Owner Carry Contract in Washington State: Rules, Taxes, and Default

An owner carry contract in Washington state is a home sale where the seller finances the buyer directly instead of the buyer getting a bank loan. The buyer makes monthly payments to the seller under terms the two of them negotiate, and the seller keeps a security interest in the property until the debt is paid off. Washington regulates these deals through its usury statute, the Consumer Loan Act, and county recording rules, and federal law layers Dodd-Frank mortgage rules and IRS installment sale reporting on top. Get the structure and the numbers right at the front end and the deal runs smoothly. Get them wrong and you can lose your profit, your license status, or the property itself.

Two Ways to Structure the Deal

Washington allows seller-financed sales to take one of two forms, and the choice changes what happens if the buyer stops paying.

The first uses a promissory note paired with a deed of trust. The seller transfers the deed to the buyer at closing. The buyer signs a promissory note spelling out the payment terms, and a deed of trust creates a lien against the property to secure the debt. A neutral trustee named in the deed of trust holds the power to sell the property if the buyer defaults. Because the buyer holds the deed from day one, the seller’s only route to recover for nonpayment runs through the foreclosure process in RCW 61.24.¹

The second is a real estate contract, sometimes called a land contract or contract for deed. The seller keeps the deed until the buyer finishes paying. The buyer takes possession and gets equitable interest, but legal title stays with the seller for the full contract term. If the buyer defaults, the seller can pursue forfeiture under RCW 61.30, which is faster and simpler than foreclosure. The tradeoff is that buyers have less protection under this structure, and some walk away from deals set up this way for that reason.

Most owner carry sales involving a buyer’s primary residence use the deed of trust approach. Title companies and closing agents are more familiar with it, and it gives buyers more security. Real estate contracts show up more often for vacant land or investment property. The rules on interest rates, licensing, and federal compliance apply either way.

Interest Rate Limits

Washington caps interest on private loans through RCW 19.52.020. The maximum rate is the higher of 12% per year or four percentage points above the average yield on 26-week U.S. Treasury bills from the most recent auction before the rate is set.²

The penalty for going over is severe. The contract survives, but the seller loses the interest. If the buyer hasn’t paid interest yet, the seller can recover only the remaining principal minus what would have accrued at the illegal rate. If the buyer has already paid interest, the seller loses twice the interest paid, deducted from the principal balance. The buyer also recovers attorney’s fees.³ That math can erase a seller’s return on the deal entirely.

The floor comes from the IRS. Seller-financed loans must charge at least the applicable federal rate, published monthly.⁴ If the contract rate falls below it, the IRS imputes interest at the federal rate and the seller owes tax on interest income they never received. For installment sales the test rate is generally the lowest AFR in effect during the three-month period ending with the month the contract becomes binding.⁵ The rate has to sit above the AFR and below the usury cap.

Do You Need a License?

Washington’s Consumer Loan Act, in Chapter 31.04 RCW, regulates anyone who lends money or extends credit for personal or household use, including residential mortgages. The Act implements the federal SAFE Act, which requires state licensing of mortgage loan originators.⁶

For most individual sellers, this isn’t a problem. If you’re carrying financing on the sale of the home you actually live in, you’re exempt from licensing entirely.⁷ That covers the typical owner carry scenario.

Financing the sale of a property you own but don’t live in is trickier. There’s no outright exemption. The Department of Financial Institutions decides whether licensing applies by looking at whether the seller is acting “habitually” or in a “commercial context.”⁶ Sellers who don’t qualify for an exemption may still be eligible for a license waiver allowing up to five residential mortgage loans per calendar year without a company-level license, as long as the individual doesn’t meet the definition of a mortgage loan originator.⁷ Getting this wrong can bring fines or leave a court refusing to enforce the contract. If you’re financing a sale of investment property, call the DFI before closing.

Federal Dodd-Frank Rules

The Dodd-Frank Act layered federal mortgage rules on top of state licensing, and the Consumer Financial Protection Bureau built two exemptions into Regulation Z that most individual sellers can rely on.

