Land Contracts Startup

[Travis Michael]

Here's the situation:

I'm a 24 yr old, recent college graduate who landed my first professional job. I have put away around 10k for my first investment property. A close family friend has agreed to sell me a duplex located within a 1/4 mile of a large university in my city.

The property: Duplex one bedroom renting for $350 a month and the other unit being a 2 bedroom for $450 AS IS.
The current owner lives over an hour away and bought the property to give her 2 sons a place to live while going to school. They both have recently graduated and moved on. Now that the property has served it's purpose they are eager to sell and knowing I was actively looking for my first deal I was the first call.
I've gotten comps in the area and I'm getting the property about 20% lower than what the neighborhood average is.

My plan: At this time I have practically no bills and I was going to invest my 10k into upgrading the units to get more cashflow and pay off the property more quickly while supplementing that income with my own. Realistically other units in the area rent for 600 - 700 for a 2 bedroom. 400- 450 for a one bedroom. If I could stay in that price range and provide and extra 10k a year to pay off the property within a maximum 5 years. (Note: Units are within walking distance to the university and also offer off street parking which is an issue in that area.)

The deal: The owner, being a close family friend, has offered to finance the deal for me practically with no interest as long as I manage the property, seeing as her and her husband live an hour away.

Questions I have:
1. Should I enter into this deal myself or would it be benefical later to create an LLC ?

2. Is it possible to have a land contract for a certain price and when the deal is complete and the title work is done list a lower selling price to save my family friend from capital gain taxes ?

3. Anything in general I should be aware of doing this type of deal?

[Edwin Brown]

Travis, sounds like a great deal to get started. One note, it is even more important to use an attorney when working with friends and family then when working with strangers. Attorneys make sure both parties agree in writing and that all terms are clear. It's the best way to make sure everyone is protected and on the same page.
As for lowering the sales price to help on taxes, you can structure deals many different ways, but you must always be honest. Don't say something sold for less than it did or you will find yourself if hot water fast. Besides, a lower sales price means you will have less basis in it and you will have to pay the extra taxes when you sell.

[Travis Michael]

Thanks for the quick feedback !
I will take your advice on that... My plan is to use this first deal as my capital for future opportunities. This website has more information than I could ever read... I'm trying to take in as much as I can.

[Jon Holdman]

How much are you planning to pay for this property? Don't base your price on what the rents could be. That's called "proforma" in this business, but "pretend" is a better word. The rents ARE $350 and $450. That's your price basis.

Hopefully you've done some reading in the Rental Property forum and are starting to get a handle on the reality of rentals. Applying the 50% rule, using conventional loan terms, and doing the very simple analysis, this one is break even at about $66K:

Rent: $800
Expenses: $400 (yes, they are)
NOI: $400
Price $66,000
Rate: 6%
Term: 30 years
Payment: $396
Cash flow: $4

To make $100/unit/month, you can only pay about $33K. That's because these rents are so low that extracting $100 out of $400 average rents leaves very little for a payment.

Now, the terms and payment might be different because of the land contract. But good terms cannot make up for a bad deal.

Be aware the IRS has a thing called "imputed interest". If your friend makes a 0% or nearly zero loan, the IRS will make them pay taxes on the imputed interest they should have been earning if they charged a reasonable rate. They need to charge you something like a market rate to avoid this. I had an e-mail today claiming OO rates of 4.375% for 30 year fixed. Investors will pay more, but your friend charging 4% might work.

What's your friend asking for the place?

[Travis Michael]

Jon,
The price (which is not final due to estimations on what it will take to update certain things i.e. windows, gutters, carpet and possibly siding.) is around the 50 to 55 ballpark. The property next door is a 3 bed 2 bath rental and recently sold for 87k.
I wasn't aware of "imputed interest" i'll look into that asap.
If I only carry the contract for a maximum of 5 years there must be a way to avoid all these taxes ( supplementing rental income with my own to speed things up). I'm sure i'm not the first person to say whats with all these taxes... with all the people involved (and making money) in real estate, there must be some loop holes i can find.

Death and taxes. The only things that are a sure thing :roll:

[Bill Gulley]

Hi, sounds like you have a good deal. The seller needs to charge interest and I'd suggest a higher rate as you will expense it and it will be interest income for the seller. To make that up, you can discount the sale price for the interest for a lower sale price in the beginning, having only one sale price. You can always do a master lease on the property for a period of time before doing the installment sale. Your master lease will provide what ever lease payments to your family friend and will be considered rental income, not a capital gain. If your master lease (with an option to do your CFD as two seperate contracts) costs more than what your rents are, you'll have a loss and may be able to carry the loss forward. If you put the property in a LLC, you will have the benefits of taking expenses off in the company. Doing this will give you a lower basis in the property, so when you sell you'll have a greater gain, but then you can do a 1031 exchange and move on to another property.

Being about the same age as your tenants (if college students) will have advantages as well as some draw backs. When you start out, you need to be "all business" keeping the tenants in line, you will be an authority figure and need to set an example, so don't party with them! Good luck, Bill

[Travis Michael]

Thanks for the good info bill !

My dad also has rentals and I've adopted the "no friends, no family" rule when it comes to renting.
Since you seem to be an expert in the financing department once I own this property free and clear in a few years is there a way instead of 1031 to use my first property as my capital instead of trading it. i.e. taking a loan out for multiple properties using my rental as collateral. or would I have to pay capital gain taxes before using the property as leverage ?? Do you only have to pay the capital gains tax when you go to sell the property?

[Bill Gulley]

Hi, sorry I missed this. The gain on the sale is taxable,, so you have to seel to establish the gain or profit.

Getting a cash out loan on investment properties is really tuff now at a good rate and terms. Who knows where that will be in 5, 10 or 15 years. I don't think I would count on it until it was available, so I wouldn't payoff any investment properties unless I had no better use of funds.

You can always sweeten the deal for a lender by using other properties for collateral to acquire another property. But be careful doing this, you'll want to make sure there is a stated amount that can be paid to release aditional collateral. Good luck, Bill