Buying a house opens up a whole set of potential tax deductions. If it makes financial sense for you, you can write off your interest and property taxes as well as other expenses instead of claiming the standard deduction. Furthermore, while buying a house on a contract isn't exactly the same thing as buying a house with a traditional mortgage, it's close enough in the eyes of the Internal Revenue Service. You might have to do a tiny bit of extra paperwork, but you'll get to take your write-off.
Installment Sales & You
From the perspective of tax law, a contact for deed or land contract is treated the same way as a seller-financed mortgage -- it's an installment sale -- and it's considered a sale of the property. The IRS also states in Publication 936 that your home mortgage interest is deductible if the debt is secured by your house. What this means is that you can write off your interest as long as you could lose your house if you don't make your loan payments. The IRS specifically mentions a land contract as a type of deductible secured debt, as long as you have it recorded.
Deducting Your Interest
To be able to deduct your interest payments on your contract purchase, you need to choose to itemize your deductions by filing Schedule A along with your tax return. The seller may send you a Form 1098 statement that shows how much interest you paid him. If you got one, enter your mortgage interest on line 10 of your Schedule A. If he didn't send you a Form 1098, enter the amount of interest you paid on line 11 and write the contract holder's name, address and Social Security number next to it.
Mortgage Deduction Limitations
Deducting the interest on your contract has a couple of limitations or drawbacks. First, if you itemize deductions to claim your mortgage interest and other deductions, you won't be able to claim the standard deduction any more. Second, your ability to write off interest isn't unlimited. The IRS only lets you write off the interest on up to two houses, and only lets you write off interest on up to $1.1 million of debt. If you borrow more than that, you won't be able to deduct the interest on the excess.
The Seller's Responsibilities
For the seller, the contract gets taxed as an installment sale. This essentially turns the home, for him, into an investment. As such, the seller will have to report the interest that you pay him as income on Schedule B of his tax return. He will also need to report your Social Security number to the IRS. If the seller still has a mortgage, he gets to write off the interest that he pays with the money you send it to him. For him, though, it's considered investment interest expense rather than a mortgage expense, though.
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