Selling a Rental Property via Owner Financing

MikeinTexas

I have a house that I've owned since 2004; it has never been my primary residence / homestead. There is no outstanding loan on the house. I began using the property as a rental in 2015 and that continues.

In Quicken, the house is listed as an Asset Account under "Rental Property".

I am selling the property to the existing tenant and am financing the entire purchase price. The terms are 30 years at 4% interest; there's no balloon payment. I will not maintain an escrow account.

I assume that part of each payment I receive will be interest income while the portion that applies to the loan principal will be a capital gain (less the original cost of the house). I will need to know those numbers at the end of each year for IRS obviously.

I need help determining how to make entries that will convert the Rental Property account to a loan and how to keep track of the amount that applies to the principal and interest each month. I already have the Rental Property account valued at the sales price but I'm not sure if need to close out this account somehow and then set up a new lender loan or if I can just convert the existing Rental Property asset account into a loan and somehow have Quicken set up the amortization table for the account. Recommendations please! And detailed steps are always helpful!

Tom Young

"I've always just had these entries post back to the same asset account; is your suggestion that I attribute those increases to a Capital Gains category?"

You've made that Account a bit of a fruit salad: a combination of true "cost basis" information plus assessment increases.  At this point I'd be tempted to just go back and delete the assessment transactions, leaving just the entries that really affected the cost basis of the Account, then zero out the Account with your sale entry.  The "capital gain" didn't really occur until the sale.  Before that those entries were really just estimates of "unrealized gains", though you weren't entering them as such.

"While I understand 'funding' the new asset account with the Rental Property account, I'm not clear on what amount that should be if I don't have the Rental House asset account currently valued at the sales price of the house."

You're not funding the new Mortgage Receivable Account with the Rental Property Account.  The amount that's currently in the Rental Property Account is cleared out as an expense, a form of "cost of sales", though that's captured in the net number "capital gain."  You're funding that new Account with the face value of the new Mortgage.

Let's say the cost basis of the property is $100,000 and that's the figure in the Rental Property Account.  Let's say that the sales price is $150,000, all in the form of a Mortgage Receivable.  (If there's a "down payment" involved then the Mortgage Receivable would be reduced by the down payment and you'd have an entry, an increase, to your checking Account.)

The accounting is:

Debit (increase) Mortgage Receivable Account $150,000
Credit (decrease) Rental Property Account                        $100.000
Credit (increase) Capital Gain                                              $ 50,000

As a practical matter your tax accounting is going to be completely different. For one thing you presumably have been taking depreciation for tax purposes and now you'll recapture that you haven't accounted for in Quicken, but that's OK.  It's just about impossible for most people to keep their accounting on a "tax basis", because nobody really understands most tax accounting.  Let the tax programs take care of that.

Tom Young

I'm not sure how you got the Rental Property Account up to the sales price, but I wouldn't attempt to convert that Account to a Mortgage Receivable Account.  You want to preserve the detail of the property's adjusted basis intact because if you ever have to foreclose on the property that is important for income tax purposes. 

I'd probably take a different tack altogether and just do normal "sales" accounting.  All you really need for income tax return purposes after the year of sale is the amount of principal and interest collected for the year, and most retail-level income tax return programs can handle the "installment sales" information just fine using that information.  In the year of sale you enter the basic information -  proceeds - cost = profit - and the program uses that information to develop a percentage figure that it applies to principal amounts reported each year.

"Normal" accounting, i.e., without trying to mimic the IRS's installment reporting method would be along the lines of

Debit (increase) Mortgage Note Receivable Account*  $XXX,XXX
Credit (decrease) Rental Property Account                    $YYY,YYY
Credit (increase) Capital Gain Category                          $ZZZ,ZZZ

*This is an asset Account you set up in Quicken with a beginning balance of $0.

To then convert the new Mortgage Note Receivable Account to a "lending" loan after establishing the opening balance with the above entry, here's Quicken's "help" in that regard:

About lending loans
A lending loan is a loan for which you are the lender and someone is paying you back on an amortized schedule. A lending loan is treated as an asset in Quicken that has a positive balance.

1. Add an asset account, where value of the asset is the amount you are lending.
2. In the final window of account setup, when you are asked Is there a Loan on this asset?, select No.  (You do these two steps before hand before making your entry.  Just establish the Account with a $0 initial balance, then "fund" the Account with the above entry.)
3. Open the account you just created, click the Gearwheel (the Account Actions icon), and then choose Convert to a Lending Loan Account.
4. In the Convert This Asset to a Lending Loan dialog, click Convert.
5. Quicken creates an asset account with a payoff schedule. The account is identical to a "normal" loan account in Quicken. The only difference being the sign of the lending loan and its payments are opposite that of a "normal" loan.
   

MikeinTexas

Tom - thanks for helping me work through this.

For the Rental Property account, I have made an entry each year since I took ownership that has increased the value of the asset based on the County's valuation for property taxes. That's always given me a rough estimate of the asset value and shows me those historical valuations each year. I made a similar entry this month to get the value up to the sales price. I'm not sure if that addresses your concern about being able to account for the basis in the event of foreclosure. I've always just had these entries post back to the same asset account; is your suggestion that I attribute those increases to a Capital Gains category?

While I understand "funding" the new asset account with the Rental Property account, I'm not clear on what amount that should be if I don't have the Rental House asset account currently valued at the sales price of the house.

This is the first time I've ever owner-financed a property so I apologize if I'm not quite up to speed with what I need to do.

Tom Young

"I've always just had these entries post back to the same asset account; is your suggestion that I attribute those increases to a Capital Gains category?"

You've made that Account a bit of a fruit salad: a combination of true "cost basis" information plus assessment increases.  At this point I'd be tempted to just go back and delete the assessment transactions, leaving just the entries that really affected the cost basis of the Account, then zero out the Account with your sale entry.  The "capital gain" didn't really occur until the sale.  Before that those entries were really just estimates of "unrealized gains", though you weren't entering them as such.

"While I understand 'funding' the new asset account with the Rental Property account, I'm not clear on what amount that should be if I don't have the Rental House asset account currently valued at the sales price of the house."

You're not funding the new Mortgage Receivable Account with the Rental Property Account.  The amount that's currently in the Rental Property Account is cleared out as an expense, a form of "cost of sales", though that's captured in the net number "capital gain."  You're funding that new Account with the face value of the new Mortgage.

Let's say the cost basis of the property is $100,000 and that's the figure in the Rental Property Account.  Let's say that the sales price is $150,000, all in the form of a Mortgage Receivable.  (If there's a "down payment" involved then the Mortgage Receivable would be reduced by the down payment and you'd have an entry, an increase, to your checking Account.)

The accounting is:

Debit (increase) Mortgage Receivable Account $150,000
Credit (decrease) Rental Property Account                        $100.000
Credit (increase) Capital Gain                                              $ 50,000

As a practical matter your tax accounting is going to be completely different. For one thing you presumably have been taking depreciation for tax purposes and now you'll recapture that you haven't accounted for in Quicken, but that's OK.  It's just about impossible for most people to keep their accounting on a "tax basis", because nobody really understands most tax accounting.  Let the tax programs take care of that.