for 10 years, and sell it (on contract) for $300K. $200K profit, no tax. The buyer pays $150K then defaults. The market has tanked, so I immediately resell it for $200K cash. Now my total receipts from selling it (in two tries) are $350K, which is a $250K profit, and shouldn't be taxable at all. At worst, when I recover the (now worth $200K) house for $150K remaining debt, that's a $50K gain. It doesn't make sense to convert the $150K I've already received from excludable LTCG to ordinary income.

Seth

It does make sense to me. Essentially you bought the house for 100K and sold it at the very end for 200K. You got 100K profit for this. In the middle you got 150K and it is taxable. The manner in which you received this 150K is unusual -- there was an attempt to sell the house and a downpayment but the buyer forfeited -- but all the same it is 150K of income.

Now is the 150K taxed as Other Income or self-employment income or long term capital gain?

Thinking about it more, the the gain when the house is eventually sold is probably not 200-1000K. From section 1038(b)(2) it is I think

All of the money I got came from selling the house. The total I received was $350K.

It comes from the sale of a long-term capital asset, doesn't it?

Suppose that when the buyer defaults, I sell the _contract_ for $190K. The buyer of the contract seizes the house, and sells it for $200K cash. That's clearly $10K in ordinary income (if he's in the trade or business), or short-term capital gains.

But now I've clearly received a total of $340K for selling the house, (profit of $240K), $200K of which is excludible (the other $40K is profit from the sale of the contract, which has a basis of $150K).

Seth