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Dear Tax Talk,
I inherited my parents’ home via will in 2000. I sold it in 2004. The house was vacant until it was broken into. I let a friend live there for about a year and he paid me $400 a month to cover utilities, etc. The house was appraised at $125,000 at time of death. It sold for $135,000. I am the “bank” for the 15-year loan on the sale. I pay tax on all the interest portion of monthly payments made to me.
Do I also have to pay tax on the principal portion of monthly payments, or just on the profit of $10,000 resulting from the sale?
Based on IRC Section 1014, I believe my tax preparer has been handling this part of my tax return prep incorrectly. Thank you so much for your time and expertise.
The taxes you pay in the current year depend on how the sale was reported on your 2004 income tax return.
If you reported the sale of the property on Form 6252, Installment Sale Income, then for each year you hold the mortgage you should be reporting a portion of the gain on Form 6252 based on multiplying your “gross profit percentage” by the amount of principal payments you received during the year. The gross profit percentage would have been calculated and reported on Form 6252 back in 2004, when you sold the property. Additionally, you should report all the interest you received in the current year.
However, if you reported the entire gain on the sale in 2004, then you would only need to report the amount of interest income you receive each year.
So my recommendation is for you to contact your tax preparer and determine what was reported to the IRS back in 2004 and then go forward from that point.
Thanks for the question and all the best to you.
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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.