Every now and then you might be asked by a seller or buyer if seller financing could be an option to make a transaction work.
A common scenario might be for a buyer to ask a seller to take back a small second mortgage (we're talking about a legitimate, recorded, and disclosed second here) in order to help them get into a home.
Being a good guy the seller says "sure, I'll do that and because I like you so much I'll only charge you 3% interest on this $25,000 second you're going to pay off in 5 years."
Sounds like a match made in heaven; a gracious seller and a grateful buyer, a meeting of the minds, and a paycheck for their Realtors.
All goes well and a couple of years down the road your seller goes to his mailbox and there's a letter from the IRS.
"Greetings" says the letter; "We've noticed you're carrying a second mortgage on your former principal residence and only charging 3% interest."
"That's nice but the AFRs (Applicable Federal Rates) for seller financing say you should have been charging 4.88% for a mid-term note so we've imputed the correct interest rate for you and you still owe..............................."
OUCH! You're 'good guy' seller is now not only stuck with a tax bill for back taxes he's also looking at paying interest on money he still won't be receiving in the future because the note rate for his second mortgage is only 3%.
AFRs also fluctuate according to money market conditions so it could be even more next year than it is this.
You need to consult a qualified tax professional to advise sellers before advising them to do any sort of seller financing.