Generally yes, at least in part. The sale of a note is generally treated as a taxable event, and how much of the money is taxed depends on how you came to hold the note and what you have already reported. What follows is the general idea, so that you know what to ask a CPA.
Tax follows the gain
Tax generally falls on gain, which is less than the full amount you receive. To find it, a CPA starts with your basis: roughly, what you have invested in the note for tax purposes, meaning what it cost you or the part of it you have already paid tax on. The share of the sale price that returns your basis is generally not taxed again, and tax can apply to the share above it. Two people who sell identical notes for the same price can therefore owe very different amounts.
Notes created when you sold your own property
When you sold the property and carried the financing, the gain on that sale may have been reported on the installment method. Under it, a share of the gain is reported each year as payments arrive, which spreads the tax across the life of the note.
Selling the note generally brings that spreading to an end, and the gain you had not yet reported tends to come due in the year of the sale. A note sells at a discount, meaning for less than the balance owed, so the amount you actually receive enters the calculation. Your CPA works the figure out from your original sale, what you have reported since and the price a buyer will pay, so it helps to get your note priced before that conversation. If the property was your home, say so, because different rules may have applied to the original sale.
Notes that reached you another way
| How you got the note | What to raise with a CPA |
|---|---|
| You bought it | Basis generally starts with what you paid and is adjusted for the principal you have collected. |
| You inherited it | Inherited notes follow their own rules, and one that came from an installment sale may be treated differently from an inherited house. Ask before assuming. |
| It was a gift | Gifts of notes have rules of their own for the giver and for the receiver. Tell the CPA who gave it to you and when. |
| It came from selling a business | The original sale may have been divided among several kinds of asset, each taxed in its own way, and that can carry through to the note. |
| It is held in an IRA | The sale takes place inside the account. Ask your IRA custodian how it is handled. |
Full sale or partial
A full sale puts the whole event in one tax year. A partial sale, where you sell a set number of payments and keep the rest, raises less cash, and whether the proceeds from a partial are taxable in the same way depends on how the agreement is written. Settle that with a CPA before you choose between them.
Questions a CPA will ask
The tax question is best raised early in the sale of a note, before you accept an offer. Expect to be asked:
- How you came to hold the note, which decides the set of rules that applies.
- Whether the original sale was reported on the installment method, which shows whether unreported gain is waiting.
- What your basis is today.
- How long you have held the note, since holding period can affect how a gain is treated.
- Whether you plan a full sale or a partial.
- Which state you live in, because state tax rules differ from federal ones and from each other.
What to take to the appointment
The figure worth planning around is what you keep after tax. A CPA can estimate it only from actual numbers, so bring the offer with you, along with the closing statement from your original sale, the tax return for the year you sold the property and your payment record. A short call beforehand will tell you whether the CPA wants anything else. If the terms are new to you, read the overview of taxes when you sell a note first, so the appointment is spent on your figures and not on vocabulary.
Rules vary by state and by situation, and nothing on this page is tax advice. Your own answer sits in the returns you have already filed, so the person who prepared them is the natural one to ask first.
Related questions
Will I owe tax on the whole amount I receive?
Generally not. Tax generally applies to gain, which is what you receive above your basis in the note. Your basis depends on how you acquired the note, so ask a CPA to work it out.
Does selling at a discount mean I have a loss?
It may or may not. The discount is measured against the balance owed, while tax gain or loss is measured against your basis. Those are different numbers, and a CPA can tell you which way yours falls.
Should I talk to a CPA before or after I get offers?
Both, if you can. A short call first tells you what records to gather. A second call with real offers in hand lets the CPA estimate what you would keep after tax.