Debt over basis: when the tax at close exceeds the check
A mortgage the buyer takes over — or that gets paid off out of escrow — is a payment in the year of sale. Put a long-held, low-basis property behind a big loan and the seller can owe more tax than the cash they actually receive. This runs the numbers.
The deal
Year one
Where the line is on this deal
Holding basis and price fixed, raising only the loan:
| Mortgage | LTV | GPR | Boot | Tax yr 1 | Cash at close | Cash − tax |
|---|
Why this happens
Under Reg. §1.453-4(c) the contract price is the selling price reduced by the mortgage — but only down to adjusted basis. Anything the mortgage exceeds basis by is added back and treated as money received in the year of sale. Two consequences follow:
- The gross profit ratio climbs to 100%. Once the loan passes basis, contract price equals gross profit, so every dollar collected is gain. There is no basis left to recover.
- The excess is taxed immediately. Debt relief is a payment. The seller never touches it — it goes to the lender — but it is taxed as though they had.
Spreading the remainder over 20 years does not help the boot. It is recognized in year one no matter how the back end is structured. The rule of thumb: if the loan is more than about three-quarters of the price and the basis is old, the tax at close can exceed the check. Run it before the listing agreement, not at the closing table.