I'm a Newbie Cash Buyer, Buying Directly. Seller wants me to Wire

[William David Kelly]

I'm a newbie real estate investor with only 1 deal under my belt. I happen to do well and want to expand. Thank you Bigger Pockets. Luckily, my father is selling his San Diego house and I happen to find a deal that would benefit both my father and I. 

The first objective is to save my father from paying capital gains tax by doing a 1031 exchange. I've verified with out accountant that this property meets all the widgets with no issues. My father plans on retiring in a few years and living in this property. Then potentially selling it tax free using the home exclusion act.

Details on the Sale and Purchase of the new property are as follows: My father is selling his San Diego house and will receive $450,000 after all said and done. The new property is listed at $480,000. 

Here's where I'd really appreciate feedback and opinions. The selling owner of the property my father is buying from is acting as his own Agent. He seems legitimate and is an Agent for Coldwell Banker. The selling owner/agent wants to work directly with my father. This is possible since my father isn't using an exclusive agent. The selling owner/agent has told my father that he will lower the purchase price to $440,000 if my dad completes the purchase of this home by wiring $390,000 for the home. Then wiring an additional $50,000 to him. The selling owner/agent told my father that this would allow him to not pay long term capital gains tax on the $50,000 he would otherwise have to pay on if he had sold it to my father for the one lump sum purchase price of $440,000.

The second objective my father and I have is to renovate the property and then do a cash out finance and pull out as much money as possible.

Here are my questions:

1. If I finance the property with a lower sales price, will that lower my appraisal?

2. Should I have my father tell the selling owner/agent the plan to finance and how it'll negatively impact the appraisal if we buy it for a lower price, therefore, we could pay $10,000 more and have the total purchase price be $450,000?

3. Can my father finance the property 5 months after we complete the 1031 exchange and finish renovations and pull out 75% of the appraised value? What are some pointers about doing this, since it's kind of the reverse of what most people do.

4. Will that money being pulled out be subject to tax?

5. If we hypothetically purchase the property for $450,000 and then put $80,000 into renovations. Should we theoretically be able to finance the property as an investment mortgage up to 75% LTV?

6. Theoretically, is it a stretch to say that an appraiser will look at the purchase price and all the work we've done (backed up by the actual costs of renovation invoices of work done) after 5 months of the purchase and just add the renovation cost to the purchase price and make that the appraisal value?

Thank you for reading this and providing any advice or feedback.

[Dave Foster]

@William David Kelly, a refi is not taxable.  As a matter of fact, the best way to complete a 1301 exchange with no tax liability is to complete the 1031 and then refi after the fact so the integrity of the 1031 remains intact, he gets the cash he wants with no associated tax liability and the tenants pay the mortgage.  That parts all fine.

Where I see all kinds of red flags is following:

1. That Coldwell agent is blatantly committing tax fraud.  He's not planning on reporting $50K of income.  No bueno!  Oh and now that he has told you what he's doing you're complicent

2. Any kind of activity that produces a lower net purchase price for you will create a taxable event.  If your father's net sale is $450K and you "buy from that realtor for $440K  you would have a $10K taxable event.

3. A lower net price will directly effect your ability to refi later.  A lender will not want to hear that although you paid $440K for a property you really paid $480K.  You just lost $30K of refi in one fell swoop.

4. A fraud produced net price is unfair to the neighbors.  Comps build a neighborhood.  What produces and artificial gain for him will set a comp that might make it harder for the next neighbor to sell for market value.

5. No way you'll be able to use your exchange account (with a reputable qualified intermediary) to pay that $40K.  An intermediary with integrity will demand an accounting and paper trail that will sustain an audit.  You do this deal and the only thing that will show in an audit is that you worked with that agent to defraud the government.

6. If he's willing to defraud the government he'll defraud you in a heart beat as well.  So you'd better have your A-team on the due diligence case and inspections etc.  And you'd also better create an addendum that specifies that the $50K does not go to him unless you purchase the property and have it held in escrow with a 3rd party attorney (again, defeating your 1031).  Of course when you do this you increase the paper trail showing fraud.

Sorry to be so blunt, but this kind of crappy unethical behavior is what starts to kill a good market - it's just greed.

So run don't walk from this guy.  Or at least tell him to pound sand and that you'll buy his property the proper way and now that you know what you know his real price to you will be $440K.

"stepping down from soap box now"