One-Property Exemption

A natural person, estate, or trust that finances only one property sale in any 12-month period qualifies for the broader exemption. The seller doesn’t have to verify the buyer’s ability to repay. Balloon payments are allowed. The interest rate can be fixed or adjustable, as long as any adjustable rate doesn’t reset for at least five years and includes reasonable caps on rate changes. Negative amortization isn’t allowed. The seller must own the property and cannot have built the home as a contractor.⁸

Three-Property Exemption

A seller of any type, including a business entity, that finances three or fewer property sales in any 12-month period can use the narrower exemption. The loan must be fully amortizing with no balloon payment, and the seller must determine in good faith that the buyer has a reasonable ability to repay. The regulation doesn’t require formal underwriting paperwork, but sellers should keep records of the buyer’s income, debts, and financial situation to back up that good-faith determination if it’s ever challenged. The same restrictions on adjustable rates and construction activity apply.⁸

A seller who fits neither exemption is treated as a loan originator and must comply with the full range of federal mortgage lending regulations. Almost no individual seller wants to end up there.

The Risk From Your Existing Mortgage

The biggest way owner carry deals fall apart involves the seller’s own mortgage. Nearly every conventional mortgage includes a due-on-sale clause that lets the lender demand the entire remaining balance the moment the property changes hands. Federal law specifically authorizes lenders to enforce these clauses and preempts state laws that would say otherwise.⁹

When the seller transfers the deed to a buyer, or even transfers possession under a real estate contract, the existing lender can treat that as a sale that triggers the clause. The lender typically sends a breach letter giving the borrower about 30 days to fix the issue. If the seller can’t pay off the remaining mortgage balance in that window, the lender can accelerate the loan and start foreclosure. The buyer’s investment sits at risk even while they’re making payments on time.

A few transfers are exempt. Transfers to a spouse or children, transfers on the borrower’s death, transfers into a trust where the borrower remains the beneficiary, and leases of three years or less with no purchase option are all outside the reach of the clause.¹⁰ A standard owner carry sale to an unrelated buyer isn’t on that list. If you still owe on a mortgage, plan to pay it off at closing, get the lender’s written consent, or go in eyes-open about the risk that the lender may call the loan.

Contract Terms That Have to Be Spelled Out

Vague language creates disputes, and disputes in seller-financed deals get expensive fast because no institutional lender with standardized paperwork is managing the process. A solid owner carry agreement pins down each of the following:

The legal description of the property from the deed or county tax records, not just the street address. Without it, the agreement may not be recordable.
Purchase price and down payment. Down payments in private deals typically run 10% to 20%, though the parties can agree on any amount.
Interest rate, set between the IRS applicable federal rate floor and Washington’s usury ceiling.
Amortization schedule and payment dates: whether payments are monthly, the exact amount, and when each is due. State late fees as a specific dollar figure.
Balloon payment, if the loan isn’t fully amortized: the date and amount need to be clearly identified. Sellers using the three-property Dodd-Frank exemption cannot include a balloon at all.
Property taxes and insurance: who pays them directly and whether payments are escrowed. If the buyer lets insurance lapse, the seller’s collateral is exposed.
Default and remedies: define what counts as default and the seller’s options, whether forfeiture under a real estate contract or foreclosure under a deed of trust.

Standardized forms from the Northwest Multiple Listing Service or a Washington real estate attorney give you a framework that already covers most of these terms.

Recording and Excise Tax at Closing

A deed of trust has to be signed and acknowledged before a notary, then recorded with the county auditor in the county where the property sits.¹¹ Recording puts the world on notice that the seller holds a lien, which protects that interest against later buyers or creditors.

Recording fees start at $5 for the first page plus $1 for each additional page, but a stack of statutory surcharges pushes the actual cost much higher.¹² After technology modernization fees, library surcharges, and housing-related assessments, the first page of a deed of trust can run roughly $300 in some counties.¹³ Each extra page adds a small amount. Totals vary by county, so pull the current fee schedule from your county auditor before you go.

