How a Partial Purchase Mortgage Note Offer Helps with Taxes

A partial purchase mortgage note offer can deliver serious benefits. You get instant access to cash by selling a portion of your note to a buyer, while still retaining regular interest payments and enjoying some significant tax benefits to boot.

But accepting a partial purchase mortgage note offer isn’t the right move for every note holder. Not sure what the right move is for your seller financed note? This guide can help.

Key takeaways

By the end of this article, you will know that:

1. A partial purchase mortgage note offer allows you to sell a portion of your mortgage note, giving you a lump sum of cash while retaining a part of your regular income from the note.
2. A partial sale of your note can help you spread out the capital gains taxes you pay on your investment property across multiple years, rather than paying it all in one year, as is the case with a complete sale.
3. If you’ve taken substantial depreciation deductions on your property, you may be better off with a full sale rather than a partial sale of your mortgage note.

What is a Partial Purchase Mortgage Note Offer?

You have three options when you have an owner financed note on your hands. You can 1) Keep the note, and see it through until the home has been paid off in full, 2) sell the entire loan on a full purchase note offer to a private note buyer and recuse yourself from the equation altogether or 3) do both, and sell a portion of the note while still retaining some share of the loan.

This last option is called a partial purchase mortgage note offer, and it can be a great way to ensure consistent income from your note, while also enjoying some valuable tax perks along the way.

Benefits of a Partial Purchase Note Offer

Under a partial purchase note agreement, you retain a portion of your note, while a note buyer purchases the remaining share in exchange for a lump sum of cash.

This can come with some benefits:

1. You get instant access to cash. Use it to purchase additional investment properties, put it in savings or use it toward other expenses you might have.

2. You will receive a remaining portion of the loan down the road. Thanks to this type of note buyout structure, you retain a portion of the asset down the road by using a Remainder Interest Agreement (also referred to as a Memorandum of Interest) which would be reflected in public record for all to see. Once the loan reverts back to you, you’ll continue getting installment payments until the property has been paid off in full or maturity. For many, this can offer some much-needed and convenient financial security.

3. You can save on capital gains taxes. By retaining the note, you’ll receive smaller loan installment payments, rather than one large lump sum. That means save on capital gains taxes, among other things. (More on this below.)

The tax benefits you stand to gain from a partial purchase mortgage note offer depend on a few things, like your income tax bracket, the cost of the home, what you paid for the property and other details.

Spreading out your capital gains taxes

When you sell real estate, you’re required to pay capital gains taxes on any profit you earn on the property. The bigger the profit, then the bigger that tax burden is. If you sold a home for $400,000 and made $300,000 in profits, then you’d have to pay capital gain taxes on that entire $300,000 in the same tax year. That can equate to a serious amount of money, which could cause cash flow issues for your household and finances.

By selling only a portion of the note and retaining your installment loan with the buyer, you get to spread out those capital gain taxes over years (depending on your note structure). This may make covering these costs easier in the long run.

Lower tax rates with installment loan payments

Another benefit comes in the way of tax rates. When you have an installment loan in place, you qualify for what are called “long-term” tax rates. These are often lower what your short-term tax rate would be, meaning you’ll pay less in total taxes over time.

There’s also your income tax bracket to consider. Any income you receive from the sale of your property/note will need to be reported as income. If that sale comes by way of a large, lump sum, it could push your income into a higher income tax bracket, which means a bigger tax burden come April. Using a partial note offer, while keeping your installment loan in place and amortizing, can help keep your tax bracket lower and more affordable.

A cause for concern

Though there are certainly big benefits to a partial purchase mortgage note offer, they are not for everyone — especially if you’ve taken substantial depreciation deductions on the property. This may occur if you use the property for business or you work out of the home.

The IRS’s depreciation recapture rule requires you to pay a 25% tax on the total amount of depreciation write-offs you’ve taken over the years — even if you retain an installment style loan with your buyer. If you’ve taken large amounts of depreciation deductions, it could equate to a significant sum. This is when having a larger, full lump sum payment would be beneficial.

What to know about selling real estate notes

If you’re thinking a partial purchase mortgage note offer is the best move for you, it’s important to learn a little about the mortgage note industry before diving in.

First, you’ll need to find a company that buys mortgage notes. Make sure you choose one that’s experienced, has plenty of resources to help you through the process and, of course, offers partial note purchases (not all of them do). Check references and ratings online. If there are none, move on.

Next, you’ll want to get a quote from the note buyers you’re considering. The offers will likely vary, so make sure you compare apples to apples. Are there any extra fees? When can you expect to be paid? What is their customer service like? You’re under no obligation to choose a note buyer just because they’ve given you a quote.

Finally, accept the offer you feel is best, or opt to keep your installment loan, in full, with your buyer. If you’re not happy with the quote, you can always try again in a few months and see if your offer changes. In general, this is the best guidance on how to create a mortgage note that will sell for top dollar.

How Do You Buy a Partial Note?

