Is it illegal in MN to sell a house interest free? Was told IRS would consider it intentional avoidance of taxable income!

I assume you that you asking about providing an interest-free loan to the buyer, correct? It's not illegal, but there indeed are tax consequences. The IRS considers the difference between the market rate interest and the interest actually charged to be either a gift or income in the form of foregone interest. It depends on the nature of the loan (is it a demand loan versus a gift loan). See the section titled "Below-Market Loans" here: Publication 550 (2012), Investment Income and Expenses (http://www.irs.gov/publications/p550/ch01.html#en_US_2012_publink10009882) . Basically if the loan is a mortgage (which is a form of demand loan) then the lender must report the foregone interest as income. The good news is that the borrower can also report the foregone interest as deductible mortgage interest (assuming the terms of the loan meet all the requirements for deductibility).