Owner carry, also called seller financing, works like this: instead of the buyer borrowing from a bank, the seller becomes the lender. The buyer makes a down payment, signs a promissory note, and pays the seller directly in monthly installments until the loan is paid off or a balloon payment comes due. The property secures the loan through a recorded deed of trust or mortgage, so if the buyer stops paying, the seller can foreclose. Federal rules cap how many of these deals one seller can do, the IRS treats the payments as an installment sale with its own tax reporting, and both sides carry obligations that differ meaningfully from a conventional closing.
What Owner Carry Actually Is
The buyer and seller negotiate the loan terms between themselves, without a bank in the middle. Down payments typically run 10% to 25% of the purchase price, higher than many conventional mortgages, because the seller absorbs the risk a bank would otherwise underwrite. That money gives the seller immediate cash and locks the buyer into the deal from day one.
Interest rates are also negotiated directly and usually sit above what a bank would charge, reflecting the seller’s added risk. The repayment schedule looks familiar: monthly installments covering principal and interest, amortized over a set term. What often differs is length. Many seller-financed loans run five to ten years rather than thirty, with a balloon payment at the end covering whatever principal remains. Balloon structures keep monthly payments manageable, but the buyer needs a plan to refinance with a traditional lender or pay the balance in cash when it comes due.
The structure a seller can legally use depends on federal exemption rules covered below. That is not a formality. Get the structure wrong and the seller loses their exemption from mortgage loan originator licensing.
The Paperwork That Makes It Real
Two documents do the work. The promissory note is the buyer’s written promise to repay. It lays out the principal, interest rate, payment schedule, maturity date, and consequences for missed payments. Default provisions usually include a late fee, often a percentage of the overdue installment, and an acceleration clause letting the seller call the full remaining balance due if the buyer falls behind.
The security instrument, a deed of trust or a mortgage depending on the state, creates the lien. It includes the legal description of the property and must be recorded at the county recorder’s office. Recording is what makes the seller’s claim public and protects it against later creditors of the buyer. Without recording, the loan may not qualify as secured debt for tax purposes, which affects the buyer’s ability to deduct interest. Most sellers use a real estate attorney or title company to draft these documents so the language is enforceable under state law.
Federal Rules That Limit How You Can Structure It
Federal law treats anyone who originates a mortgage loan as a loan originator, which pulls them into licensing, disclosure, and ability-to-repay requirements. Sellers financing their own property sales can sidestep those requirements, but only inside two narrow exemptions created by the Dodd-Frank Act and implemented through Regulation Z.
The One-Property Exemption
A person, estate, or trust that seller-finances only one property in any 12-month period is exempt if three conditions hold: the seller owns the property and it secures the loan, the seller did not build the home as a business, and the loan does not allow negative amortization. This exemption does not require full amortization, so balloon payments are allowed, and it does not require the seller to formally verify ability to repay.
The Three-Property Exemption
A seller who finances up to three properties in 12 months can also qualify, but the conditions tighten. The loan must be fully amortizing, meaning no balloon. The seller must determine in good faith that the buyer can reasonably afford the payments. The interest rate must be fixed, or adjustable only after at least five years and with reasonable rate caps. Unlike the one-property version, this exemption is available to any “person,” including LLCs and other business entities.
If You Exceed the Exemptions
A seller who finances more than three properties in a year, or who fails any of the conditions above, must work with a licensed mortgage loan originator registered through the Nationwide Multistate Licensing System under the SAFE Act. A violation can expose the seller to the buyer’s actual damages plus statutory damages between $400 and $4,000 on a loan secured by a home, along with attorney’s fees and court costs.
The Due-on-Sale Trap
If the seller still owes on an existing mortgage, transferring title to the buyer can trigger the loan’s due-on-sale clause. Federal law gives lenders the right to demand full repayment when the property is sold or transferred without their written consent, and that right is federally preempted, so state law cannot block it.
The existing lender may not immediately discover the transfer. If it does, it can declare the entire balance due, and if the seller cannot pay, it can foreclose, even with the new buyer living in the home and paying the seller.
Some transfers are exempt from due-on-sale enforcement: property passing to a surviving co-owner after death, transfers to a spouse or child, transfers resulting from divorce, and transfers into a living trust where the borrower remains a beneficiary. A standard sale to an unrelated buyer through seller financing does not fit any of these. Wraparound arrangements, where the seller keeps paying the original mortgage while collecting from the buyer at a higher rate, are specifically classified by federal regulation as transfers that trigger the clause. A seller using a wrap is betting that the original lender will either miss the transfer or choose not to act on it.
