Capital Gains on Contract for Deed Sale: Understanding the Tax Implications

If you are selling property through a contract for deed, it is important to understand the tax implications of the transaction. One of the key considerations is capital gains tax, which is a tax on the profit you make from the sale of an asset.

A contract for deed is an agreement between a buyer and seller where the buyer pays the purchase price in installments over time, rather than in a lump sum upfront. The seller retains ownership of the property until the buyer fulfills the terms of the contract.

When the property is eventually sold, the seller will likely have a capital gain (or loss) on the sale. This is because the sale price will likely be higher (or lower) than the original purchase price. The capital gain is calculated by subtracting the original purchase price from the sale price.

So, how is capital gains tax calculated on a contract for deed sale? The first step is to determine the holding period of the property. This is the length of time the seller held the property before it was sold. If the holding period is less than a year, the capital gain is considered short-term and is taxed at the seller`s ordinary income tax rate. If the holding period is more than a year, the capital gain is considered long-term and is taxed at a lower rate.

The rate for long-term capital gains tax depends on the seller`s income. For 2021, the tax rate for long-term capital gains is 0% for those in the 10% and 12% income tax brackets, 15% for those in the 22%, 24%, 32%, and 35% income tax brackets, and 20% for those in the 37% income tax bracket.

It is important to note that if the seller financed the sale and the buyer defaults on the contract for deed, the seller may be able to claim a loss on their tax return. This is called a bad debt deduction and can offset any capital gains tax liability.

In addition to capital gains tax, sellers may also be responsible for paying other taxes such as state and local real estate transfer taxes and federal income tax on any interest earned on the contract for deed.

To ensure that you are meeting all tax obligations related to a contract for deed sale, it is advisable to consult with a tax professional or attorney. They can help you understand your specific tax situation and provide guidance on how to minimize your tax liability.