Real Estate Tax Calc
What is a land contract and how it differs from a mortgage
A land contract (also called a contract for deed, installment land contract, or bond for deed) is a seller-financing arrangement in which the seller conveys possession to the buyer but retains legal title until the buyer completes all payments. The buyer receives equitable title — the right to occupy and use the property, claim deductions, and eventually receive legal title — but the deed is not transferred until the final payment is made or some other agreed milestone is reached.
This structure differs from a conventional mortgage in a critical way: with a mortgage, the buyer receives both possession and legal title at closing, and the lender holds a lien. With a land contract, the seller retains the deed as security — if the buyer defaults, the seller may be able to reclaim the property through a simpler forfeiture process rather than a formal foreclosure. The tax consequences, however, are very similar to an installment sale with a seller-financed mortgage: both qualify for installment method reporting under IRC Section 453 if structured correctly.
Installment sale reporting: how the seller recognizes gain
The IRS treats a land contract as an installment sale from the seller's perspective, meaning the seller reports gain proportionally as payments are received rather than all at once. The calculation uses the gross profit percentage: gross profit divided by the contract price.
Example: the seller sells a rental property for $250,000 on a land contract, with a $20,000 down payment and $230,000 in future installment payments. The seller's adjusted basis is $150,000 and selling costs are $10,000, so the gross profit is $90,000 ($250,000 − $150,000 − $10,000). The gross profit percentage is 36% ($90,000 ÷ $250,000). Every dollar of principal received — whether the down payment or a monthly principal payment — is 36% taxable gain and 64% tax-free return of basis. Over the life of the contract, the seller reports the full $90,000 gain, but over many years rather than in one lump sum. The seller reports the installment sale on Form 6252 (Installment Sale Income) for the year of sale and every subsequent year in which principal payments are received.
The installment method is the default for qualifying sales. To opt out and recognize all gain in the year of sale, the seller must elect out on a timely filed return. Opting out of installment reporting makes sense when the seller has capital loss carryforwards or is in a low bracket in the sale year and expects higher rates in future years.
Interest income on a land contract
Land contract payments typically include both principal and interest. The interest component is ordinary income to the seller — not capital gain — and is taxable in the year received, regardless of whether the seller uses the installment method for the capital gain portion. If the contract specifies an interest rate, that stated rate is used. If the contract does not specify an interest rate (or specifies an unreasonably low rate), the imputed interest rules under IRC Sections 483 and 1274 require the parties to treat a market-rate portion of each payment as interest.
For 2025, contracts with a stated rate below the Applicable Federal Rate (AFR) — published monthly by the IRS — are subject to imputed interest. The AFR depends on the loan term: short-term (up to 3 years), mid-term (3–9 years), and long-term (over 9 years). A seller who sets the interest rate too low — or charges zero interest — does not avoid interest income; the IRS recharacterizes the excess principal as interest. This can increase the seller's ordinary income while reducing the capital gain portion, which may be unfavorable if ordinary income is taxed at a higher rate than capital gains.
The buyer also benefits or is harmed by the imputed interest rules: if the stated rate is above the market rate, more of each payment is treated as interest (deductible by the buyer if the property is a rental), and less is principal. If the stated rate is below the AFR, the imputed interest rules reduce the buyer's deductible interest. Properly pricing the land contract interest rate near the current AFR avoids recharacterization surprises for both parties.
Depreciation recapture on a land contract sale
One important exception to installment sale treatment: depreciation recapture is recognized in full in the year of sale, even on an installment sale. If the seller owned a rental property and claimed depreciation, the recapture portion (unrecaptured Section 1250 gain for real property, or ordinary income Section 1245 recapture for personal property) must be reported in the year of sale regardless of when the payments are received.
Example using the prior scenario: of the $90,000 gain, suppose $40,000 is attributable to unrecaptured Section 1250 gain (accumulated depreciation). That $40,000 is taxable in the year of the land contract closing — not spread over the payment period. Only the remaining $50,000 of Section 1231 capital gain is eligible for the installment method. This is a significant cash-flow point for sellers with large amounts of accumulated depreciation: they owe taxes on the recapture component immediately, even though the cash from the sale arrives over many years. Sellers should set aside funds at closing to cover the recapture tax, just as they would in any installment sale with a cash down payment.
