Should I buy my dad's "deadweight" property?

Question

Hi all

My dad has a 1br/1ba lower unit condo/apartment up in Alameda and is looking to sell it because:

"don't want to deal with increasing HOA Mgmt Fees, additional liability Insurance, Prop taxes NONE of which will be useful for tax deductions as ours cap at $26.5K and NO SALT.

CASH FLOW will be declining and not worth hassle.Not really managing anything, just one more thing I don't want to deal with and adds to taxable income."

This is more a deadweight it sounds like.

There were a couple options he presented originally:

1) Gift the property to either one of my brothers or I, or all three of us if we were to get into some sort of LLC/Business/venture. This could create complications down the road as far as splitting it up in relationship to inheritance, etc.

2) Sell the place because he's "tired" of dealing with it and park the money in their trust invested in CA Tax free funds.

The other option of course would be for me (probably not my brothers as they wouldn't be interested) to buy the place from them on a privately backed loan from them.

He is *not* looking for something with higher returns - he wants to reduce his taxable income, not increase it. Both he and my mom are retired and are both collecting pensions in addition to other sources of income from a couple other properties they own. This condo just seems to be not worth their time. On the other hand, they've been charging below-market rent for a long time now (also probably due to not wanting to generate so much additional taxable income).

All this said, both the options presented above would incur capital gains taxes (either on is if he gifts it) or on him (if he sells). There's no way around that unless it becomes inherited (stepped-up basis) but I don't think he or my mom want to wait that long and would rather unload it sooner than later. Given the options stated, what do you guys think would be the best route to take? Especially if I've been considering getting into REI? Or is it just not a good idea given high housing costs in that area, etc?

BTW: he bought the place for $25k roughly and it would probably sell for $500k at least...

Marcy Moyer · Answer

@Jeremy Lee there are a lot of things to consider here so speaking with a tax planner is a very good idea to get answers on your parents' particular situation. I have a few more facts you can put in the mix, but this is not tax advice and I am not an accountant.

1. In general, if you sell an investment property in California there is a 20% long term Fed cap gain tax plus a 13% state capital gains tax. The 3.8 ACA tax on the sale of investments has been repealed. So 33% of the gain can be taxed. Check with tax person.

2. It is possible your parents could gift it to you and subtract that from the total amount you would inherit when they pass. If they do that you can also keep their property tax basis. Find out if this applies to you.

3. If they or you hire a property manager the cost will easily be made up by bringing the rent up to market value and it becomes less of a headache.

4. Property tax on a rental property is considered and expense and not part of the SALT changes. It is still fully deductible. Check with a tax person.

Ok, now here are some things to be careful about.

1. Alameda is geologically sensitive and low lying. There could be a lot of damage in an earthquake. If you or your parents keep it it would be prudent to make sure you have plenty of additional insurance in addition to what the HOA has incase the building is damaged.

2. There have been a lot of little rumblings on the Hayward Fault recently. It is a question of when there is another large earthquake not if.

3. Alameda is beautiful and condos are selling rapidly right now. This may not always be the case.

4. It is more difficult to get to the city or other east bay cities due to no BART stops. The low inventory right now makes that less important than it could be if there is a market correction.

Your family may not want this condo, but there are plenty of other people right now who would

Just my 2 cents.

Jeremy Lee · Answer

I have this conception that it would be difficult owning because of the fact that it has been in the family for so long and there would be certain "expectations" as to how it should be managed, etc (even though they want to have nothing to do with it, apparently)

If the deciding factor is ROI on current/future net income divided by current market value of the place, it doesn't look too great as current NOI is around $8k. Future NOI with a new tenant could probably look something more like $16k-17k. The place I think would likely sell anywhere from $500k-515k based on comps. He bought it for $25k, so capital gains would be considerable. He estimates netting $350k-$360k back for it after taxes and fees. In either case, the best case scenario in this context would be a cash-on-cash of around 3% - not sure if that's necessarily good for that area. As far as outright buying it from them, there's no way we'd be able to do a cash buy at $500-515k.

JD mentioned buying as if it were at a distressed price - I'm not sure how to determine what that would be. Would we price is based on what he would net from selling it otherwise? So offer to buy at market price *minus* broker and agent fees, and on a private sale and privately backed loan? I'm not sure they'd even want to deal with a loan because it would still be taxable income that they're trying to avoid.

Managing it from afar, us being in Southern California while they're 15 minutes away from it, would be weird I think. I'd be tempted to ask them to check on it, and they wouldn't be happy about that. Yet at the same time, they'd probably feel some inclination to check on things themselves. It might make for a weird dynamic.

As far as the trust, they have a trust setup and their properties are all accounted for in it. Obviously the ideal situation would be just to have it pass to inheritance or to the surviving spouse so that we get the stepped-up basis, but it doesn't sound like they even want to wait to have to get to that point. Overall, this seems like a big burden to my dad that he just doesn't want to deal with anymore. Besides paying the bills and collecting rent, he probably doesn't want to be "on call" for emergencies, repairs and maintenance. This is how one of my brothers feels too. And other brother seems to have very little interest (as well as knowledge or desire to know) in real estate and landlording in general.

Wenda Kennedy JD · Answer

Do you really want to own it?  Start with that and go from there.

They don't sound like they need the money.  Can you manage it in the meantime for them, so they don't have to worry with it?

Can they put it into a family trust for you and your brothers? You could then hold it within that framework.

Selling with owner financing would limit the current tax liability.  You can have a long pay-back agreement to limit the income stream.

As far as capital gains & Federal taxes, have they been depreciating it?  Will there be recaptured gains?  Depreciation sounds minimal from their purchase price.

If they sell it to "John Doe" out there, what will that look like for them financially?

Jeremy Lee · Answer

If they were selling it "distressed" we could maybe throw out a number like $450k for the sake of an example if they wanted a 'fast, easy and discounted' sale without dealing with brokers and agents.

Expenses w/o a loan or mortgage are about $6600 a year (this includes property tax, insurance, HOA dues).

Current rents they collect are well below market at $14.4k. If they were properly pricing rents they would have been getting closer to $22k+ by now.

Seems like it might be a better idea for them just to outright sell the thing at this rate (and for us to not be the buyers).

Was curious if gifting it would make any sense but it kinda sounds like it wouldn't either. Just take the profit, even if cap gains is owed, and eventually reinvest in something else.

Them camping on it till it goes to inheritance sounds great but it also sounds like they would rather not deal with keeping it to that point.

JD Martin · Answer

What are the numbers if you buy it outright? Just run the numbers as if it were a distressed property you were buying from anyone, including purchase price, rent potential, ancillary costs, etc. It shouldn't matter if the seller is your father or some guy on the street.

Should I buy my dad's "deadweight" property?

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