The Mechanics of Seller Financing
Seller financing (or owner financing) is a transaction where the seller acts as the lender, financing the purchase for the buyer instead of requiring a bank mortgage. The buyer makes monthly principal and interest payments directly to the seller based on a promissory note.
To keep payments affordable for the buyer while allowing the seller to cash out, owner-financed notes often use a long amortization period (e.g., 30 years) with a shorter balloon payment term (e.g., 5 to 7 years). At the balloon date, the buyer must refinance or sell the property to pay the remaining loan balance.
From a tax perspective, seller financing is treated as an installment sale under IRS Section 453. Instead of paying capital gains taxes in the year of the sale, the seller pays taxes proportionally as they collect principal payments, deferring their tax liability.