How the buyer treats a land contract
From the buyer's perspective, a land contract is economically identical to a purchase with seller financing. Even though the buyer does not yet hold legal title, they are treated as the owner for tax purposes from the date of the contract. The buyer can:
Depreciate the property starting from the date possession was taken (if it is a rental or business property). The depreciable basis is the purchase price allocated to the building (less land), including any assumed liabilities. Even though legal title is still with the seller, IRS Revenue Ruling 55-749 and subsequent guidance confirm that buyers under land contracts can depreciate property they have possession of and are obligated to maintain.
Deduct mortgage interest — the interest component of each land contract payment is treated as qualified residence interest (if the property is the buyer's home) or as rental property interest (if it is a rental). The buyer needs Form 1098 or a seller-provided statement showing the interest paid each year.
Claim property tax deductions — the buyer typically pays property taxes (often through escrow or directly) and deducts them on Schedule A or Schedule E.
One complexity: because the buyer does not hold legal title, title insurance and some financing issues may arise if the buyer wants to refinance or sell before completing the land contract. Consult a real estate attorney about how your state handles land contract buyer rights before entering into a large land contract.
Default and repossession: what happens when the buyer stops paying
If the buyer defaults and the seller repossesses the property, additional tax consequences arise. The seller must report the fair market value of the property repossessed as proceeds received in the repossession year. If the FMV of the repossessed property exceeds the seller's basis (original basis plus any gain already recognized minus any losses), there is additional gain to recognize. IRC Section 1038 provides some relief: the gain recognized on repossession is limited to the gain previously deferred under the installment method, reduced by any principal payments received from the buyer that exceeded the FMV of amounts returned on repossession. This ensures the seller is not taxed more on the repossession than they would have been if all installment payments had been received.
From the buyer's side, a default on a land contract is typically treated as an involuntary disposition. The buyer had equitable title but loses it. The tax consequence is usually a capital loss equal to the total principal payments made (which established the buyer's investment in the property) minus any amounts recovered from the seller on termination. If the property was held as a rental and the buyer has suspended passive losses, those losses become available to offset ordinary income upon the involuntary disposition, just as they would on a sale.
Land contracts in estate planning and related-party sales
Land contracts are sometimes used in family estate planning: a parent 'sells' real estate to an adult child on a land contract, often at below-market rates. Several tax rules police related-party transactions. The interest rate on a family land contract must meet AFR requirements, or the imputed interest rules recharacterize payments. If the purchase price is significantly below fair market value, the difference may be treated as a gift, triggering gift tax reporting if above the annual exclusion.
For estate tax purposes, a land contract installment note held by the seller at death is included in the estate at its fair market value — not its face value. The estate must report any remaining installment gain as income in respect of a decedent (IRD), which does not receive a step-up in basis. Heirs who receive installment obligations through inheritance continue to report income as payments are received, and the income is reported on the inherited-IRD income tax basis, not at fair market value at the date of death. Related-party installment sales (to a spouse, child, or entity controlled by the same person) have additional restrictions under IRC Section 453(e): if the buyer resells within two years, the seller must recognize the remaining deferred gain immediately. This two-year reuse rule is particularly important to know in family planning transactions.
Frequently asked questions
Is a land contract the same as an installment sale?
For tax purposes, yes. The seller reports gain using the installment method on Form 6252, and the buyer is treated as the property owner for depreciation and deduction purposes even before receiving legal title.
Does the buyer have to wait for legal title to start depreciating?
No. The buyer can depreciate the property from the date of possession under the land contract, based on IRS Revenue Ruling 55-749. Legal title is not required to begin MACRS depreciation.
Can the seller defer all gain using a land contract?
The seller can defer the capital gain portion over the payment period. But depreciation recapture (Section 1250 or 1245 gain) must be recognized in full in the year of sale, even if the payments are received over many years.
What happens if the buyer defaults on a land contract?
The seller repossesses the property and reports its fair market value as additional proceeds. IRC Section 1038 limits the gain on repossession to previously deferred installment gain. The buyer may have a capital loss equal to principal payments made minus any amounts recovered.
Is land contract interest deductible by the buyer?
Yes, if the property is a rental, the interest component of each payment is deductible as rental interest expense on Schedule E. If the property is a primary residence, it is deductible as qualified residence interest on Schedule A (subject to mortgage interest deduction limits).
Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.