Selling a note is generally a taxable event. It can bring forward gain from your original property sale that you have been reporting a little at a time. The amount depends on your own figures and your state, so speak with a CPA before you agree a closing date. This page is general information and should not be read as tax advice.
Our work is brokering notes, and tax advice is outside it. What follows explains why a tax question comes up at all, so that the conversation with your adviser starts in the right place.
Why selling a note raises a tax question
On the day you sold the property you did not receive the full price. You took a down payment and a note for the rest.
When a seller is paid over time, tax law generally allows the profit on the sale to be reported over time as well, as the money comes in. The usual name for this is the installment method, and you may be using it without having heard the term.
Under that approach, part of your profit has not been taxed yet and is waiting to be reported as future payments arrive. If you sell the note, those payments will never reach you, because you have exchanged them for a lump sum, and the untaxed profit generally has to be dealt with at that point. Seen this way, selling a note mostly changes the timing of a profit you had already made.
What each payment is made of
| Part of each payment | What it is | General treatment |
|---|---|---|
| Interest | What the payer pays you for the use of the money | Generally income in the year you receive it |
| Return of your cost | Part of the principal that represents what the property cost you | Generally not taxed, since it is your own money coming back |
| Gain | Part of the principal that represents your profit on the property | Generally taxed as it is received, under the installment method |
A simplified picture. How each part is treated depends on the property, how long you owned it, how the sale was reported and your state. Your CPA will have the actual split from your return.
What may change when you sell
A sale brings two amounts together. The first is your basis in the note. Basis is, roughly, the part of the remaining balance that you have already been taxed on or that represents your original cost. Where some of your profit is still unreported, the basis will generally be lower than the balance.
The second is the price you receive from the buyer, which is itself below the balance, because a buyer pays less than what the payer still owes.
In general terms, what gets reported is the difference between the price and your basis. Because the price is below the balance, that difference may be smaller than the profit you would have reported by collecting every payment. Whether it is smaller in your case, and what kind of income or loss results, is for your CPA to work out.
The practical effect is on timing. Profit that would have been spread across many future years may land in a single one. A CPA can estimate the effect before you commit.
Partial sales are less clear-cut
In a partial you sell a set number of payments and keep the rest. You have not disposed of the whole note, and once the buyer has collected what they bought, it is assigned back to you.
The tax treatment of that arrangement should not be assumed. Depending on how the deal is structured and documented, a partial might be viewed as a sale of part of the note or in some other way, which changes what you report and when. Take the partial agreement to your CPA while it is still a draft, and ask directly whether the proceeds from a partial are taxable when you receive them or on some other schedule.
Situations that change the picture
All of the above assumes you sold a property yourself and have been reporting the gain as payments arrived. Other circumstances have their own rules.
- You inherited the note. The basis of inherited property is often set differently from the basis of something you created or bought, and notes from installment sales can be treated differently again, so finding out how the original sale was reported is among the first things an heir should do.
- The note was a gift. The giver’s tax position may carry over to you in whole or in part.
- The property was your home. Rules that reduce the taxable profit on the sale of a main home may have applied to the original sale, which affects how much gain is left in the note.
- The property was a rental or a business asset. Past depreciation may have been dealt with in the year of the sale, separately from the installment reporting.
- The note came from selling a business. The price was probably divided among several classes of asset, each with its own treatment.
- You did not use the installment method. If all the gain was reported in the year of the sale, the position on selling the note is different.
- The note is held in an LLC, a trust or a retirement account. The entity changes who reports what. For a note in an IRA, the custodian has to be involved, as explained in selling a note held in an IRA.
State income tax is a further layer, and states differ in how they treat this kind of income.
How tax fits into the decision
Tax changes what you keep, so the figure to compare is the net after tax from each offer, set beside what you would keep after tax by holding the note and collecting. An offer that leads before tax can fall behind once the timing of the gain is counted, which is one more reason to see the whole sale laid out before fixing a date.
None of that can be estimated without a price. If you have no offers yet, send us your note details first and take the pricing sheets that come back to your CPA, who can then tell you whether the money from selling your note is taxable and roughly how much of it.
What to take to your CPA
A CPA can answer quickly if you arrive with the right papers:
- The tax return for the year you sold the property, including the installment sale schedule if there was one
- Your most recent return
- The note, and the closing statement from when the property was sold
- A payment history showing principal and interest received each year
- The current balance
- The offers you are considering, full and partial, with the net amount of each
The last item matters most, because without a net figure your CPA can only describe the rules in general. With the papers on the table, ask:
- What is my basis in this note today?
- If I sell for this net amount, what would I report, and as what kind of income or loss?
- How would a partial on these terms be treated?
- Does the year I close in make a difference?
- Does my state treat any of this differently?
- Should I set money aside or make an estimated payment?
Related questions
Do I pay tax on the whole amount I receive for my note?
Generally not on the whole amount, because part of what you receive represents your own cost coming back. How much is taxable depends on your basis in the note and how the original sale was reported. A CPA can work it out from your returns.
Can I spread the tax over several years if I sell the note?
A full sale generally ends the spreading that came with being paid over time, since you receive the money at once. Whether a partial or another structure changes the timing depends on the details, so ask a CPA before choosing.
Will the note buyer report the sale to the tax authorities?
Reporting practice varies with the buyer and the kind of transaction. You are responsible for reporting the sale correctly on your own return whether or not you receive a form, so keep the closing statement and give it to your CPA.