In selling commercial property part 4, we discuss what’s possible, and finish up with a sell financing a property sold with a dangerously low down payment. Included is a short discussion on why different investors will pay more or less taxes than others on this exact scenario.

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Transcript:   We’re getting to the fourth installment now of one of my clients selling a commercial building in New York for $1.25 million with a silly low downpayment of only $100,000, and we’ve been discussing the structure of that note. Today, let’s talk about how that note payment might be received by the seller in terms of what his liability could be to the IRS. Here’s what happens. Every dollar you receive, especially on an amortized note, has three sections to it, and there’s a formula to decide how two of those three sections add up. The first one is interest. That’s easy. Interest received is taxed at ordinary income rates for the vast majority of the time. If you receive $10,000 in interest for a year, it will be a lot more in this case, but if you did, that’s like getting a raise of $10,000 at work. Same tax, right? Now, what about the principle inside of each payment that’s amortized? We know that every payment you receive has a little bit more principal than the payments received the month before, and that’s how you pay those things off. That part of the dollar that is not interest, that is to pay down the principal balance of that loan, was divided into two parts, one is return of capital and the other is return on your capital. There is no tax liability whatsoever on return of capital. That just means you got your original downpayment or whatever or however you bought it back. If you put $200,000 down, there’s a formula and you come up with it and you get it back. That’s not taxed. The other half of that principal paydown you got in each payment is return on capital, and as long as you qualify for long-term capital gains treatment, and in this case they do, it’s taxed at 15% instead of ordinary income. We like that because you’re just paying each year on the value received, and since it’s spread out over 10 years, not only are you only paying give or take 1/10 every year, although that’s not really true, but roughly speaking, we’ll work with that. There’s no balloon payment. There’s no gigantic tax liability in any 1 year, and that can be really good planning over time because you have to plan for those liabilities. What many people don’t know, and this is a red flag, you always need to address with your attorney and/or your CPA. Many times, you can incur tax liabilities due to the way your sale was structured when you really didn’t receive all that much cash from the sale, or you receive no cash from the sale. You can still owe up to 5 or 6 figures in taxes, and people wonder about how that can happen. It’s just about your basis. The basis doesn’t have to do with, “Well I paid this much and I sold it for this much.” It’s more complicated than that, and the formulas for computing adjusted basis, especially when somebody has maybe handled more than one tax deferred exchange for that equity over time, and there’s domino after domino of deferred capital gain, that’s where you can get into a problem, where maybe you didn’t sell the property for that big of a gain, but because your adjusted basis was about $0.37 over a happy meal, you still had the tax liability. That’s something you want to really red flag and make sure that it’s not laying there to trap you.