Can I Claim Interest Paid on a Contract for a Deed on Taxes?

A land contract, also called an installment land contract for a contract for deed, is a way for a seller to finance a real estate purchase on behalf of the buyer. After the parties agree on a price, the buyer makes a down payment, takes occupancy and begins making regular "mortgage" payments to the seller, including interest.

In the installment sale, the buyer's payments include principal and interest, in addition to property taxes and hazard insurance if an escrow account has been established for these payments. Even though a land contract doesn't require the seller to transfer the deed until the buyer makes payment for the property in full, the Internal Revenue Service considers the buyer as owner for tax treatment purposes. As a result, the land contract buyer is eligible to deduct the annual interest expense from his income on his taxes.

In addition to deducting the "mortgage" interest, the buyer is also able to deduct property taxes, which she is responsible for and must pay in full, along with hazard insurance. If the buyer makes eligible capital improvements, that cost may be deducted as well. Eligible improvements include energy efficient window and doors, among other projects. The seller only acts as the bank and does not bear any financial responsibility toward the home, unless he has his own mortgage on the property to satisfy. Repairs, maintenance, improvements, taxes and insurance are all administered and paid for by the buyer.

The seller in a land contract transaction has some tax advantages as well. Although the seller must report the interest he earned on the deal as income -- and has to pay ordinary taxes on it -- he is able to spread out any gain he made on the property's value over the life of the installment agreement. If the total gain exceeds the maximum exclusion allowed by the IRS, this can result in significant tax savings.

The land contract ends when the buyer pays for the home in full. This can be accomplished in a few ways. The first and most common event occurs when the buyer secures a new home loan that pays off the seller in full at the end of the contract. Land contracts are typically short and range anywhere from two to 10 years. The second event occurs when the buyer simply pays the seller in full without having to take a new loan. Both of these options result in the transfer of the deed to the buyer. In the third case, the buyer decides to sell; when this happens, she is entitled to a return of her accumulated equity.

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