Carrying paper on a recently rehabbed property runs into an installment sale question worth checking early

The 5 year balloon is the piece I'd stare at. You're handing the refinance risk to a borrower in a year neither of you can forecast, on a four unit in a market with thin comps. If the appraisal problem that killed your two bank offers is still a problem in 2030, the buyer can't refi and you are back in the same position with a 491k balance owed to you. Shortening to 3 years makes that worse, not better.

Can someone explain installment sale in plain terms? I've read it three times. Is it just that you pay tax on the gain as the payments come in rather than all at once in the sale year?

Dumb question, why carry at all if you flip? You're 11 months in on 505k of cost. Doesn't waiting for a cash buyer at 600 beat 93k down and a five year wait for the rest?

@kevin_lombard yes, that's the mechanism. Installment reporting spreads recognition of gain across the years principal is received rather than all in the year of sale, and interest received is generally taxed as ordinary income separately.

@carlos_nunez the distinction you've hit is real. Property held as inventory by someone in the business of selling it is generally treated differently from property held for investment, and installment reporting is not available on dealer dispositions. Whether your 11 month rehab with four leased units is inventory or an investment hold turns on facts about your intent and pattern of activity, and that is a determination for your CPA and possibly a tax attorney, not something to settle from the terms sheet. Do not price the deal on an assumption you can't confirm in writing.

What you can price without waiting: if the whole gain is recognized this year, you owe cash tax on roughly 100k of gain in a year you receive 93k. Run that number. If the tax bill exceeds the down payment net of closing costs, you are funding the government out of pocket to hold a note. That single comparison decides whether 20% down is a preference or a requirement.

On the three levers, they are not equivalent. Down payment reduces loss severity if the buyer defaults. Rate raises yield if they perform. A shorter balloon raises the odds you get the property back, because the buyer's exit is the appraisal problem that already killed two bank deals. Pulling all three at once on a borrower with a real track record is how you lose the buyer and end up back at 60 day contingencies.

Also confirm with your attorney how foreclosure would run in the state the property sits in, since timeline and cost differ significantly by state.

Nobody has said this yet so I will. You just rehabbed it. When the water heater you installed fails in month seven, the buyer is going to call you, and if they're already paying you 4,422 a month they're going to feel entitled to an answer. Get the as-is language and the warranty disclaimer in front of an attorney and make sure the closing statement and the note both reflect it. I've watched a carry go sour over a 1,900 dollar repair argument that turned into a withheld payment.

If your capital is the constraint, price the note as an asset you might sell rather than hold. A 9% note, 15% down, unseasoned, four unit, thin comps, that trades at a discount if you try to move it in year one. Twelve months of clean payment history changes that discount a lot. Which argues for structuring it so it's sellable, meaning clean documents, a servicer of record, escrowed taxes and insurance.

Who collects the money in this structure is worth pinning down before the terms. Does the buyer send a check every month with you keeping the ledger yourself, or is there a licensed servicer in the middle? That is the piece that decides whether holding this paper is a small chore or a constant one.

@stephen_ok9 selling the note is where to slow down. Disposing of an installment note generally accelerates the gain that was being deferred, which would undo the reason for structuring it that way. @carlos_nunez that may be moot for you if dealer treatment applies anyway, but it is worth having your CPA hear the full plan for the note as well as the sale itself.

@ehernandez74 use a third party loan servicer. They collect, they escrow taxes and insurance, they send the annual statements, and they create a payment record that is not your word against the buyer's. The fee is a small monthly amount per loan and it is almost never the wrong call. It also means the awkward call about a late payment comes from someone who is not you.

9% secured by four leased units is a better yield than anything my land does, so I understand the appeal. But you're a flipper trying to become a lender for five years. Those are different temperaments. If you get restless in month 14 and want the cash for the next rehab, you're stuck, or you're selling the note into a discount.

If the buyer defaults in year two, what actually happens to the 93k? Does the seller keep the down payment plus whatever principal came in and then take the building back, or does some of that get clawed into the accounting? That rarely gets walked through with numbers and it should be.

For anyone reading this thread because they want income without a second job, the honest read is that carrying a note is a second job for the first year at least.

The permit question matters here. You put 90k into a four unit. If any of that work was done without pulled permits, or the certificate of occupancy doesn't match four legal units, the buyer's refinance lender in year five will find it, and then your balloon doesn't get paid. Get the file closed out before closing while you still control the leverage. Recording and permit closeout practice both vary by jurisdiction, so check with the local building department rather than assuming.

Two points on a carry like this. The seller is in first position only if no other lien survives closing and the note is secured by a recorded deed of trust, so that gets arranged and checked on title. The buyer should still get an owner's title policy, and the seller as lender should want a lender's policy.

Take 20 percent down and leave the rate at 9. The extra half point is worth about 2,600 a year. The extra 5 percent down is 31k sitting in front of you at closing. The boring option wins that comparison every time.

Question I'd have been embarrassed to ask out loud: what stops the buyer from turning around and selling the building to someone else and keeping the money? I assume the answer is that the deed of trust shows up on title and has to be paid off at their closing, but I want someone to confirm that's actually how it works and not just how it should work.