The land contract, purchase contract, or contract for deed is recommended as a method of sale when the buyer does not have a sufficient down payment. It is an agreement whereby one party agrees to convey land to another party for a certain price, with the seller retaining legal title and the deed until some specified future date (for example, until all payments are made). Although legal title stays with the seller during the contract, equitable title passes immediately to the buyer. The land contract is becoming popular in several states among unrelated parties.
There are several variations in methods of payment under the land contract. Some are as follows:
• Fixed money price and fixed annual payments.
• Payment based on fixed amount of commodities each year. For example, the contract could specify so many bush- els of wheat each year. The value of the payment would then be determined by the price of wheat for that year.
• Fixed purchase price with yearly payment based on percentage of gross receipts. This method is sometimes used on dairy farms.
• Variable purchase price with variable payments. The payments could consist of a certain percentage of the gross income during the parents’ lifetime.
• Combinations and variations of the above may be worked out.
Advantages
• The purchase contract facilitates the purchase of a farm by a young buyer with limited funds. It is one of the few ways this can be done.
• The repayment schedule encourages a young farmer to build up equity during the early years.
• Some sellers like the purchase contract because of income tax savings due to use of the installment plan. Install- ment payments allow the gain from the sale to be spread over several years.
• An element of control is left in the hands of the seller.
• Ejection of a defaulting buyer under a contract for deed may be easier than a mortgage foreclosure. However, courts often tend to require similar procedures in each case.
Disadvantages
• The buyer has less secure title to the property, since it is an equitable title, but not the legal title.
• It may be more difficult for the buyer to sell his equity if, for health reasons, he wants to quit farming.
• If the down payment is small, the seller takes more credit risk in the early years of the contract than is taken by regular lending agencies that require a larger buyer equity.
mortgage
Land Contract (Purchase Contract)
Outright Sale, with Mortgage
Use of a deed and a mortgage in combination is a common method of transferring the ownership of real estate between unrelated persons. The seller deeds title to the property to the buyer. The buyer makes a down payment and gives the seller a mortgage on the property to ensure payment of the balance of the purchase price.
Where this method is used in estate planning, the parents may for example deed title of the farm to the child and the child could encumber title by giving a mortgage back to the parents. This method should be encouraged, provided the child can make sufficient down payment. Often the child cannot; and, from the parents’ viewpoint, there are serious disadvantages when little or no down payment is required. Passing the title to a person who might have little incentive to increase equity involves some risk. In this type of situation, some authorities believe the child should pay at least one- fourth of the purchase price before the parents pass title. This amount could reasonably vary due to a number of factors.
Advantages
• Outright sale permits the purchasers to make permanent improvements on the land.
• A sale with a mortgage is a businesslike way of making the transfer. It is usually best to have the farm appraised to prevent family misunderstanding as to its value, especially if there is more than one heir.
• Equitable treatment of all the heirs can be separated from the problem of transferring the farm.
• The transfer may prevent the farm from becoming run down when owners become too old to maintain it properly.
• In instances where an estate tax problem exists, sale of the farm will set the value to be included in the estate for estate tax purposes.
• A sale to children makes it possible for the buying children to operate the farm during their most productive years.
Disadvantages
• The parents lose control over the property.
• The capital gains tax may be greater than the estate taxes would be. Selling by the installment sales method can be used to reduce the taxes. Installment sales must conform to certain restrictions.
• The parents may not receive enough for the farm. The parents often are tempted to sell for less than the market price; and, if their wealth is limited, this may later cause them hardships.
• If parents sell to one child for less than market price, conflicts may result with their other children.
• The estate cannot take advantage of current use valuation.