The IRS Minimum Interest Rate
The IRS requires seller-financed loans to charge at least the Applicable Federal Rate (AFR) in effect when the contract is signed. Charge less, and the IRS will impute interest, treating part of each principal payment as interest income regardless of what the contract says. The seller ends up with taxable income they never actually received in that form.
The AFR varies by loan length and updates monthly. As of January 2026, the annual rates compounded annually are 3.63% for short-term loans up to three years, 3.81% for mid-term loans of three to nine years, and 4.63% for long-term loans over nine years. Most seller-financed deals fall into the mid-term or long-term bucket. Sellers can use the lowest AFR from the three-month window ending with the month the contract is signed or the sale closes. Because owner-carry rates typically run above conventional mortgage rates anyway, most deals clear the AFR threshold naturally. Sellers offering a below-market rate as an incentive should confirm they are not creating an unintended tax bill.
How Taxes Work for the Seller
The IRS treats a seller-financed sale as an installment sale. The seller does not owe tax on the entire gain in the year of the sale. Each payment is split into three parts: a tax-free return of the seller’s adjusted basis in the property, taxable gain on the sale, and interest income.
The gain portion is calculated using a gross profit percentage, the ratio of total profit to total contract price. That percentage is applied to each payment, after subtracting the interest, to determine the taxable gain for that year. Interest is reported separately as ordinary income.
Installment sale income goes on Form 6252, filed for the year of the sale and every subsequent year a payment is received, even years when no payment actually arrives, until the note is paid off, sold, or otherwise disposed of. One important exception: if the property was a rental or business asset and the seller claimed depreciation, the depreciation recapture portion of the gain must be reported in full in the year of the sale, regardless of how much cash the seller actually collected that year.
A seller can elect out of the installment method and report the entire gain in the sale year. That may make sense if the seller expects a higher tax bracket later or wants to simplify future filings. The election generally cannot be reversed without IRS approval.
How Taxes Work for the Buyer
A buyer in a seller-financed deal can deduct mortgage interest just like any other homeowner, but only if the loan is secured by the property under state law. That usually means the deed of trust or mortgage has to be recorded. An unrecorded side agreement, even one both parties treat as a mortgage, does not count as secured debt for the deduction.
Because the lender is a private person rather than a financial institution, the buyer will not receive a Form 1098. The buyer reports the interest on Schedule A and includes the seller’s name, address, and taxpayer identification number. The seller must give this number to the buyer, and the buyer must give theirs to the seller in return, typically using Form W-9. Failing to exchange the numbers can trigger a $50 penalty per failure.
If the Buyer Stops Paying
Remedies depend on the security instrument and state law. With a deed of trust or mortgage, the seller has to go through formal foreclosure. Timelines swing widely by state, from roughly one year in states with streamlined nonjudicial procedures to over five years where court involvement is required.
Some owner-carry deals use a land contract, also called a contract for deed, where the seller keeps legal title until the final payment. In many states, land contracts allow forfeiture: the buyer loses payments already made and the seller keeps the property without a full foreclosure. A growing number of states now require land contract sellers to follow foreclosure-like procedures anyway, particularly when the buyer has made substantial payments or lived in the property for a long time.
The promissory note’s default terms shape what actually happens. A well-drafted note builds in a grace period before a late fee, a clear acceleration clause, and specific notice requirements the seller has to follow before declaring the full balance due. Skipping formal procedures or attempting a self-help eviction can expose the seller to legal liability and can forfeit the right to collect the remaining balance. Bringing in a real estate attorney at the first missed payment protects both sides.
Vetting the Buyer Before You Sign
Under the three-property exemption, the seller has to make a good-faith determination that the buyer can afford the loan. Even under the one-property exemption, which does not require verification, doing it anyway is the practical baseline. That means recent tax returns and W-2s, a consumer credit report, current bank balances, and a look at existing debts and monthly obligations. For self-employed buyers, profit-and-loss statements and a net worth statement give a clearer picture than tax returns alone. A call to the buyer’s current landlord or mortgage holder about payment history adds another data point. Cutting corners here does more than raise default risk; on a deal covered by the three-property exemption, skipping the ability-to-repay analysis can cost the seller the exemption itself.