Why would you want to sell on a contract for deed?
In the realm of purchasing real estate, the idea of buying on a contract for deed is often mentioned but not always understood. Because of misconceptions and misinformation, this type of transaction is often avoided or feared. However for the right buyer and seller, it can truly be a win-win scenario.
From the buyer’s perspective a contract for deed can be a good option if they don’t meet the exact criteria of a traditional lender. They might not have the needed credit score, down payment or debt-to-income ratio. Just because that is the case doesn’t necessarily mean that they would be a bad property owner. There are other considerations, like the amount of cash in the bank, experience in owning real estate, and a person’s character. Also if the buyer is self-employed, their tax returns may make a traditional loan approval difficult even though they are financial capable of making a purchase.
Even if the buyer does meet a bank’s requirements, they still may be attracted to a contract for deed because they can negotiate unique terms directly with the seller. The down payment, interest rate and length of the loan are all up for discussion, where a bank will have limited options.
From the seller’s perspective a contract for deed can have many benefits as well. If the seller has owned the property for many years they (usually) will have built up a lot of equity and also used a lot of depreciation. What that means is that the sale price would typically be much higher than their basis and they may be facing large capital gain taxes. A contract for deed allows a seller to spread out that gain from just one year to many years - thereby reducing their tax.
Assuming that the seller did take their gain in one year and pay their tax, the resulting available cash to reinvest would be greatly reduced. A contract for deed on the other hand can allow the seller to earn a return on their entire sale price. Of course, I’m not a cpa or tax professional, so be sure to consult with yours!
Just as an example and to use simple numbers - say the sale price was $100,000 and after their taxes and fees they were left with $60,000 to reinvest in something new. They could put that in a savings account and earn .0001% (i.e. $6.00 in one year). Or maybe put it in the stock market and see a (theoretical) 7% return (i.e. $3,600 in one year). Alternatively if they accepted all of their payments over many years, they could earn 5% (or whatever is negotiated) on the entire $100,000 (i.e. $5,000 assuming simple interest and no principal reduction).
Finally, by accepting a contract for deed, the seller can also save themselves the headache of searching out and learning a new investment. The seller is already familiar with the property, the expected maintenance, the expected rent and many other things related to the property. It’s almost like they are continuing the benefit of owning the property but putting someone else in charge of taking care of it. In the worst case scenario that the buyer defaults and the seller has to take back the property, then they can start over and sell the property again.
So the next time you hear about buying or selling a property on a contract for deed, consider these benefits. Be sure to talk to your attorney and tax professional and see if this is a good fit for you.
When it comes to selling your property, it may be possible to maximize your property value by financing your buyer.
In this episode, John Stiles interviews special guest Todd Dexheimer and discusses the pros and cons of using seller financing.
Some of the potential benefits may (or may not) include
a higher sale price
a quicker closing
increased overall revenue due to interest charged to the buyer / borrower
decreased income taxes due to extending the income over multiple years instead of realizing the gain all in one year
You can listen to the full episode on your favorite podcast player such as Anchor.fm