Tom Kelly: Huge tax hit? Spread out cabin payments over time

Our elderly friends had just returned from a weekend at their lakefront cabin, their first time at the place since Memorial Day. A long-awaited European vacation – coupled with no visit by the grandkids – left the once-popular cottage vacant all summer.

“I darn near sold it five years ago when I got rid of the ski boat,” Robert Shelton said. “But the kids talked me out of it, said they all planned to come back and use the place. But they’ve used it less and less and it’s one of the few real assets we have. I could use some cash, but I don’t need it all and I don’t want to pay the tax. We bought it so long ago that we’d really take a hit.”

Not all property sellers demand all cash, right now. The monthly payment income from the sale of a family home, a rental property or vacation cabin can supplement retirement income and serve as a continuing comfort zone.

Shelton, like many retirees, says he needs only simple comforts. The mere mention of selling the cabin meant he had re-examined that comfort zone. To another person, the cabin sale could now be viewed as an extremely important – perhaps critical – flow of income.

If you no longer choose to nurse a rental or vacation cabin and want to sell it, you can spread any resulting capital gains tax over time by “playing the bank” and providing seller financing. And you can save the new buyer, perhaps a young family that has shown interest in your getaway community, the costs of a conventional loan while negotiating a favorable interest rate for both sides.

If you participate in any sort of seller financing, however, make sure to build in safety features that protect your investment and sanity. In fact, it’s not a bad idea to copy many of the loan requirements a local bank would insist upon. Among them:

• It’s a good idea to obtain a credit report on the buyer. Why would you want to sell your home or other property to someone you know nothing about?
• Write into the earnest money agreement that the buyer provides, and keeps current, a homeowner’s insurance policy.
• Purchase tax registration coverage from a title company. That way, if the property taxes are not paid, you will be notified. Include in the earnest money that the buyer make timely tax payments.
• Insist on a “due on sale” clause or that you, as the initial seller, must approve any subsequent sale in writing. That way, if the property is sold before the term of your note or contract, you will receive all your cash upon the transfer of the property or retain the ability to approve the new buyer.
• If you absolutely cannot be cashed out early (say you need monthly income or do not want to pay taxes on the lump-sum gain) request a prepayment penalty. That way, if you receive a huge balloon payment when you don’t necessarily want it, you will be reimbursed for the inconvenience (tax consequences, loss of reliable income, etc.).
• Consider taking a down payment of at least 20 percent. If you need to sell the note before term (illness or other emergency) this will make it easier to sell. Like regular mortgages, lenders require mortgage insurance for loans they write with less than 20 percent down. You will reduce the risk of any future note holder by having an amount at least equal to a conventional down payment.
• Consider a third-party collection account. You can split the cost with the buyer, and the service is well worth the money. It provides you with complete tax statements (seller must submit principal and interest amounts to the buyer-payer annually) and receives and deposits monthly payments – especially valuable if you have to go out of town unexpectedly.

When honest, competent parties are involved, seller financing via a real-estate contract or deed of trust can be a wonderful vehicle for buying and selling property. Take time to prepare if you are going to assume the position of playing the bank. The bank certainly does.