Expect a partial to have tax consequences, because you are selling payments for cash and a sale is something that normally has to be reported. How much of the money is taxable, and in which year, depends on your own figures, so have a CPA look at the offer before you sign.
What follows is the general idea in plain words, written by a note broker so that you know what to ask. It is not tax advice, and it cannot stand in for a CPA working from your own records.
Why the same sale can produce different tax bills
Two note holders can sell the same 60 payments for the same price and owe different amounts, because tax follows each holder’s history with the note and takes no account of the size of the buyer’s check.
The first piece of that history is your basis. Roughly, basis is the part of the note you have already paid tax on or put your own money into, and money that returns your basis is generally treated differently from money that is gain. A person who created the note by selling a property starts from one figure. A person who inherited the note, or bought it from someone else, is likely to start from another.
The second piece is how the original sale was reported. If you sold a property with seller financing, you may have been reporting your gain a little at a time as the payments arrived. Taking a lump sum for a block of those payments can pull some of that spread-out gain forward. Whether it does in your case, and by how much, is for your CPA to work out.
The third is the wording of the partial itself. A partial is drawn up as a sale of payments, and whether a partial is a loan explains why, yet the terms of the agreement can still affect how it is treated. Hand your CPA the actual document and let them read all of it.
How a partial differs from a full sale
A full sale ends your ownership in one transaction, so the whole event, and the tax that goes with selling a note, falls in one tax year. A partial is a smaller sale: you take less cash at closing and keep the later payments, which reach you again once the buyer has collected the ones they bought.
Choosing a partial leaves the first question, whether the money from selling a note is taxable, where it was. What it may change is the timing: a smaller amount to report in the year you sell, with the rest of the note taxed later as the returned payments come in. Treat that as a possibility until a CPA has confirmed it for your situation.
Interest on the payments you sold
Each payment on your note is part principal and part interest, and while you collect the payments the interest portion is income to you. During a partial, the payments you sold go to the buyer.
So ask, before closing, who reports the interest on the payments the buyer collects, and who sends the year-end statements to the payer and to you. A servicing company that handles the note may produce those statements as part of its job, but get that confirmed in writing. Once the note is back with you, the payments are yours again and so is the reporting on them.
What to bring to your CPA
- The closing papers from the sale that created the note, or the papers showing how you came to own it.
- Your recent tax returns that report income from the note.
- The current payoff balance and the payment record.
- The written partial offer, with its pricing worksheet.
- The draft partial agreement, including the early payoff and default terms.
From those papers a CPA can estimate what you would keep after tax from a partial, from a full sale and from holding the note. Compare the routes on that after-tax figure, since the headline prices leave tax out.
State taxes, trusts, estates and retirement accounts
State rules differ from federal rules and from each other. A note held in a trust, an LLC, an estate or a retirement account brings extra rules of its own. If any of those applies to you, tell your CPA at the start, and for a retirement account ask the custodian as well.
Get the written offer before the tax answer
A CPA can only test real figures, and a guess at the price gives them little to work with. Send us the details of your note for pricing, ask for the draft partial agreement along with the numbers, and take both to your CPA before you decide anything.
The offer can still move after that conversation. If the after-tax figure for one length of partial disappoints, the number of payments sold can be changed and the sum run again, a choice that a partial purchase leaves open and a sale of the whole note does not.
Related questions
Is a partial taxed the same way as a full note sale?
Not necessarily. A partial is a smaller sale and the rest of the note stays with you, so the timing can differ. The rules depend on your situation, so ask a CPA to compare both using your real offers.
Do I pay tax on payments the buyer collects during the partial?
Those payments belong to the buyer once you have sold them. Who reports the interest on them should be confirmed with your CPA and the servicing company before closing.
Can you tell me how much tax I will owe?
No. Working out tax is a CPA's job and depends on records we do not hold. What we can give you is the written offer and the figures behind it, which is what a CPA needs to produce an after-tax number.