Reporting the Interest

• When you earn interest from a seller financed mortgage, the IRS requires you to report it when you file your taxes. In this situation, you must complete a Schedule B form. On the Schedule B form you include information about how much interest you earn from the seller-financed mortgage. You must also include the personal information for the individual you are selling the house to, such as the name, address and Social Security number.
  
  

Paying Taxes

• When you receive this interest income, you must pay taxes on it. The amount of interest that you receive is added to your annual income. You then pay taxes on your income at the appropriate marginal tax rate. Interest income does not receive any special tax treatment as is the case with capital gains or qualified dividends. Instead, it is taxed just like any other income that you generate from a job or from a business.
  
  

Capital Gains

• One of the advantages of using seller financing to sell a house is that it it can spread out the capital gains taxes that are due on the property. If the property that you are selling is not your primary residence, capital gains taxes must be paid on the amount that the property has appreciated. Since you are selling the house in an installment sale fashion, you get to spread out the capital gains tax payments. You only have to pay taxes on the amount that you receive for the year.
  
  

Mortgage Interest Deduction

• For the buyer and a seller financed transaction, the interest that he pays is deductible. The buyer of the property needs to report the interest that he paid on the mortgage to the IRS. On the tax return, the buyer should include the seller's personal information. This way, the interest claimed on both ends can be checked against the other's tax return, if necessary. The buyer must itemize his deductions in order to take this deduction.