Along with the recording, the parties file a Real Estate Excise Tax Affidavit. Washington charges a graduated state excise tax on every property sale based on selling price:

$525,000 or less: 1.10%
$525,000.01 to $1,525,000: 1.28%
$1,525,000.01 to $3,025,000: 2.75%
Over $3,025,000: 3.00%

Agricultural land and timberland are taxed at a flat 1.28% regardless of price.¹⁴ Many cities and counties add a local REET on top of the state rate, so the total bite runs larger than the state rates alone suggest. The seller traditionally pays, and the county won’t record the transfer documents until it’s paid.

Federal Tax Treatment for the Seller

Seller financing creates an installment sale for federal tax purposes. Instead of reporting the full gain in the year of the sale, the seller spreads it across the years the payments come in, reporting on Form 6252.¹⁵

Each payment breaks into three parts: return of basis (the seller’s original investment, not taxed), capital gain, and interest income. The seller calculates a gross profit percentage by dividing total gain by contract price, and that percentage of each principal payment is reported as capital gain. Interest is reported separately as ordinary income.⁵

One trap catches sellers who’ve been depreciating rental or investment property. Any gain attributable to depreciation recapture has to be reported in the year of the sale, even if the seller hasn’t received enough payments yet to cover it.¹⁶ A seller who has depreciated a rental heavily over many years can owe a real tax bill at closing, before installment payments start coming in.

What Happens if the Buyer Stops Paying

The remedy depends on the structure, and the difference in timeline is dramatic.

Default Under a Real Estate Contract

The seller pursues forfeiture under RCW 61.30. A notice of intent to forfeit goes to the buyer identifying the contract and the specific default. The buyer has 90 days to cure by catching up on payments. If they don’t, the seller records a declaration of forfeiture with the county auditor and takes the property back. This is the fastest path, and it’s the main reason some sellers pick the real estate contract structure for investment property.

Default Under a Deed of Trust

Non-judicial foreclosure under RCW 61.24 runs longer and is more heavily regulated. The trustee must record a notice of sale at least 90 days before the auction date, or 120 days if a pre-foreclosure letter is required, and the sale cannot happen less than 190 days from the date the buyer first defaulted.¹⁷ If the property is the buyer’s residence, additional pre-foreclosure notices and mediation offers stretch the process further, often past 200 days.

The seller can also sue for the missed payments instead of foreclosing. If the promissory note has an acceleration clause, the seller can sue for the entire remaining balance. That path leads to judicial foreclosure if the seller wants to recover the property through the courts, but judicial foreclosure is slower and gives the buyer a redemption period of 8 to 12 months after the sale to reclaim the property by paying the debt in full.

Whichever structure you use, an owner carry deal in Washington works best when both sides go in with clear documentation, realistic terms, and a solid grasp of the rules that govern the agreement. A few hundred dollars for legal review at the front end prevents the years-long disputes that come out of shortcuts.

1
Washington State Legislature. Washington Code 61.24 – Deeds of Trust
2
Washington State Legislature. Washington Code 19.52.020 – Rate of Interest
3
Washington State Legislature. Washington Code 19.52 – Interest – Usury
4
Internal Revenue Service. Applicable Federal Rates
5
Internal Revenue Service. Publication 537, Installment Sales
6
Washington State Department of Financial Institutions. Residential Seller Financing under the Consumer Loan Act
7
Washington State Department of Financial Institutions. Residential Seller Financing and Third-Party Lending
8
eCFR. 12 CFR 1026.36 – Prohibited Acts or Practices
9
Office of the Law Revision Counsel. 12 USC 1701j-3 – Preemption of Due-on-Sale Prohibitions
10
eCFR. 12 CFR 191.5 – Limitation on Exercise of Due-on-Sale Clauses
11
Washington State Legislature. Washington Code 64.04.020 – Deeds
12
Washington State Legislature. Washington Code 36.18.010 – Fees of County Auditor
13
Spokane County, WA. Filing and Fee Schedule
14
Washington Department of Revenue. Real Estate Excise Tax
15
Internal Revenue Service. About Form 6252, Installment Sale Income
16
Internal Revenue Service. Topic No. 705, Installment Sales
17
Washington State Legislature. Washington Code 61.24.040 – Foreclosure and Sale