Subject-To (“subto”) Income Tax Reporting

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In a “subject to” (also known as a “subto”) real estate deal, the buyer acquires a property, and the title transfers to the buyer’s name, while the seller retains the existing mortgage in their name. The buyer agrees to make the monthly payments on the mortgage as part of their agreement with the seller. So we say the property was bought “subject to the existing mortgage,” which is where the term “subject to” comes from. The mortgage company isn’t informed anything has changed with the property, they’re still just getting paid each month as normal, except that the payments are now coming from the new buyer. The buyer benefits from not having the time and expense of acquiring a mortgage, and the original terms and interest rate of the original mortgage. The seller benefits from being able to sell their house, which they may have had difficulty selling otherwise.

These arrangements raise some complex tax questions. Who gets to take a deduction on their taxes for the mortgage interest? Does the seller pay capital gains based on the value of the mortgage, since the mortgage is still in their name? We’ll address these questions in this article.

Capital Gains

When a property is sold subject to the original mortgage, the buyer is agreeing to make all future payments on the mortgage debt. For tax purposes, that means value has passed from the buyer to the seller, in the form of relief from a mortgage debt responsibility (despite the loan still being in the seller’s name). The capital gain for the seller is calculated by including the amount of the mortgage debt. The seller’s capital gain is calculated as any cash payment they received from the sale, plus the value of the remaining balance of the mortgage, minus their basis in the property.

Likewise, the buyer’s basis in the property is determined by the cash they paid, along with the mortgage obligation they acquired, plus any other acquisition fees. For federal tax purposes, it doesn’t matter if the original mortgage is still in the seller’s name, since the buyer is now contractually obligated by the sales contract to pay the mortgage payments.

Mortgage Interest Deduction

In a subject-to arrangement, after the property transfers ownership to the buyer, the seller no longer has the right or ability to claim a deduction on their tax return for the interest on the mortgage. If the seller receives a 1098 form from the mortgage company, they may only use the portion of the interest that applied to the period of time they still owned the property. Ensuring the seller is aware of this is crucial to prevent them from attempting to claim the interest.

The buyer can claim the mortgage interest they are paying on the original mortgage after the purchase date, just as they could if the mortgage was in their name. So for example, if the buyer is using the property as a rental property, they can claim the mortgage interest as an expense on their Schedule E. However, it might be advisable for the buyer to enter the mortgage on the “other interest” line rather than the “mortgage interest line” on the Schedule E. The result is the same, but this may potentially help to avoid having the returned be flagged by the IRS computers because there isn’t a matching 1098 form in the buyer’s own name.

Payment of Back Interest, Property Taxes, etc.

If the buyer pays back interest, property taxes, or other expenses either to the seller, or directly, as part of the conditions of the sale of the property, then those costs are added the buyer’s tax basis in the property because these amounts are considered to be part of the sale price of the property. The seller would also consider these payments to be part of their sale price when calculating their capital gains.


What about property taxes paid by the buyer after the sale? In a subto, the property is still transferred to the buyer’s name as normal, and so any property taxes are billed to the new owner. So the buyer will pay the property taxes and they can claim any deductions from the expense as normal.

Can the buyer claim depreciation, bonus depreciation, etc? The buyer owns the property just as they would in any real estate transaction, and so they can claim the same depreciation, etc. that they would be eligible to qualify for with any real estate they own.

This article is part of The Ultimate Real Estate Investor Tax Guide.

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David Orr

I am a credentialed tax professional with a primary focus on tax preparation and advising for real estate investors. Have tax questions or want me to do your taxes? Contact us.

This article was written or updated in 2023 or 2024 and is current for the 2023 and 2024 tax years.

The information presented here is meant for guidance purposes only, and not as personal legal or tax advice.