If you’re on the other side, looking to buy a partial purchase mortgage note, you can follow these steps to achieve your aim:

1. Find a Suitable Mortgage Note: Begin by identifying a seller who is willing to accept your partial purchase mortgage note offer. This could involve reaching out to personal finance networks, exploring specialized real estate investment platforms, or connecting with companies that focus on the trading of mortgage notes.
2. Assess the Investment: Thoroughly evaluate the note to ensure it’s a worthwhile investment. This includes analyzing the borrower’s reliability, reviewing the payment history, assessing the property’s market value, and understanding the terms of the mortgage note. An investment that looks good on paper can help ensure stability and predictability in returns, which is crucial for long-term tax planning.
3. Negotiate Purchase Terms: Once a promising note is identified, negotiate the terms of your partial purchase. Determine the percentage of the note you wish to buy, the duration of your investment, and the specifics of the income stream you will receive. This step is vital as it defines the scope of your investment and its potential tax implications.
4. Draft Legal Agreements: Ensure all aspects of the partial note purchase are documented in a legally binding agreement. This document should detail every part of the transaction, including your investment’s duration, the payment schedule, and the conditions under which the deal operates.
5. Finalize the Transaction: Completing the transaction involves more than just exchanging funds. You need to ensure that all legal paperwork is correctly processed and filed. This provides a verifiable record of the investment, which is essential for accurate tax reporting.

The final word

We at Amerinote Xchange are experts in the note-buying field as a private investment firm, but we are not financial or legal advisors. This information should not be construed as tax or legal advice.

If you have questions regarding the legalities or tax implications of your full or partial purchase mortgage note offer, then contact a legal or financial expert in your area.

If you’re ready to sell your note or just have questions about buying or selling real estate notes in general, reach out to the Amerinote team today.

Frequently Asked Questions 

What happens if I make a partial mortgage payment?

If you make a partial payment on your home mortgage, most mortgage servicers will place the funds into a suspense account until you submit the full amount due. A suspense account temporarily holds the money instead of applying it toward your mortgage loan balance. If you continue to make partial payments without catching up, you could be charged a late fee and eventually fall delinquent, putting you at risk of foreclosure.

Can I make partial payments on my mortgage?

In most cases, you cannot simply make partial mortgage payments and expect to stay current. Mortgage servicers generally require the full payment amount every month as outlined in your mortgage contract. If you want to make partial payments because you’re struggling financially, you must contact your mortgage servicer immediately to discuss your options, such as loan modification, escrow adjustments, or a repayment plan.

What is a partial payment in mortgage terms?

A partial payment in mortgage terms means sending less than the total payment due for your monthly mortgage payment. This typically violates the terms of the mortgage and may result in payments in a suspense account until you’ve submitted enough to cover the full installment. Until then, you may face late charges, impact your credit, or trigger other issues with your loan.

What happens to a suspense account in a mortgage?

When a suspense account is used, the funds stay there until the borrower submits enough money to satisfy the full payment. Only then will the mortgage company apply the payment toward your principal, interest, escrow, or other required fees. If the suspense account remains underfunded for too long, it can cause delinquency and could eventually lead to foreclosure if you don’t contact your lender to resolve the shortfall.

How does escrow work when you make a partial mortgage payment?

If you make partial payments on your mortgage, your escrow, which covers property insurance and property taxes, can be disrupted. Your monthly statement might still show the escrow portion due, but if you haven’t paid the full amount required by your loan agreement, your servicer may not disburse payments to the tax authority or insurer. This could result in a tax lien for unpaid property taxes or cancellation of your insurance, so it’s crucial to stay current.

What happens to PMI if you make a partial mortgage payment?

If you purchase private mortgage insurance (PMI) and then submit partial mortgage payments, your servicer may not apply the funds toward your PMI premium until the full amount is made. PMI is required when your loan-to-value (LTV) ratio is high, especially in FHA or conventional loan products. Falling behind could add penalties or stop your PMI from being counted, which affects your credit and may complicate your mortgage debt management.

Can a lien be placed for nonpayment of a partial mortgage?

If you continue to make partial payments or fail to meet the full payment requirements on your mortgage loan, the lender has the right to foreclose. As part of the foreclosure process, a lien on your property (specifically a mortgage lien) acts as a legal mechanism securing the loan. The lender can then enforce their lien rights to reclaim the property securing the loan through sale.

How does a partial mortgage purchase affect amortization?

In a partial purchase of a mortgage note, the amortization schedule remains tied to the original note terms unless renegotiated. The borrower still makes regular monthly payments to the note holder, but a portion of the payment now goes to the note investor who bought part of the payment stream. This allows the seller to free up capital to purchase other investments while keeping a share of the income.

What happens if you can’t make the balloon payment or full mortgage balance?

If you have a fixed-rate mortgage or balloon loan structure and you can’t pay the balloon or full mortgage balance when payment is due, the mortgage lender can foreclose. You must either refinance the balance, sell the property to satisfy the mortgage debt, or negotiate a modification. Otherwise, the property securing the loan is at risk.

How does foreclosure affect escrow and suspense accounts?

When foreclosure begins, your escrow balance and suspense account balances are reviewed. Any money in escrow is typically applied toward outstanding debts like property insurance, taxes, and lien-related fees. The mortgage servicer must account for these funds according to federal regulations (under agencies like the Department of Housing and Urban Development) and local law.

How does a delinquency impact your total payment amount?

If you’re delinquent ( meaning you’ve missed your mortgage payments) the total payment amount due will include the regular mortgage amount, late charges, and possibly additional fees associated with lien management. Delinquency also damages your credit score and could ultimately trigger the lender’s right to foreclose under the terms of the mortgage.