The choice of whether to reflect the risk premium as an increase in the sales price (principal risk premium) or as an increase in the interest rate (interest rate risk premium), depends on the relative tax situations of the buyer and seller. If the risk premium is reflected in the sales price (principal risk premium), the seller will report more of each payment as capital gain and less as interest income. The buyer will pay less interest (which is deductible if the interest is investment or trade or business interest and not personal interest), but his or her basis will be higher. If the property is depreciable and the buyer and seller are in similar tax brackets, the principal risk premium may be preferred to give the buyer a larger depreciable base. However, if the property is not depreciable, the buyer may prefer the interest rate premium where the basis is lower but deductible interest payments are higher.
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