How do taxes work for contract for deed?

[EvenSteven]

Party A owns a home as a primary residence and has lass than $500,000 (MFJ) in capital gains. Under an ordinary sale all of the capital gains would be non taxable.

If party A sells the house to party B under a contract for deed over 15 years, at 2% interest, how do capital gains taxes work for party A? Can they all be "realized" in the first year so that they are all excluded? I assume they should be reporting their 2% interest income as ordinary income in the year they receive it?

[seattlecyclone]

Look up "installment sales" on the IRS web site for more information.

From what I can tell, the $500k exclusion applies regardless of whether it's sold in an installment sale or not. Per Pub. 523, you only need to report the sale to the IRS if the gain exceeds $500k, if you receive a Form 1099-S related to the sale, or if you choose to be taxed on the gain (which will probably only happen if you expect to sell another primary residence for a bigger gain within two years). If any of those apply, you'll need to file Form 6252 to report the capital gains portion each year until the contract is done.

The interest income doesn't go on that form, it goes on Schedule B with all your other interest and dividends (or directly on the 1040 if the amount is too low for Schedule B).

[EvenSteven]

Thanks for the link, it does indeed look like if the exclusion applies it will apply equally whether or not it is an installment sale.

[MDM]

I assume they should be reporting their 2% interest income as ordinary income in the year they receive it?

Not only reporting it on Schedule B (and see instructions if B "used the property as a personal residence"), but also generating a Form 1098 with copies for A, B, and the IRS.