October 5, 2022
Farmland in Wisconsin is often transferred by land contract. There are a number of reasons for this.
One way to think of a land contract is that it is a deed, mortgage and promissory note, all wrapped up into one document. At the time that the land contract is executed and recorded with the register of deeds office, the tax bill will then show the buyer as the owner of the property.
A land contract has several advantages for the seller. It allows the seller, if he or she desires, to pay taxes on only the actual payments received from the buyer each year, rather than reporting the entire sale price on his or her tax return all in one year. Because of our progressive tax system, this can allow a seller to fill up his or her lower tax brackets each year over the life of the land contract so less is paid in taxes overall. Also, under current tax law, if the rest of the seller’s income is fairly low, the seller may be able to take advantage of at least some of the 0% federal capital gains tax bracket each year.
Another advantage for the seller is that similar to a mortgage, a land contract works like a lien on the real estate subject to the land contract, but unlike a mortgage, a land contract allows for strict foreclosure. This means rather than the property being sold at a sheriff’s sale, a judge can order that the title to the property be returned to the seller, and the seller can retain all previous payments made by the buyer.
Further, a mortgage can have usually a six-month or a 12-month redemption period, but a land contract can have a redemption period as short as seven days. The redemption period is the time allowed for the buyer to try to come up with the money to keep the property after the seller has obtained a judgment.
An advantage for the buyer is that the seller is acting as his or her lender. The buyer does not have to go to a bank to obtain financing and pay additional financing costs.
Sometimes, a buyer and seller, while negotiating a deal, will agree that no interest will be owed. However, the IRS does not allow this under something known as the imputed interest rule. Each month, the IRS establishes the minimum interest rates for loans of three years or less, more than three years to nine years, and more than nine years.
If, for example, a buyer and seller agree on a sale price of $100,000 with no interest paid over five years in monthly payments, the IRS will instead impute interest, and if the minimum interest rate for a midterm loan is 3%, the IRS will indicate the sale price was actually $92,715 (i.e., the principal), with the remaining amount ($7,285) being treated from a tax standpoint as interest.
As with just about any other real estate transaction, the buyer should still require title insurance from the seller so the buyer can ensure he or she is receiving clear title. The buyer wants to ensure that when the land contract is paid in full and the property is fully theirs, that there are no mortgages or other unwanted encumbrances on the property.
Land contracts can be advantageous for both buyers and sellers. As with any real estate transaction, make sure you know what you are doing or have qualified people advising you.
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