Is seller finance the solution?

Question

Landlord since 1999. Duplex I lived in back in the day and kept after moving out. Very good area (Northwest Arkansas) and good property to attract solid tenants. It's been 95% good experience all these years as I screen tenants properly.

Bought for 125k with loan, value today approx. 335k. Ran a proforma sale through TurboTax to see the damage Cap Gain and Depr Recap would bite me. It's impressive, about 60k.

Retired three years, 64 now. Duplex mortgage will be paid off next year. Rent income will net annual about 17k. As far as risk goes, based on my 23 yrs rental history, I put the risk of significant income interruption at very low. More appreciation very likely.

But, I would like to divorce myself of being a landlord. I've paid my dues and prefer to simplify.

I run three scenarios in Excel to see which options leaves me with the most cash at 70, 75, 80, 85, & 90 yrs old. 1) Sell and add 275k to my three fund Vanguard portfolio, 2) not selling and maybe get property mgmt and 3) seller finance. If I could get a minimum 4% market return for the next 20 yrs, I would sell as soon as my tenants payoff the mortgage next year. But no such guarantees are available.

My fear. A prolonged bear market and watching my investment slowly dwindle and want to kick myself for selling a "sure thing".

Possible solution - seller finance at 6.5% or whatever with a 10 year balloon. At the 10 yr mark, a 30yr, 335k loan at 6.5% with 10% buyer down has a payoff of 284k. Total pymts to date to me 252k.

This takes my anxiety away as I have excellent collateral if buyer gets goofy. Plus an infusion of cash (less taxes) in ten yrs.

Many more variables to come into play, but what do ya'll think about the seller finance route to ease my investment diversification fears and spread that tax impact?

Dustin Allen · Answer

@Bruce Reeves

Sounds like you’ve put a lot of thought into this already.

One suggestion would be to run a few more scenarios where the buyer pays off the seller financing at 1, 3, 5, and 7 years and see how those might affect your appetite to go that route. Not many buyers are going to go with seller financing that has a prepayment penalty (you might find one). So at least account for the possibility in the even rates go down over the next few years and they choose to get traditional financing after they have some rental history on the books.

Either way, looks like you’ve done a good job and you’ll make a smooth exit one way or another. Congratulations!

Dave Foster · Answer

@Bruce Reeves, Seller finance could work.  You always want to have it in the back of your mind that you may have to take the property back.  The best price you'll get will probably come from the least experienced investor.  Doesn't make it a bad plan.  Just one that you may have to abort and restart if something happens to the property, the market, or the buyer.

With seller financing you'll be paying all that tax anyway.  It will just spread it out over time.  So it would be worth a quick comparison to your cash flow from a note but paying tax.  And cash flow from holding the property but with a full service management company.

Many of our investors will do the 1031 to dst route.  Depending on your situation there might be the opportunity to self accredit.

Bruce Reeves · Answer

I did take a quick look at the DST idea. If I remember right you have to be an accredited investor which I am not. Is that correct? I haven't lived there since 1999, so no soap on the exclusion.

Dylan J Berget · Answer

Hey there love the strategy. I'm going to through in some food for thought.

Seller Finance is definitely a good path to take. And it sounds like it would accomplish your goals. I hate paying capital gains tax. So here are some other options to consider:

You could consider a Delaware Statutory Investment Trust or syndication. These are both options that may allow you to avoid the 20% capital gains tax and get out of being a landlord.

A Delaware Statutory Investment Trust is a type of investment vehicle that allows you to defer capital gains tax by exchanging your property for shares in the trust. You can then sell those shares later and pay the capital gains tax at a potentially lower rate or just continue to receive cash dividends.

A syndication is another option where you pool your money with other investors to purchase a larger property. This allows you to spread out the risk and avoid being a landlord while still receiving rental income. You can have someone else run the operations side. Monthly check, but much less work.

Another option to consider when selling your rental property is to take advantage of the home sale exclusion rule. If you have lived in the property for at least 2 of the last 5 years as your primary residence, you may be able to sell the property and avoid paying capital gains tax on up to $250,000 (or $500,000 if you're married filing jointly) of the profit from the sale.

I hate the idea of paying uncle sam any money. So I always try to find ways to deter paying that 20% haircut.

Is seller finance the solution?

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