The IRS recognizes a Contract for Deed as a sale and therefore if you purchased a home under a contract for deed and meet all the other requirements - you would qaulify for the First Time Homebuyer Credit.
A contract for deed, also referred to as a land contract, is typically used like a substitute for a mortgage or deed of trust. It is an installment contract in which the seller finances the purchase, comparable to owner financing.
In a typical situation, you have an owner needing a quick sale and a buyer with a limited amount of funds, problem credit, or other limitations. The buyer takes possession of the property and makes monthly installment payments of principal and interest until the balance is paid off. During the term of the contract for deed, the buyer is required to pay all of the taxes, maintain fire and casualty insurance, and keep the property in good repair. In essence, the seller is relieved of most responsibilities while the buyer enjoys the benefits of ownership, including the tax deductions.
So, what's the catch? Possession of the deed. The deed, transferring title to the buyer, is held by the seller. The buyer does not get the deed (and ownership) until the contract is paid in full.
Potential Risks
The contract for deed still remains a popular creative financing tool, despite the potential risk to both seller and buyer. When using this method, be aware of the following concerns:
1. The seller is giving possession of their property to someone who may have an increased risk of defaulting on the contract. If the buyer defaults, the seller gets the property back, but the down payment may not cover the expense of foreclosure and repairs. Most contracts provide a clause that requires the buyer to waive their rights of foreclosure in the event of a default, to minimize the expenses of recovering the property. Even with this clause, a buyer may refuse to relinquish possession of the property, forcing costly eviction or foreclosure proceedings. To further protect the seller, at the time of the initial sale, some sellers require the buyer to execute a quit claim deed back to the seller (stating that the deed is only valid in the event of a default on the contract for deed) to be used in the event of a default.
2. It is recommended that the contract for deed always be recorded. If the property being sold is mortgage, technically, a Contract for Deed could trigger the "due-on-sale" clause of any existing
mortgage. Because a sale using a contract for deed is still a "transfer," the lender may call the loan due and payable immediately. If the buyer is unable to refinance or qualify for an assumption, he or she would be forced to transfer title back to the seller or foreclosure could result. Some loans,Administration contain regulations exempting a Contract for Deed sale from the due-on-sale provisions.
3. The seller's financial or legal problems could affect the buyer's ability to obtain clear title. This is especially true in cases where the contract for deed is not recorded.
4. For various reasons, the seller, when the time comes, may be unable to grant title to the buyer. For instance, if the seller has died, the property may be tied up in probate or already have passed to the heirs. You may not be able to locate the seller or they may be incompetent and unable to give title. As a protective measure, the buyer could ask the seller to pre-issue an executed deed to be held by a trusted third party. This deed should clearly state that it is subject to and would only be valid upon satisfaction of the terms of the contract for deed.
5. Most contract for deed forms are seller-oriented documents, which fail to provide adequate remedies for the buyer. For example, most forms do not permit a purchaser to stop making payments to a seller who has defaulted on an existing mortgage.
Even with these possible pitfalls, many property owners have used the Contract for Deed with successful results. Those considering this type of creative financing should seek the advice of an attorney in these areas to minimize risk and maximize profits.
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