220k House for 80k... what should I do?

[Cory Bittick]

I have an extremely rare opportunity to jump start my real estate investing goals. I'm getting a STEAL of a deal. My parents are moving out of the country and are selling me their 220k (market value) house for 80k. My question is, what would you suggest I do? Leave 20% equity in, and pull out around 175k to pay the 80k to them and have 96k left over to reinvest? Or pull out a loan for less and retain more equity in the house? Also, this will be a RENT house. My wife and I will not be living in it. What kind of loan should I go for? FHA? It's in Houston. -Cory Bittick

[Joe Splitrock]

@Cory Bittick make sure your parents are aware it is their legal responsibility to pay the gift taxes if there are any. Here is the formula:

Retail value - parents original purchase price - amount you pay - minus maximum gift amount = taxable amount

Maximum gift amount is the IRS maximum amount they can gift you without taxes. If they own the house jointly, they can each gift you the maximum amount. That is $30,000 in 2018. So the numbers look like this:

$220,000 - parents original purchase price - $80,000 - $30,000 = taxable amount 

Hopefully they paid more than $110,000 for the property and you are in the clear.

This is important because if you are keeping it as a rental, you want to claim the higher basis cost. Basis cost is structure cost, so is generally calculated as purchase price - land cost. That becomes basis for depreciation. If you use the $80,000 - land as basis, you will have much less depreciation and therefore pay way more taxes on rental income. You will want to use $220,000 - land as basis, which means the IRS becomes aware of the true value. 

To answer your question, yes I would finance 80% and pull all the extra equity out for another down payment. The interest is deductible from your income on the property so will further reduce your tax burden. The $96K will be plenty to get your second property.

I would talk to a CPA and work through the tax ramifications. Talking to your friends is fine, but a CPA is the one who signs their name next to yours on the tax form, so get them on board with what you are doing. 

Congratulations. If you manage this gift properly, it will be truly life changing.